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Commissioner v. Tufts | 461 U.S. 300 (1983)
The United States Supreme Court’s 1947 decision in Crane versus Commissioner is one of the most influential cases in tax-law history. In that case, the Court held that the amount realized in the disposition of property subject to a mortgage includes the amount of the unpaid mortgage if the value of the property exceeds the unpaid mortgage amount. In a footnote, the Court posed an unanswered hypothetical asking whether the same would be true if the unpaid mortgage amount exceeded the property value. The Court finally addressed this famous footnote in the 1983 case of Commissioner versus Tufts.
In 1970, Clark Pelt formed a partnership with Tufts and several others to build an apartment complex. The partnership entered into a $1,851,500 nonrecourse mortgage to finance the complex’s construction. The partners paid no taxes on the mortgage transaction.
The partners made a total of $44,212 in capital contributions and claimed a tax deduction of $439,972 on their allocated shares of losses and depreciation. The partnership’s adjusted basis in the complex was $1,455,740, which was calculated by the $1,851,500 mortgage, plus the $44,212 capital contributions, minus the $439,972 deductions.
Prior to the complex’s completion, the city experienced widespread layoffs. Rental income was lower than expected and the partnership couldn’t pay the mortgage. The partners sold their interests to a third party, who assumed the mortgage. At the date of the sale, the property’s fair market value was $1,400,000. The partners reported the amount realized on their respective federal income taxes as a $55,740 partnership loss, representing the difference between the complex’s fair market value and the adjusted basis.
The Commissioner of the Internal Revenue Service determined that the sale created a partnership gain of nearly $400,000. The Commissioner reasoned that the amount realized by the sale included the amount of the unpaid mortgage, even though the mortgage exceeded the fair market value of the building. The partners incorrectly subtracted that amount in their tax calculations.
The United States Tax Court upheld the Commissioner’s determination. The Court of Appeals for the Fifth Circuit reversed. The United States Supreme Court granted certiorari.
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