                        T.C. Memo. 2006-61



                      UNITED STATES TAX COURT



     MAZHAR TABREZI, f.k.a. AGHA HUSSAIN, AND SAJIDA RAZVI,
                         Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5213-04.              Filed March 30, 2006.



     Richard D. Grossman, for petitioners.

     Kathleen C. Schlenzig, for respondent.



                        MEMORANDUM OPINION


     GOEKE, Judge:   Respondent determined a deficiency in

petitioners’ 2001 Federal income tax of $43,829 and an accuracy-

related penalty of $8,765 pursuant to section 6662(a).1   After


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
                                                   (continued...)
                                 - 2 -

concessions,2 the remaining issues for decision are:   (1) Whether

respondent has the burden of proof in this case under Rule

142(a); (2) whether petitioners must recognize cancellation of

indebtedness (COD) income under section 61(a)(12) of $62,707; and

(3) whether petitioners are liable for the accuracy-related

penalty under section 6662(a).    We hold that (1) respondent has

the burden of proof in this case; (2) petitioners do not have to

recognize COD income because respondent failed to meet his burden

of proving that they were solvent on the date immediately

preceding the discharge of the debt (calculation date); and (3)

as a result, there is no accuracy-related penalty under section

6662(a).




     1
      (...continued)
Court Rules of Practice and Procedure.
     2
      On brief, respondent concedes that petitioners are not
liable for COD income attributable to the discharge of three
debts as determined in the notice of deficiency because that
income is excludable under sec. 108(a)(1)(B). However,
respondent also takes the position that petitioners must
recognize COD income of $62,707 from discharge of a fourth debt
that was not included in the notice of deficiency. In addition,
respondent continues to assert that petitioners are liable for
the accuracy-related penalty under sec. 6662(a). Respondent also
determined in the notice of deficiency that petitioners had gross
income of $13 in dividends received by Sajida Razvi from her
Mellon Investment Services account. Petitioners did not raise
this item of income in their petition or otherwise argue against
it throughout the litigation process. We therefore consider
petitioners to have conceded their liability on the dividend
issue.
                                - 3 -

                              Background

     Petitioners, who are husband and wife, resided in Glendale

Heights, Illinois, at the time of filing their petition.    Between

December 1998 and May 1999, petitioners signed 22 notes as the

obligors in the aggregate principal of $2,529,700 and 22

mortgages securing those notes.    Petitioner Sajida Razvi’s

brother, Syed Razvi, asked petitioners to sign the documents as a

personal favor to him.   Petitioners signed the documents without

extensively reviewing them.    Each note was used to purchase a

different property (all condominiums) and was secured by a

mortgage.   There was a covenant in most of the notes and the

accompanying mortgages obligating either petitioner to pay the

full amount of principal and accrued interest of the debt.

Petitioners also signed 22 U.S. Department of Housing and Urban

Development (HUD) settlement statements in connection with each

mortgage.   The principal amount due under each of the 22 notes

was over $100,000.   Unknown to petitioners, the mortgages were

obtained by fraud because the fair market value of the properties

securing the mortgages was substantially inflated and, in some

cases, was in fact far less than the face amount of the notes

that petitioners signed.

     In October 2004, Mr. Razvi was indicted for participating in

a scheme with others to defraud and obtain more than $27 million

of mortgage loan proceeds from various banks and mortgage lending
                                 - 4 -

institutions by means of materially false and fraudulent

pretenses.     Petitioners, although mentioned in the indictment,

were not charged with any crime regarding their involvement in

Mr. Razvi’s fraudulent scheme, and there is no evidence in the

record that petitioners were aware of the fraudulent scheme.

Thereafter, most of the properties securing the mortgages were

foreclosed upon in separate actions, with petitioners named as

defendants.     The sheriff then sold the properties in a judicial

sale pursuant to the decree of foreclosure.     After the sale, the

Illinois State court where the actions were brought issued orders

approving the sales.     Some sales resulted in deficiencies (i.e.,

the proceeds were less than the judgment amount).     In those

cases, the plaintiffs (usually a bank or other type of commercial

lender) obtained an in rem deficiency judgment3 against the

properties but did not obtain an in personam judgment against

petitioners.    Other sales resulted in zero deficiencies, and the




     3
       A judgment in rem affects the interests of all persons in
designated property, whereas a judgment in personam imposes a
personal liability or obligation on one person in favor of
another. Hanson v. Denckla, 357 U.S. 235 (1958). It is
characteristic of a judgment in rem that it operates on a thing
or status rather than against the person, and binds all persons
to the extent of their interest in the thing whether or not they
were parties to the proceedings. 50 C.J.S., Judgments, sec. 1054
(2005).
                              - 5 -

outstanding debts were extinguished.    During 2001, four of the

notes were partially discharged by the following lenders:


