USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
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No. 96-1053
CARLOS J. QUIJANO AND JEAN M. QUIJANO,
Appellants,
v.
UNITED STATES OF AMERICA,
Appellee.
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APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MAINE
[Hon. Gene Carter, U.S. District Judge]
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Before
Cyr, Circuit Judge,
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Aldrich, Senior Circuit Judge,
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and Gertner,* U.S. District Judge.
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Paula N. Singer, with whom Robert S. Grodberg and Vacovec,
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Mayotte & Singer were on brief for appellants.
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Kenneth W. Rosenberg, Attorney, Tax Division, Department of
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Justice, with whom Jay P. McCloskey, United States Attorney, Loretta
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C. Argrett, Assistant Attorney General, Gary R. Allen and Richard
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Farber, Attorneys, Tax Division, Department of Justice, were on brief
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for appellee.
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August 21, 1996
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*Of the District of Massachusetts, sitting by designation.
CYR, Circuit Judge. Appellants Carlos J. and Jean M.
CYR, Circuit Judge.
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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
I
BACKGROUND
BACKGROUND
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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
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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, Ltd. v. Commissioner, 214 F.2d 815
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(1st Cir. 1954), and that the tax imposed violates the Sixteenth
Amendment, see Eisner v. Macomber, 252 U.S. 189 (1920). In due
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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
II
DISCUSSION1
DISCUSSION
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1In 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
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Service of the United States, 15 F.3d 203, 205 (1st Cir. 1994)
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(citing Lewis v. Reynolds, 284 U.S. 281, 283, 52 S. Ct. 145, 146,
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76 L.Ed 293, modified on other grounds, 284 U.S. 599, 52 S. Ct.
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264, 76 L. Ed. 514 (1932)). We review the challenged summary
judgment ruling de novo. McCabe v. Life-Line Ambulance Serv.,
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Inc., 77 F.3d 540, 544 (1st Cir. 1996), petition for cert. filed,
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3
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64 U.S.L.W. 3808 (U.S. May 29, 1996) (No. 95-1929).
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A. Foreign Exchange Transactions
A. Foreign Exchange Transactions
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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
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that a proper adjustment shall be made for "expenditures . . .,
or other items, properly chargeable to capital . . . ." Id.
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1016(a)(1).
Section 985(a) generally requires that all income tax
liability determinations are to be made in the "taxpayer's
functional currency," id. 985(a), which is the U.S. dollar for
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individual United States taxpayers, id. 985(b)(1)(A). With
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exceptions not relevant here, section 165(a) permits "a deduction
[for] any loss sustained during the taxable year . . . ." Id.
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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.
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165(c).
1. Loss on Mortgage Loan Transaction
1. Loss on Mortgage Loan Transaction
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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; Church's English
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Shoes, Ltd. v. Commissioner, 24 T.C. 56, 59 (1955), aff'd, 229
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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.
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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
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F.2d at 818, we recognized that an integrated approach to the
transaction might have been elected by the taxpayer.2
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2Willard Helburn involved the tax treatment accorded a
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purchase of lambskins in New Zealand for inventory in the United
States, where both the purchase and the financing were in pounds
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Unfortunately for appellants, Congress has since foreclosed an
integrated transaction approach to the exclusively foreign-
currency financed acquisition involved in the present case.
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
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regulations," id., borrowing under a debt instrument in which the
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taxpayer is obligated to repay the loan in "a nonfunctional
currency," id. 988(c)(1), will qualify for treatment as part of
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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)
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identified the transaction as a section 988 hedging transaction.
Id. 988(d)(2)(B).
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Even assuming their transaction qualified, however,
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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
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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
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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.
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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
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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 individual's 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
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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.
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2. Capital Gain on Real Estate Sale
2. Capital Gain on Real Estate Sale
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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 Church's English Shoes, 229
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F.2d at 958.3 Appellants agree that the 453,374 pounds received
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3In Willard Helburn, the parties and the court, sub
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silentio, analyzed the purchase and financing of the lambskins as
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though the U.S. dollar were the taxpayer's functional currency.
The parties stipulated that the cost of the lambskins added to
the taxpayer's inventory was to be translated at the dollar-pound
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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.
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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 government's computation, and the
$200,000 gain appellants suggest, approximates a $100,000
unrealized foreign exchange gain on the residence that resulted
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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.
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 unit's activities
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exchange rate prevailing at the date of their purchase, 214 F.2d
at 818, and their stipulation was accepted by the court, id. at
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819.
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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
B. The Sixteenth Amendment Claim
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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 205.4
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Since Eisner, the Supreme Court has described "`income' . . . in
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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.
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426, 432 n.11 (1955) (internal quotation marks omitted), id. at
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431. Their Sixteenth Amendment claim fails as well.
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4"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.
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1. The Mortgage-Loan Transaction Loss
1. The Mortgage-Loan Transaction Loss
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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
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States, 750 F.2d 1101, 1106 (1st Cir. 1985) (citing New Colonial
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Ice. Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788, 790, 78
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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
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v. Commissioner, 246 F.2d 319, 324 (1st Cir. 1957) (citing
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Helvering v. Independent Life Ins. Co., 292 U.S. 371, 381
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(1934)).
2. The Capital Gain on the Residence
2. The Capital Gain on the Residence
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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
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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.
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7-9. As the government points out, to purchase property with a
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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 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
III
CONCLUSION
CONCLUSION
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Accordingly, the district court judgment is affirmed.
The parties shall bear their own costs.
SO ORDERED.
SO ORDERED.
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