76
A.F.T.R.2d 95-7739; 1995 WL 810021 (D.Me.) United
States District Court, D. Maine. Carlos
J. QUIJANO and Jean M. Quijano, Plaintiffs v. UNITED
STATES OF AMERICA, Defendant No. CIV.
94-381-P-C. Dec. 15,
1995. SUBSEQUENT HISTORY: Affirmed, 93 F.3d 26 (1st Cir.
1996) ORDER
AFFIRMING THE RECOMMENDED DECISION OF THE MAGISTRATE JUDGE OPINION BY: CARTER [*1] The United States
Magistrate Judge having filed with the Court on November 15, 1995, with copies
to counsel, his Recommended Decision on Cross Motions for Summary Judgment
(Docket No. 16); and (Plaintiffs having filed their objection thereto on
December 1, 1995 (Docket No. 17), to which objection Defendant filed its
response on December 13, 1995 (Docket No. 18); and this Court having reviewed
and considered the Magistrate Judges Recommended Decision, together
with the entire record; and this Court having made a de novo determination of
all matters adjudicated by the Magistrate Judges Recommended
Decision, and concurring with the recommendations of the United States
Magistrate Judge for the reasons set forth in his Recommended Decision, and
having determined that no further proceeding is necessary; it is ORDERED as follows: (1) The objection of the Plaintiffs is hereby DENIED; (2) The Recommended Decision of the Magistrate Judge
is hereby AFFIRMED; (3) Judgement shall enter in favor of the Plaintiffs
in the amount of Two Thousand Six Hundred Sixty-Eight Dollars ($2,668.00) plus
interest and penalties as provided by law. RECOMMENDED
DECISION ON CROSS MOTIONS FOR SUMMARY JUDGMENT The plaintiffs seek to recover an overpayment of their
1990 federal income tax. The parties filed cross motions for summary judgment,
[FN1] and have since agreed to have the case decided on the basis of a
stipulated record. See Boston Five Cents Sav. Bank v. Secretary of the Dept
of Housing & Urban Dev., 768 F.2d 5, 11-12 (1st Cir.1985). For the
reasons set forth below, I recommend that judgment be entered in favor of the
plaintiffs in the amount of $2,668, plus applicable interest and penalties as
provided by law. I.
Facts and Procedural History The plaintiffs bought a residence in London, England
on September 30, 1986 for 297,500 Pounds Sterling (pounds).
Stipulation of Facts (Docket No. 5) ¶ 6. They financed the purchase
Pounds Sterling (pounds). Stipulation of Facts (Docket No.
5) ¶ 6. They financed the purchase in full in England with a mortgage
loan from Mr. Quijanos employer. Id. While
they owned the residence, the plaintiffs made capital improvements totaling
45,647 pounds. Id. ¶ 7. At no time did they use United States
funds to purchase or improve the residence. Id. ¶ 9. They refinanced
the loan in 1988 for 300,000 pounds, and again in 1990 for 333,180 pounds. Id.
¶ 8. On July 27, 1990 the plaintiffs sold the residence for a net
price of 453,374 pounds. Id. ¶ 10. The plaintiffs filed a federal tax return for 1990 in
which they included $308,811 in capital gain from the sale of the residence.
Id. ¶¶ 5-6. To calculate their adjusted basis in the
residence, the plaintiffs used the exchange rate in effect at the time of
purchase, 1.49 U.S. dollars (dollars) to 1 pound. Id.
¶ 11. The plaintiffs later filed an amended return, claiming a
reduction in capital gain from $308,811 to $199,491. Id. ¶ 5. To
calculate the adjusted basis as reflected on the amended return, the plaintiffs
used the exchange rate in effect as the time of sale, 1.82 dollars to 1 pound.
Id. ¶ 11. On January 14, 1994, after reviewing the
plaintiffs amended return, the Commissioner of Internal Revenue
refused to remit to the plaintiffs the $30,610 they claim to have overpaid. Id. ¶
12. II.
Legal Analysis [*2] A taxpayers gross
income includes gain from dealings in property. 26 U.S.C.
§ 61(a)(3). Gain from the sale of property equals the excess
of the amount realized over the adjusted basis. Id. § 1001(a).
The adjusted basis is the cost of the property adjusted for certain
expenditures, including capital improvements. Id.
§§ 1011(a), 1012, 1016(a)(1). In 1986, Congress added Subpart J--Foreign
Currency Transactions to the Internal Revenue Code. Tax Reform Act of
1986, Pub.L. No. 99-514, § 1261(a), 100 Stat.2085, 2585-91.
Taxpayers must make all Subtitle A (Income Taxes) determinations, including
amount realized and adjusted basis, in their functional currency. 26 U.S.C.
§§ 985(a) and 1001(a). Functional
currency means the dollar, except in the case of a qualified business
unit. Id. § 985(b). The plaintiffs concede that they did not
operate as a qualified business unit, so their functional currency is the
dollar A. Separate Treatment of the Loan and the Residence For purposes of determining gain or loss, borrowing
and repayment of foreign currency are treated separately from the purchase and
sale of property acquired with the borrowed currency. Federal Natl
Mortgage Assn v. Commissioner, 100 T.C. 541, 582 (1993); see Rev. Rul. 90-79,
1990-38 I.R.B. 26. This is true even where the borrowing arose only for the
sake of the underlying transaction. Federal Natl Mortgage Assn, 100 T.C.
at 583. Thus, to the extent that the plaintiffs sustained an exchange loss
[FN2] on repayment of the loan, they may not offset that loss against the gain
realized from sale of their residence. Rev. Rul. 90-79 (citing 26 U.S.C.