                         Initial Note         Amount of Debt
      Creditor             Amount               Canceled

     Household            $111,200              $62,707
       Finance

     Countrywide           127,200               74,670
       Home Loans

     Superior              111,200              103,171
       Federal
       Bank

     Washington            111,200               75,615
       Mutual

The Household Finance debt was canceled on April 27, 2001, and

the Superior Federal Bank debt was canceled on March 1, 2001.

The remaining debts listed were canceled in 2001.    Petitioners

did not include the amounts of debts canceled as income in their

2001 joint Federal income tax return.    Petitioners reported a

total income in 2001 of $78,416, comprising mostly wages.

     On December 29, 2003, respondent issued petitioners a notice

of deficiency for the taxable year 2001.    Respondent determined

that the amounts of canceled debt from Countrywide Home Loans,

Superior Federal Bank, and Washington Mutual should have been

included in petitioners’ gross income.    Respondent did not

include the canceled debt of $62,707 from Household Finance in

the notice of deficiency but raised it at trial through the

stipulation of related exhibits without explaining that it was a
                               - 6 -

new matter.   In the posttrial brief, respondent conceded the

discharge of the other three mortgages did not result in COD

income because petitioners were insolvent on the calculation

dates and argued only for the inclusion of the Household Finance

debt in petitioners’ income.   Also, respondent conceded that he

failed to include the Household Finance mortgage in the notice of

deficiency.   Respondent did not attempt to amend any of his

pleadings.

                            Discussion

A.   Petitioners’ Argument That Respondent’s Addition of the
     Fourth Adjustment Increases the Overall Deficiency

     Petitioners question whether respondent met the requirements

of section 6214(a), which provides:

     SEC. 6214.   DETERMINATIONS BY THE TAX COURT.

          (a) Jurisdiction as to Increase of Deficiency,
     Additional Amounts, or Additions to the Tax.--* * *
     [T]he Tax Court shall have jurisdiction to redetermine
     the correct amount of the deficiency even if the amount
     so redetermined is greater than the amount of the
     deficiency * * * and to determine whether any
     additional amount, or any addition to the tax should be
     assessed, if claim therefor is asserted by the
     Secretary at or before the hearing or a rehearing.

Although respondent argued on brief that the Household Finance

mortgage gave rise to COD income without seeking to amend his

pleadings, see Henningsen v. Commissioner, 243 F.2d 954 (4th Cir.

1957), affg. 26 T.C. 528 (1956); Koufman v. Commissioner, T.C.

Memo. 1977-225; Mazzoni v. Commissioner, T.C. Memo. 1970-37,

supplemented T.C. Memo. 1970-144, affd. 451 F.2d 197 (3d Cir.
                                  - 7 -

1971); Cascade Milling & Elevator Co. v. Commissioner, 25 B.T.A.

946 (1932), respondent conceded that the COD income from the

discharge of the three mortgages (Countrywide Home Loans,

Superior Federal Bank, and Washington Mutual) identified in the

notice of deficiency qualified under the exception to COD income

provided in section 108(a)(1)(B) because petitioners were

insolvent on the dates those mortgages were discharged.      The new

adjustment claimed by respondent to be COD income is $62,707,

while the three mortgages respondent treated in the notice of

deficiency as giving rise to COD income totaled $253,456.

Therefore, since there is no assertion of an overall increase in

deficiency, this case does not fall under section 6214.      However,

by claiming that an amount arising from a different mortgage is

COD income, respondent has raised a new matter and therefore

under our Rules has the burden of proof in regard to that claim.

B.   Burden of Proof

     Gross income includes income from the cancellation of

indebtedness.   Sec. 61(a)(12).    However, an exception to the

inclusion of COD income in gross income is provided for taxpayers

who are insolvent at the time of cancellation of indebtedness.

Sec. 108(a)(1)(B).     The determination of insolvency is based on

the taxpayer’s liabilities and assets immediately before the

discharge of debt.     Sec. 108(d)(3).    Petitioners claim that they

were insolvent on the calculation date.      Normally, the burden of
                                - 8 -

proof is on the taxpayers.    Rule 142(a).   Accordingly, the burden

of establishing that the insolvency exception applies is

generally placed on the taxpayers.      Traci v. Commissioner, T.C.

