93 F.3d
26, 78 A.F.T.R.2d 96-6190, 96-2 USTC P 50,441 United
States Court of Appeals, First Circuit. Carlos
J. QUIJANO and Jean M. Quijano, Appellants, v. UNITED
STATES of America, Appellee. No.
96-1053. Heard May
7, 1996. Decided
Aug. 21, 1996. PRIOR HISTORY: Order of
the U.S. District Court, D. Me., affirming recommendation of the magistrate
judge: 76
A.F.T.R.2d 95-7739 SUBSEQUENT HISTORY: Certiorari denied, 519 U.S. 1059 (Jan. 6, 1997) (No. 96-788) [*27] COUNSEL: Paula N.
Singer, Newton, MA, with whom Robert S. Grodberg and Vacovec, Mayotte &
Singer, were on brief, for appellants. Kenneth W. Rosenberg, Attorney, Tax Division,
Department of Justice, Arlington, VA, with whom Jay P. McCloskey, United States
Attorney, Bangor, ME, Loretta C. Argrett, Assistant Attorney General,
Washington, DC, Gary R. Allen and Richard Farber, Attorneys, Tax Division,
Department of Justice, Washington, DC, were on brief, for appellee. JUDGES: Before CYR, Circuit Judge,
ALDRICH, Senior Circuit Judge, and GERTNER, [FN*] U.S. District Judge. FN* Of the District of
Massachusetts, sitting by designation. OPINION BY: CYR, Circuit Judge. Appellants Carlos J. and Jean M. Quijano, husband and
wife, appeal from a district court order rejecting their joint claim for a
federal income tax refund relating to the 1990 sale of their residence located
in the United Kingdom. We affirm the district court judgment. I BACKGROUND Appellants, United States taxpayers, acquired their
residence for 297,500 pounds sterling on September 30, 1986. The entire
purchase price was financed through a mortgage loan in pounds sterling. On
October 12, 1988, it was increased to 330,000 pounds (exchange rate: $1.73 to 1
pound); on March 27, 1990, to 333,180 pounds (exchange rate $1.62 to 1 pound).
Ultimately, their capital improvements to the residence cost 45,647 pounds. No
U.S. funds were used either to purchase or improve the residence. On July 27,
1990, it was sold for 453,374 pounds, net of selling expenses, and the mortgage
loan was retired. Appellants' 1990 joint federal income tax return
originally reported a $308,811 capital gain, utilizing the exchange rate at
date of purchase ($1.49 to 1 pound) to calculate the adjusted cost basis, but
using the exchange rate at date of sale ($1.82 to 1 pound) to calculate the
sale price. Appellants later amended their 1990 return to claim a $30,610
refund arrived at by utilizing the exchange rate at date of sale ($1.82 to 1
pound) to determine the adjusted cost basis as well as the sale price, thus
resulting in a reduced $199,491 capital gain. After the Internal Revenue Service disallowed their
amended refund claim, appellants initiated the present action. The complaint
alleged that Revenue
Ruling 90-79 misinterprets our decision in Willard Helburn, Inc. v.
Commissioner, 214 F.2d 815 (1st Cir.1954), [*28] and
that the tax imposed violates the Sixteenth Amendment, see Eisner v.
Macomber, 252
U.S. 189, 40 S.Ct. 189, 64 L.Ed. 521 (1920). In due course, appellants
moved for summary judgment. The government responded that the total cost basis
of the residence must be arrived at by utilizing the respective dollar-pound
exchange rates in effect when the residence was purchased and each
capital-improvement payment was made. The parties stipulated that, thus
calculated, appellants had overpaid $2,668, plus related interest and penalties
not presently relevant. Ultimately, the district court entered judgment for
appellants in the amount of $2,668 plus interest and penalties as provided by
law. On appeal, appellants challenge the district court order rejecting their
motion for summary judgment in the larger amount of $30,610. II DISCUSSION
[FN1] FN1. In a civil action for refund
under 26 U.S.C. § 7422(a), the taxpayer must bear
the burden of proving that the challenged IRS tax assessment was
erroneous. Webb v. Internal Revenue Service of the United States, 15 F.3d
203, 205 (1st Cir.1994) (citing Lewis v. Reynolds, 284 U.S. 281, 283, 52
S.Ct. 145, 146, 76 L.Ed. 293, modified on other grounds, 284 U.S. 599, 52 S.Ct.
264, 76 L.Ed. 514 (1932)). We review the challenged summary judgment ruling de
novo. McCabe v. Life-Line Ambulance Serv., Inc., 77 F.3d
540, 544 (1st Cir.1996), petition for cert. filed, 64 U.S.L.W. 3808 (U.S. May
29, 1996) (No. 95-1929). A. Foreign Exchange Transactions We first consider the challenge to the tax refund
calculation arrived at by the district court under Revenue Rulings 90-79 and 54-105.
Section 1011 of the Internal Revenue Code provides that the adjusted
basis for determining the gain
from the sale or other disposition of
property, whenever acquired, shall be the basis (determined under section 1012
), adjusted as provided in section 1016. 26 U.S.C.
