MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS, Judge:* Respondent determined a deficiency in the petitioners' income tax for the year 1979 in the amount of $5,172.00. The sole issue for decision is whether the petitioners are entitled to report on the installment basis under section 4531 gain on the sale of real property encumbered by a mortgage the balance of which on the date of sale ($73,669.64) exceeded 30% of the selling price ($150,000). Resolution of the issue involved herein depends upon whether the purchasers, who paid off the mortgage at the closing of sale, acquired the property subject to the mortgage. If the purchasers acquired the property subject to the mortgage, then satisfaction of the mortgage by the purchasers would not be deemed to be a payment to the petitioners in the year of sale and the petitioners could report their gain on the installment basis.However, if the property was not taken subject to the mortgage, then the satisfaction of the mortgage by the purchasers at closing would constitute a payment to the petitioners in the year of sale that exceeded 30% of the selling price, and therefore the petitioners would be foreclosed from reporting their gain on the installment basis.
FINDINGS OF FACTS
The facts have been fully stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated by this reference.
At the time of the filing of the petition herein, the petitioners, Charles R. Kucklick and his spouse Elizabeth T. Kucklick (hereinafter sometimes referred to as "Charles" and "Elizabeth", respectively) resided in Stratford, Connecticut.
In November, 1977, the petitioners purchased improved commercial real estate from William O'Reilly for $100,000. Petitioners paid O'Reilly $25,000 in cash and gave him a $75,000 purchase money mortgage (hereinafter sometimes referred to as "the O'Reilly mortgage") 2. Pursuant to the terms of the O'Reilly mortgage, the entire balance became due and payable, at the mortgagee's election, upon a subsequent conveyance or transfer of the encumbered property. 3
On or before March 8, 1979, Charles investigated the possibility of selling the property to Anton Schadl and/or Julie Kish (hereinafter referred to as "Schadl" and "Kish"), both of whom were then tenants of the property.It was intended that the new purchasers would either assume or take the property subject to the O'Reilly mortgage. Charles wrote to O'Reilly advising him of the contemplated sale of the property to Schadl and Kish, and inquired as to whether O'Reilly would allow the new purchasers to assume the mortgage. O'Reilly indicated that assumption of the mortgage might be possible subject to a review of Schadl and Kish's credit worthiness.
By May 2, 1979, it was determined that Schadl would purchase the property for $150,000 4, with the closing schedled for June 1, 1979. Schadl decided that he would pay the O'Reilly mortgage in full at the closing. Accordingly, petitioners wrote to O'Reilly's attorney on May 2, 1979, requesting a mortgage release and advice as to the amounts required to pay off the mortgage as of June 1, 1979. By letter dated May 24, 1979, O'Reilly's attorney informed petitioners' attorney as to the pay off figures and sent him the requested release. 5
The sale of the property closed on June 1, 1979 as scheduled.On that date, the balance of the O'Reilly mortgage was paid in full. 6 The petitioners' adjusted basis in the property at the time of the sale was $97,796.00.
ULTIMATE FINDING OF FACT
Petitioners did not sell the property subject to the O'Reilly mortgage. The purchasers' satisfaction of petitioners' liability on the O'Reilly mortgage constituted a payment in the year of sale to the petitioners.
Petitioners received payments ($73,669.64) totalling more than 30% of the selling price ($150,000) in the year of sale.
OPINION
The controversy herein is governed by section 453 prior to revision by the Installment Sales Revision Act of 1980 (which generally applies to sales occurring after October 19, 1980) Pub. L. 96-471, 94 Stat. 2247 (1980). The pre-1980 version of section 453(b)7 affords a taxpayer the option of installment reporting of the gain realized from a deferred payment sale of real property provided (a) there are two or more payments, and (b) the amount of all payments received in the year of sale does not exceed 30% of the selling price (hereinafter referred to as the "30% initial payment limitation").
On their return for 1979, petitioners elected the installment basis to report gain on the sale of their property. Petitioners reported no recognized gain for 1979 (on the basis that they received no cash in that year from the sellers 8), but they did report gain in subsequent years as payments were received. Respondent contends that satisfaction of the O'Reilly mortgage by the purchasers at closing constituted a payment to petitioners in the year of sale, and that therefore petitioners are not entitled to report the gain on the installment basis because the amount of the payments received in 1979 exceeded the 30% initial payment limitation.
