shall be charged to capital account and shall be treated as paid in the period to which so allocable.

Thus, a cash basis taxpayer may deduct prepaid interest no earlier than in the taxable year in which (and to1981 U.S. Tax Ct. LEXIS 53">*57 the extent that) the interest represents a charge for the use or forbearance 77 T.C. 701">*703 of borrowed money during that period. See Joint Committee Explanation of Tax Reform Act of 1976 (Dec. 29, 1976), 1976-3 C.B. (Vol. 2) 1, 112; H. Rept. 94-658 (1975), 1976-3 C.B. (Vol. 2) 695, 791; S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 141.

Prior to the enactment of section 461(g) (sec. 208, Tax Reform Act of 1976, Pub. L. 94-455, 90 Stat. 1520, 1541), considerable confusion surrounded the deductibility of prepaid interest and a case-by-case analysis, to determine whether the deduction of prepaid interest materially distorted or clearly reflected income, characterized opinions of this Court ¹ and rulings ² published by respondent. See Joint Committee Explanation, supra, 1976-3 C.B. (Vol. 2) at 112; S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 141; and H. Rept. 94-658, supra, 1976-3 C.B. (Vol. 2) at 791. It was intended by Congress that section 461(g)(1) would compel the cash basis taxpayer to deduct interest1981 U.S. Tax Ct. LEXIS 53">*58 prepayments in the same manner as the accrual basis taxpayer. See H. Rept. 94-658, supra, 1976-3 C.B. (Vol. 2) at 792; S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 142; and Joint Committee Explanation, supra, 1976-3 C.B. (Vol. 2) at 112-113.

1981 U.S. Tax Ct. LEXIS 53">*59 An exception to the general rule of section 461(g)(1) is set forth in section 461(g)(2) which provides that section 461(g)(1):

shall not apply to points paid in respect of any indebtedness incurred in connection with the purchase or improvement of, and secured by, the principal residence of the taxpayer to the extent that, under regulations prescribed by the Secretary, such payment of points is an established business practice in the area in which such indebtedness is incurred, and the amount of such payment does not exceed the amount generally charged in such area.

Therefore, if the requirements of section 461(g)(2) are satisfied, 77 T.C. 701">*704 the taxpayer is not limited to a ratable deduction of the "points," ³ as would be the case for other instances of prepaid interest. Petitioners claim their "prepaid finance charges" fall within this exception.

1981 U.S. Tax Ct. LEXIS 53">*60 Respondent contends that in order to fall within section 461(g)(2), prepaid finance charges must be "paid" and that the receipt of discounted loan proceeds is not "payment." Respondent further contends that, even if petitioners' receipt or use of the discounted loan proceeds can be construed as the "payment of points," in the case at bar such proceeds were not used for, and the points were not paid in respect of, "any indebtedness incurred in connection with the purchase or improvement of * * * the principal residence of the taxpayer" since the loan was used to pay their existing indebtedness.

Petitioners contend that they "paid" the "prepaid finance charges" in 1977, the year that the balance of the proceeds became available to pay their debts. Petitioners concede that the amount of the loan proceeds used to pay debts owed J. C. Penney's, Maas Bros., and Sears was not an amount used "in connection with the purchase or improvement" of their residence. ⁴ However, they contend that amounts used to pay Overstreet and Florida Federal were used for that purpose and accordingly a percentage of the points is "points paid in respect of any indebtedness incurred in connection with the purchase1981 U.S. Tax Ct. LEXIS 53">*61 or improvement" of their residence.

We agree with respondent's first argument that since petitioners received, or had available, only the face amount of the loan less the "prepaid finance charges," those "prepaid finance charges" were not "paid" during1981 U.S. Tax Ct. LEXIS 53">*62 1977. In Rubnitz v. Commissioner, 67 T.C. 621">67 T.C. 621, 67 T.C. 621">628 (1977), we said:

77 T.C. 701">*705 it has been consistently held that a cash basis borrower has not paid interest when the loan transaction is structured so that a loan fee is "withheld" by the lender from what is called the principal amount of the loan and only the supposed principal amount minus the loan fee is actually made available for the borrowing taxpayer's use. J. W. Solof, 1 B.T.A. 776">1 B.T.A. 776, 1 B.T.A. 776">783; A. O'Day, 20 B.T.A. 455">20 B.T.A. 455, 20 B.T.A. 455">458; John C. Cleaver, 6 T.C. 452">6 T.C. 452, affirmed 158 F.2d 342">158 F.2d 342 (7th Cir.), certiorari denied 330 U.S. 849">330 U.S. 849; John Randolph Hopkins, 15 T.C. 160">15 T.C. 160, 15 T.C. 160">180-181; Sanford Campbell, T.C. Memo. 1970-126, 29 T.C.M. 539, 1970 P-H Memo. T.C. par. 70,126; Rev. Rul. 75-12, 1975-1 C.B. 62; Rev. Rul. 59-260, 1959-2 C.B. 137.