§ 1011. Under section 1012, generally the basis of property
is its cost. Id. § 1012. For relevant purposes,
section 1016(a)(1) states that a proper adjustment shall be made for
expenditures
, or other items, properly chargeable to
capital
. Id. § 1016(a)(1). Section 985(a) generally requires that all income tax
liability determinations are to be made in the taxpayers
functional currency, id. § 985(a), which is the
U.S. dollar for individual United States taxpayers, id.
§ 985(b)(1)(A). With exceptions not relevant here, section
165(a) permits a deduction [for] any loss sustained during the
taxable year
. Id. § 165(a).
Finally and importantly, in relevant part section 165(c) limits the deductions
available to individual United States taxpayers to (1) losses
incurred in a trade or business [and] (2) losses incurred in any transaction
entered into for profit, though not connected with a trade or
business
. Id. § 165(c). 1. Loss on Mortgage Loan Transaction The government essentially agrees that appellants
sustained a loss in their mortgage loan transaction, since the value of the
dollar declined, as against the pound sterling, from the time of the mortgage
loan to the date of its repayment. Nonetheless, says the government, appellants
may not offset their mortgage-loan-transaction loss against their real-estate-transaction
gain, because the borrowing and repayment of the mortgage loan is a
separate transaction from the purchase and sale of the personal
residence. Rev. Rul. 90-79, 1990-38
I.R.B. 26 (citing Willard Helburn, 214 F.2d at 818-19; Churchs
English Shoes, Ltd. v. Commissioner, 24 T.C. 56, 59, 1955 WL 545
(1955), affd, 229 F.2d 957 (2d Cir.1956) (per curiam)). Moreover,
since the mortgage-loan-transaction loss was not incurred in an
activity or as the result of an event described in section 165(c) of the
Code[,]
[it] may not [be] deduct[ed]
. Id. Appellants concede that the mortgage loan transaction
was neither carried out by a trade or business nor entered into for profit, but
nonetheless urge an integrated transaction approach so as to permit their
$100,000 mortgage-loan-transaction loss to be set off against the capital gain
realized from the sale of their residence. Appellants point out that though we
employed a separate transactions approach in Willard Helburn, 214 F.2d
at 818, we recognized that an integrated approach [*29] to
the transaction might have been elected by the taxpayer. [FN2] Unfortunately
for appellants, Congress has since foreclosed an integrated transaction
approach to the exclusively foreign-currency financed acquisition involved in
the present case. FN2. Willard Helburn involved the
tax treatment accorded a purchase of lambskins in New Zealand for inventory in
the United States, where both the purchase and the financing were in pounds
sterling. We noted that [t]he purchases of the skins in New Zealand
and the various financial arrangements whereby [the taxpayer] ultimately
discharged in dollars its obligations arising out of such purchases might be
regarded as a single integrated transaction. 214 F.2d at 818. But we
also went on to note that [t]he purchases of the skins in New Zealand
might be viewed separately and distinct from the subsequent financial
arrangements
. Id. Since the taxpayer rejected the
integrated transaction approach, and the parties stipulated to the tax
treatment of the purchase, we treated the financing separately from the
purchase. Id. at 819. Finally, since the pound had dropped in
relation to the dollar, we concluded that the taxpayer had realized a taxable
gain by settling the mortgage loan with less costly pounds than the pounds
originally borrowed. Id. Appellants urge, in effect, that their mortgage loan
transaction be considered part of a hedging transaction
under I.R.C. § 988(d)(1), which might result in its
integrated treatment as part and parcel of their real estate transaction. See
26 U.S.C. § 988(d)(1). To the extent provided in
regulations, id., borrowing under a debt
instrument in which the taxpayer is obligated to repay the loan in a
nonfunctional currency, id. § 988(c)(1), will
qualify for treatment as part of a section 988 hedging
transaction provided the taxpayer (i) entered into the transaction
primarily to reduce risk of currency fluctuations with respect to
property which is held or to be held by the taxpayer, id.
§ 988(d)(2)(A)(i), and (ii) identified the transaction as a
section 988 hedging transaction. Id.
§ 988(d)(2)(B). Even assuming their transaction qualified, however,
appellants were ineligible for hedging transaction
treatment because it is conceded that their mortgage-loan-financing transaction
was neither conducted by a trade or business nor entered into for profit. See
id. 988(e). The Tax Reform Act of 1986 provided that the section 988 rules, and
thus hedging transaction treatment under section 988,
would be inapplicable to 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. The principles of current law would continue to apply to such
transaction. H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. II-669,
reprinted in 1986 U.S.C.C.A.N. 4757. By reason of the interpretation adopted by
Congress, moreover, [e]xchange gain or loss is separately accounted
for, apart from gain or loss attributable to the underlying
transaction under present law. Id. at 4750.