Memo. 1992-708; Bressi v. Commissioner, T.C. Memo. 1991-651,

affd. 989 F.2d 486 (3d Cir. 1993).      In order to prove insolvency

and therefore qualify for the exception under section

108(a)(1)(B), a taxpayer

     must prove by a preponderance of the evidence that he
     or she will be called upon [as of the date of
     cancellation of the debt] to pay an obligation claimed
     to be a liability and that the total amount of
     liabilities so proved exceed the fair market value of
     his or her assets.

Merkel v. Commissioner, 192 F.3d 844, 850 (9th Cir. 1999), affg.

109 T.C. 463, 468 (1997).

     There are exceptions to the general rule that the taxpayers

bear the burden of proof.    See Rule 142(a)(1).   One of those

exceptions is if the Commissioner raises a “new matter”.         Id.   If

the new matter is allowed to be raised, Rule 142(a) requires that

the Commissioner bear the burden of proof.      Shea v. Commissioner,

112 T.C. 183, 190-191 (1999).   The Commissioner raises a new

matter when he “attempts to rely on a basis that is beyond the

scope of the original deficiency determination”.      Id.   In

particular, a new matter is raised when the Commissioner’s new

theory “‘either alters the original deficiency or requires the
                                - 9 -

presentation of different evidence.’”    Id. at 191 (quoting Wayne

Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989)).

     Thus, we conclude that respondent has raised a new matter.

Respondent went beyond the scope of the original deficiency

determination by arguing in his posttrial brief that the

discharge of the Household Finance mortgage gave rise to COD

income.   The deficiency determined in the notice of deficiency

was based on COD income from the discharge of three other

mortgages.   Different evidence is required to show that the

Household Finance mortgage generated COD income, because the date

of its cancellation, and thus the date for determining

petitioners’ solvency for purposes of section 108(a)(1)(B) and

(d)(3), differs from the date on which any of the other three

mortgages was canceled.   Therefore, respondent bears the burden

of proof and must show, by a preponderance of the evidence, that

petitioners were solvent under section 108(a)(1)(B) as of the

calculation date.   For the reasons discussed below, we conclude

that respondent has failed to meet his burden of proof.

C.   Respondent’s Failure To Meet His Burden of Proof

     In order to establish petitioners’ solvency as of the

calculation date, respondent must prove by a preponderance of the

evidence that the fair market value of petitioners’ assets then

exceeded their liabilities.   See Merkel v. Commissioner, 109 T.C.

483, 484 (1997).    To exclude from that calculation any portion of
                               - 10 -

an obligation claimed by petitioners to be a liability,

respondent must prove that it is more probable than not that

petitioners would not be called upon to pay that portion of the

obligation claimed.   Id.

     Respondent has failed to prove that the value of

petitioners’ assets exceeded their liabilities as of the

calculation date of April 26, 2001.     The record shows that

petitioners had $210,764 in assets with known values, and

respondent concedes that petitioner had $213,120 in liabilities

on the calculation date.    Respondent claims that petitioners

failed to introduce evidence with respect to the values of

several of their assets and therefore failed to prove that they

were insolvent.   However, the burden of proof is on respondent.

Therefore, respondent had the burden to produce evidence that

petitioners were not insolvent.    Respondent has not done so.

     Petitioners argue that under Illinois State law they were

still personally liable for several of their mortgage debts as of

the calculation date of April 26, 2001, because the foreclosure

sales that took place with respect to those debts had not yet

been approved by the Illinois State court.     See, e.g., Citicorp

Sav. v. First Chicago Trust Co., 645 N.E.2d 1038, 1045 (Ill. App.

Ct. 1995); 27A Ill. Law and Practice, Mortgages, sec. 87 (2005)

(quoting Morgan v. Sherwood, 53 Ill. 171 (1870)).     Since we have

decided that respondent had the burden of proof in this case and
                                - 11 -

failed to meet his burden, it is unnecessary for us to decide

whether petitioners’ liabilities on the calculation date were

greater than the amount respondent conceded.

                              Conclusion

       Because he introduced a new matter, respondent has the

burden under Rule 142(a) of proving that petitioners were

insolvent.    Rule 142(a).   Respondent failed to meet that burden.

We therefore hold that no COD income is includable in

petitioners’ gross income for the year in suit.    In addition,

because we find    there is no COD income, there is no addition to

tax.

       To reflect petitioners’ concession of the dividend income,

and the foregoing,


                                           Decision will be

                                      entered under Rule 155.