See also Heyman v. Commissioner, 70 T.C. 482">70 T.C. 482, 70 T.C. 482">485 (1978),1981 U.S. Tax Ct. LEXIS 53">*63 affd. without published opinion 633 F.2d 215">633 F.2d 215 (6th Cir. 1980); Wilkerson v. Commissioner, 70 T.C. 240">70 T.C. 240 (1978), revd. 655 F.2d 980">655 F.2d 980 (9th Cir. 1981); Roemer v. Commissioner, 69 T.C. 440">69 T.C. 440, 69 T.C. 440">463 (1977), affd. sub nom. Holgerson v. Commissioner, 638 F.2d 104">638 F.2d 104 (9th Cir. 1981). ⁵

Petitioners contend that those cases involving discounted loans are not applicable since they concerned taxable years prior to the enactment of section 461(g). However, as stated in H. Rept. 94-658, supra, 1976-3 C.B. (Vol. 2) at 793, and S. Rept. 94-938, supra, 1976-3 C.B. (Vol. 3) at 143, Congress "[did] not intend the new rule to change the treatment of a discount1981 U.S. Tax Ct. LEXIS 53">*64 loan under present law by a cash method taxpayer." See also Joint Committee Explanation, supra, 1976-3 C.B. (Vol. 2) at 113. ⁶

1981 U.S. Tax Ct. LEXIS 53">*65 It is petitioners' position that this statement in the Committee reports should be limited to section 461(g)(1) and that Congress did not intend the rules applicable to discounted loans to apply to prepaid finance charges which are points within the meaning of section 461(g)(2). Petitioners contend 77 T.C. 701">*706 that if this were not the case, the relief which Congress intended to provide by enacting section 461(g)(2) would be "circumvented."

Looking solely to the statute, we find two separate analyses which indicate that petitioners' reading of congressional intent is erroneous. First, when Congress, well aware of case law existing at that time and the narrow meaning accorded the word "paid," provided in section 461(g)(2) that section 461(g)(1) "shall not apply to points paid in respect of any indebtedness" (emphasis supplied), it did not intend points withheld to fall within this exception. We cannot find any indication that Congress intended "paid" to mean something other than its meaning under then-existing case law and petitioners have not pointed to, nor could we find any, legislative history indicating otherwise.

But even if Congress used the word "paid" inadvertently1981 U.S. Tax Ct. LEXIS 53">*66 in section 461(g)(2), the interplay of section 461(g)(1) with section 461(g)(2) further indicates that Congress did not intend to allow a cash basis taxpayer a current deduction for "points withheld" and that petitioners' analysis of congressional intent is erroneous. Section 461(g)(1) provides an exception, or a limitation (see Wilkerson v. Commissioner, 70 T.C. 240">70 T.C. 257), to the ordinary rules of interest deduction; section 461(g)(2) is an exception to this exception, merely lifting the limitation. Thus, the ordinary rules of deductibility of interest outside of section 461(g), including those pertaining to discounted loans, are applicable if the section 461(g)(2) exception applies. In other words, even if section 461(g)(2) did not include the word "paid," the most petitioners could hope for is escape from section 461(g)(1) and, therefore, in order to get a deduction, they still must "pay" the points. The logical explanation for this statutory construction is that Congress considered the entire section 461(g) (as evidenced further by the title of that section) to be applicable only to cases of prepaid interest and did not intend section 461(g)(2)1981 U.S. Tax Ct. LEXIS 53">*67 as a provision entitling a cash basis taxpayer to a current deduction for points withheld.

The payment required to entitle a cash basis taxpayer to a deduction is the payment of cash or its equivalent and the giving of a note is not the equivalent of cash. Don E. Williams, Co. v. Commissioner, 429 U.S. 569">429 U.S. 569 (1977); Helvering v. Price, 309 U.S. 409">309 U.S. 409 (1940); Beck v. Commissioner, 74 T.C. 1534">74 T.C. 1534, 74 T.C. 1534">156277 T.C. 701">*707 (1980), on appeal (9th Cir., Jan. 22, 1981). The theory in disallowing a full deduction for interest withheld by the lender in the year it is withheld is that giving a promissory note and having interest withheld from the loan proceeds (i.e., discounting the loan) are indistinguishable. Wilkerson v. Commissioner, 70 T.C. 240">70 T.C. 257; 70 T.C. 482">Heyman v. Commissioner, supra at 485.⁷ We find this theory to be applicable to points withheld from a cash basis taxpayer and, as indicated by the statute itself and the legislative history, Congress intended this to be the result.

1981 U.S. Tax Ct. LEXIS 53">*68 In view of our holding that "prepaid finance charges" (including interest on the new loan) withheld by the lender are not points "paid" so as to entitle petitioners to a deduction for the full amount of such charges in the year withheld, we need not decide whether the indebtedness was incurred in connection with the purchase or improvement of their personal residence.

Decision will be entered for the respondent.