Thus, appellants' claim fails. 2. Capital Gain on Real Estate Sale The government follows up with the contention that
the cost and selling price of the [residence] should be expressed in
American currency 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 Churchs English Shoes, 229 F.2d
at 958. [FN3] Appellants agree that the 453,374 pounds received for their
residence should be translated into U.S. dollars at the $1.82 exchange rate
prevailing at the date of sale. They argue, however, that the 343,147 pound
adjusted cost basis of the residence, consisting of the 297,500 pound purchase
price and the 45,647 pounds paid for capital improvements, likewise should be
expressed in U.S. dollar terms as of the date of the sale. Appellants correctly
state that, viewed in the foreign currency in which it was
transacted, the purchase generated a 110,227 pound gain as of the
date of the sale, which translates to approximately $200,000 at the $1.82 per pound
exchange rate. Therefore, they say, the difference between the approximate
$300,000 gain under the governments [*30]
computation, and the $200,000 gain appellants suggest, approximates a $100,000
unrealized foreign exchange gain on the residence that resulted from the
increase in the dollar-pound exchange rate between the dates the residence was
bought and sold. However fair and reasonable their argument may be, it amounts
to an untenable attempt to convert their functional
currency from the U.S. dollar to the pound sterling. FN3. In Willard Helburn, the
parties and the court, sub silentio, analyzed the purchase and financing of the
lambskins as though the U.S. dollar were the taxpayers functional
currency. The parties stipulated that the cost of the lambskins added to the
taxpayers inventory was to be translated at the dollar-pound exchange
rate prevailing at the date of their purchase, 214 F.2d at 818, and their
stipulation was accepted by the court, id. at 819. Under I.R.C. § 985(b)(1), use of a
functional currency other than the U.S. dollar is restricted to qualified
business units ("QBU"s). The functional currency of a QBU that is not
required to use the dollar is the currency of the economic
environment in which a significant part of such units activities are
conducted and which is used by such unit in keeping its books and
records. 26 U.S.C. § 985(b)(1)(B). Although
appellants correctly assert that their residence was purchased for a
pound-denominated value while they were living and working
in a pound-denominated economy, under I.R.C.
§ 989(a) a QBU must be a separate and clearly
identified unit of trade or business of a taxpayer which maintains separate
books and records. 26 U.S.C. § 989(a). And since
appellants concede that the purchase and sale of their residence was not
carried out by a QBU, the district court properly rejected their plea to treat
the pound as their functional currency. B. The Sixteenth Amendment Claim Appellants launch a double-barreled claim that the
income taxation at issue in this case was imposed in violation of the Sixteenth
Amendment. The Sixteenth Amendment eliminated any requirement that
income taxes imposed by Congress be apportioned among the
states. See Eisner, 252 U.S. at 205, 40 S.Ct. at 192. [FN4] Since
Eisner, the Supreme Court has described 'income'
in its
constitutional sense, as instances of undeniable accessions
to wealth, clearly realized, and over which the taxpayers have complete
dominion. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 432 n. 11,
75 S.Ct. 473, 478 n. 11, 99 L.Ed. 483 (1955) (internal quotation marks
omitted), id. at 431, 75 S.Ct. at 477. Their Sixteenth Amendment
claim fails as well. FN4. 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 of enumeration. U.S. Const. amend. XVI. 1. The Mortgage-Loan Transaction Loss With their initial volley, appellants implicitly
challenge the longstanding congressional power to determine allowable deductions
from gross income. Federal income tax deductions are matters of legislative
grace. Welch v. United States, 750 F.2d 1101, 1106 (1st
Cir.1985) (citing New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54
S.Ct. 788, 790, 78 L.Ed. 1348 (1934)). The nonintegrated tax treatment Congress
accords the acquisition, sale, and financing of appellants' residence simply
renders nondeductible the foreign exchange loss on their foreign-currency
denominated mortgage loan. As we have made clear in the past, Congress
possesses plenary power to determine allowable deductions from the gross income
it has elected to tax. See State Mut. Life Assurance Co. of Worcester v.
Commissioner, 246 F.2d 319, 324 (1st Cir.1957) (citing Helvering
v. Independent Life Ins. Co., 292 U.S. 371, 381, 54
S.Ct. 758, 760, 78 L.Ed. 1311 (1934)). 2. The Capital Gain on the Residence Second, appellants argue that it would violate the
Sixteenth Amendment to tax, as income, any foreign-exchange
gain relating to the sale of their residence, since they
realized no accession to wealth as a result of the exchange
rate disparity which developed between the purchase and sale of their
residence. Their argument attempts to revive the functional
currency debate already discussed. See supra pps. 29-30. As the
government points out, to purchase property with a foreign currency necessarily
places the individual United States taxpayer in a position to gain or
lose from a change in the exchange rate
. Should the foreign
currency increase in value (as against the dollar) by the time the property is
sold, the [*31] resulting gain in U.S. dollars, the functional currency of the
individual United States taxpayer, plainly qualifies as realized income, fully
taxable under the Constitution. III CONCLUSION Accordingly, the district court judgment is affirmed.
The parties shall bear their own costs. Appellate Briefs Reply Brief for the
Appellants (Apr. 27, 1996) Brief for the United
States (Apr. 22, 1996) Brief for the
Appellants (Feb. 26, 1996) |