Kuhn v. Commissioner

*274 The Commissioner determined a deficiency of $10,253.82 in petitioner's income tax for 1930. He disallowed a "loss on endorsement and guarantee of notes for R. A. Mercier, adjudicated bankrupt March 4, 1930, * * * in the amount of $69,974.44, as not having been paid in the year 1930."

FINDINGS OF FACT.

Petitioner kept his accounts and filed his returns on the cash basis. In 1929, in order to assist one Mercier to finance a public works contract, he loaned Mercier certain stocks and bonds which Mercier deposited as collateral security for his 7 percent promissory note of $69,728.38 due March 17, 1930. Petitioner was not a party to this note. On January 13, 1930, for*722 a second loan, Mercier gave his 6 percent unsecured promissory note for $25,000, due March 14, 1930, which was endorsed by petitioner. Petitioner was to receive 7 percent accumulated interest on both these amounts. On March 4, 1930, Mercier was adjudicated a bankrupt.

Petitioner, between March 4 and March 17, 1930, to avoid the sale of his securities which were pledged to secure Mercier's first note, paid $4,728.38 and executed his own note for $65,000, secured by the same collateral. This note was due June 16, 1930. On that date petitioner paid $2,500 plus interest and gave his new note for $62,500 due September 19, 1930. On that date he paid $2,500 plus interest and gave a new note for $60,000 due December 18, 1930. On that date he paid $1,500, thus reducing the note to $58,500 at the end of 1930. Thereafter payments were made, collateral released, and new notes executed from time to time until the entire amount was paid and the entire collateral was released.

On March 14, 1930, when Mercier's $25,000 note upon which petitioner was endorser was due, petitioner paid $5,000 cash and executed his own note for $20,000 and deposited collateral security consisting *275 *723 of $25,000 of bonds. After 1930 petitioner paid this note and repossessed his collateral.

Petitioner in 1930 filed a claim with the referee in bankruptcy for $94,728.38, the aggregate face amount of the two notes, and in 1931 and 1932 received dividends aggregating $7,004.25 from the bankruptcy estate.

The Commissioner in his determination of deficiency allowed the deduction in 1930 of the aggregate payments of $11,228.38 upon the first loan, the $5,000 upon the second loan, and all of the interest paid during the year. He disallowed the deduction of the rest.

OPINION.

STERNHAGEN: Although the petitioner states his familiarity with the rule of , and other cases, ¹ that a taxpayer on the cash basis may not deduct, either as a sustained loss or a debt ascertained to be worthless, the amount of a note made by him as primary obligor in substitution for a note given by another upon which the taxpayer had theretofore been a secondary obligor, until he pays on the note, he urges that this rule is inapplicable where the new note given by the taxpayer is collaterally secured by his pledge of property. His argument treats the*724 pledge as if it were a loss of the property. This clearly is not correct. Title to the property continues in the pledgor, and by paying the debt he may retake possession. During the pledge the property is so clearly his that it would be within his gross estate upon his death, ; certiorari denied, ; . Thus the loss is no more realized in this case because the taxpayer has deposited collateral than in the Eckert case, where collateral was not mentioned.

As to the second note, upon which petitioner was endorser, it can be said here, as it was in the Eckert case, that the petitioner "merely exchanged his note under which he was primarily obligated for [Mercier's] note under which he was secondarily obligated, without any outlay of cash or property having*725 a cash value." As to the first note, upon which petitioner was not an endorser but only furnished the collateral, he might have permitted the pledgee to realize upon Mercier's obligation by liquidating the pledge. Thus he might have sustained a loss. Instead, however, he elected to save himself from the immediate realization of loss by giving his successive promissory notes. In both cases, being on the cash basis, he sustained no loss in *276 1930 beyond the cash payments which he made and which he has been allowed to deduct.

The petitioner relies upon , but that case stands for an entirely different principle, namely, that a taxpayer whose investment is lost in the taxable year is not to be deprived of the deduction therefor merely because the lost investment was derived from borrowed capital. The distinction between that case and , appears in , in which it is also said that the Weis case must be regarded, in so far as it considers the cash basis, as overruled by the Eckert case. ² Cf. *726 ; . Petitioner cites , but that case supports the deduction of interest which was paid with the proceeds of a new note for a principal amount large enough to include both the interest and principal of an earlier note. This is consistent with the Commissioner's allowance in the present case of the interest and part payments actually made.

The Commissioner correctly disallowed the deduction in 1930 of the amount in excess of the actual payments.

Judgment will be entered under Rule 50.