§ 165) (limiting losses that individuals may deduct)). The plaintiffs argue that Rev. Rul. 90-79 contains a
fundamental flaw: if they had sold their house for the same amount in pounds as
they paid for it, they would have a taxable profit because of the different
exchange rates, even though they had no real economic gain
from which to pay the tax. Ironically, this example illustrates the fundamental
flaw in the plaintiffs own argument. It is true that there would be
no gain in pounds. Congress, however, requires the plaintiffs to calculate gain
in the their functional currency: the dollar. 26 U.S.C.
§ 985(a), (b). In dollars, they would have a real
economic gain because a given number of pounds was worth more dollars
in 1990 than in 1986. Before Congress enacted Subpart J, the conference
committee noted that pre-1986 law treated exchange gain. or loss separately
from gain or loss attributable to an underlying transaction. H.R. Conf. Rep.
No. 99-841 at 11-662, 1986 U.S.C.C.A.N. at 4750. The committed observed that
such separate treatment would continue in the case of foreign
currency gain or loss recognized by a U.S. individual residing outside of the United
States upon repayment of a foreign currency denominated mortgage on the
individuals principal residence. Id. at
II-669, 1986 U.S.C.C.A.N. at 4757. That is precisely the situation in this
case. The factual differences between cases cited in Rev. Rul. 90-79 and the
present case do not undermine its applicability here. The committees
interpretation of pre-1986 law reinforces the interpretation set forth in Rev.
Rul. 90-79. [*3] Section 165(a) provides a
deduction for uncompensated losses. Individuals, however, may only use this
deduction for losses incurred in a trade or business, losses incurred in a
transaction entered into for profit, and casualty or theft losses. I.R.C.
§ 165(c). Thus, the plaintiffs may not offset the loss
realized on repayment of the loan against the gain realized from the sale of
their residence. Id.; Rev. Rul. 90-79. B. Applicable Exchange Rates Determining gain in their functional currency requires
the plaintiffs to report the cost and selling price of their residence
at the rate of exchange prevailing as of the date of the. purchase
and the date of the sale, respectively. Rev. Rul. 54-105, 1954-1 C.B.
12; see also Rev. Rul. 78-281, 1978-2 C.B. 204. Similarly, they must report the
cost of capital improvements at the exchange rate prevailing on the date of
each expenditure. See Rev. Rul. 54-105; see also Rev. Rul. 78-281. The plaintiffs assert that only the exchange rate
prevailing on the date of sale should be used to determine their adjusted
basis. Otherwise, they argue, they will be taxed on phantom
gain, the increased value of the pound relative to the dollar. As the
plaintiffs concede, however, had they converted dollars into pounds to purchase
their residence they would have realized an actual gain
when they sold it. The Internal Revenue Code treats the transaction as if the
plaintiffs had converted dollars into pounds to make the purchase, because they
must determine adjusted basis in their functional currency: the dollar.
Accordingly, the plaintiffs must determine the cost in dollars of the purchase
price and capital improvements based on the prevailing exchange rates at the
time of each expenditure. See Rev. Rul. 54-105; see also Rev. Rul. 78-281. C. Sixteenth Amendment The plaintiffs claim that they never realized the
exchange gain on the residence, so that gain is not taxable income under the
Sixteenth Amendment. [FN3] See Eisner v. Macomber, 252 U.S. 189, 207, 211
(1920) (receipt of stock dividend is not income because it is not realization
of profits for stockholders own use). As the value of the pound
increased relative to the dollar, the value of the plaintiffs
residence, measured in dollars, also increased. The plaintiffs realized the
economic benefit of that currency gain when they sold their residence. The
currency gain, therefore, constitutes taxable income within the meaning of the
Sixteenth Amendment. III.
Conclusion Accordingly, I recommend that judgment be entered in
favor of the plaintiffs in the amount of $2,668, plus applicable interest and
penalties as provided by law. NOTICE A party may file objections to those specified
portions of a magistrate judges report or proposed findings or
recommended decisions entered pursuant to 28 U.S.C.
§ 636(b)(1)(B) for which de novo review by the district court
is sought, together with a supporting memorandum, within ten (10) days after
being served with a copy thereof. A responsive memorandum shall be filed within
ten (10) days after the filing of the objection. [*4] Failure to file a timely
objection shall constitute a waiver of the right to de novo review by the
district court and to appeal the district courts order. Dated at Portland, Maine this 14th day of November,
1995. FN1. The defendant filed a partial
motion for summary judgment because it agrees that the plaintiffs have
overpaid, but disagrees as to the extent of the overpayment. The parties have
stipulated that, under the defendants method of calculation, the
plaintiffs are entitled to an overpayment of $2,668, plus applicable interest
and penalties as provided by law. Stipulation for Decision on the Written
Record (Docket No. 14) at 1 n. 1. FN2. Exchange
gain and exchange loss refer to gain or loss
arising from fluctuations in the value of foreign currency. H.R. Conf. Rep. No.
99-841, 99th Cong., 2d Sess. II-659, reprinted in 1986 U.S.C.C.A.N. 4075, 4747. FN3. The Congress shall
have power to lay and collect taxes on incomes, from whatever source derived,
without apportionment among the several States, and without regard to any
census or enumeration. U.S. Const. amend. XVI. |