Generally, when a buyer satisfies the seller's debts in connection with an installment sale of property, the satisfaction of the seller's debts is treated as a payment in the year of sale in determining whether the 30% initial payment limitation applies. Sallies v. Commissioner, 83 T.C. (1984); Maddox v. Commissioner,69 T.C. 854, 858 (1978). See Sterling v. Ham,3 F. Supp. 386 (D. Me. 1933). The regulations, however, provide a special rule applicable to certain installment sales of mortgaged property. Section 1.453-4, Income Tax Regs., provides that where encumbered property is either sold subject to an existing mortgage, or the mortgage is assumed by the purchaser, the amount of the mortgage, in general, is not taken into account for purposes of determining the amount of payments received by the seller nor for the purposes of determining the contract price. 9 However, to the extent that the mortgage exceeds the seller's basis in the property, the excess is considered as a payment received and is included in the contract price. 10
In the present case, petitioners' adjusted basis in the property at the time of sale exceeded the unpaid balance of the O'Reilly mortgage. The petitioners argue that, as a factual matter, the purchasers took the property subject to the O'Reilly mortgage, and that therefore the exclusion provided in the regulation applies (i.e., the amount of the unpaid mortgage balance is not taken into account for purposes of the 30% initial payment limitation), with the result that the sale qualifies for installment reporting treatment. The respondent, on the other hand, contends that installment reporting is not available to the petitioners, because the purchasers neither assumed the O'Reilly mortgage nor took the property subject to the mortgage, and therefore the repayment of the mortgage at closing constituted a payment in the year of sale that exceeded the 30% initial payment limitation.
As this Court pointed out in Voight v. Commissioner,68 T.C. 99 (1977), affd. per curiam 614 F.2d 94 (5th Cir. 1980), the terms used in the regulation, "property is merely taken subject to the mortgage" and "mortgage is assumed by the purchaser," have the meanings customarily attributed to them in real estate transactions. In Stonecrest Corp. v. Commissioner,24 T.C. 659 (1955), we stated our understanding of these terms as follows:
Taking property subject to a mortgage means that the buyer pays the seller for the latter's redemption interest, i.e., the difference between the amount of the mortgage debt and the total amount for which the property is being sold, but the buyer does not assume a personal obligation to pay the mortgage debt. The buyer agrees that as between him and the seller, the latter has no obligation to satisfy the mortgage debt, and that the debt is to be satisfied out of the property. Although he is not obliged to, the buyer will ordinarily make the payments on the mortgage debt in order to protect his interest in the property.Where a buyer assumes a mortgage on property, he pays the seller for the latter's redemption interest, and in addition promises the seller to pay off the mortgage debt. This promise of the buyer can ordinarily be enforced by the mortgagee.
Stonecrest Corp., supra, 666. Furthermore, this Court has previously held that the actual and intended relationships created among the parties, rather than the form of the transaction, determines whether or not the mortgage has been assumed or the property has been transferred subject to the mortgage. Voight v. Commissioner,supra at 112-113; Waldrepv.Commissioner,52 T.C. 640, 646 (1969), affd. per curiam 428 F.2d 1216 (5th Cir. 1970).
In support of their contention that the purchasers took the property subject to the O'Reilly mortgage, the petitioners rely on the fact that the various documents executed in connection with the sale, i.e., the sale contract, the deed, and the purchase money mortgage taken back by the petitioners, all recite that the conveyance of the property was subject to the O'Reilly mortgage. The petitioners' argument is also premised on the facts that neither they nor their attorney ever received the mortgage proceeds at the closing and that the mortgage release was recorded after the deed to the buyers. While unquestionably these facts represent the formal indicia of a transfer of real property subject to an existing mortgage, they are not decisive of the question here of whether or not the property in fact was sold subject to the O'Reilly mortgage.
Although the evidence shows that O'Reilly, the mortgagee, would have allowed a conveyance of the property subject to the mortgage if the purchasers qualified as credit worthy, there is no suggestion in the record that the purchasers submitted to a credit review. The evidence indicates, rather, that as early as May 2, 1979, the date on which petitioners' attorney requested a release from O'Reilly's attorney, the purchasers sought a transfer of the property unencumbered by the mortgage. The fact that petitioners' attorney requested the release and the mortgage pay-off figures from O'Reilly's attorney establishes that the petitioners, prior to the closing, were aware of, and acquiesced in, the purchasers' intention. We find therefore that there was no mutual intention that the property would be transferred subject to the O'Reilly mortgage, and that in fact an unencumbered transfer occurred.
We find support for our conclusion here in our decisions in Maddox v. Commissioner,69 T.C. 854 (1978), and in Sallies v. Commissioner, 83 T.C. (1984).
The issue in Maddox was whether there had been an assumption where the escrow closing agreements required the purchaser to obtain new loans, the proceeds of which were to be applied to pay off the petitioners' existing mortgages.Reasoning that the vendor-mortgagor retains his liability, even if only secondarily, where either the property is transferred subject to a mortgage or the mortgage is assumed, we held that the substitution through escrows of new mortgages for existing mortgages did not amount to an assumption where the petitioners retained no liability whatsoever on any of the mortgages at the close of the escrows.
Sallies v. Commissioner, 83 T.C. (1984), presented the issue before us in a factually similar context. We held there that, despite recitations in the deed to the contrary, the purchaser neither assumed the seller's mortgage liability nor took the real estate subject to the mortgage where the seller retained no liability on the mortgage after the sale because the purchaser had paid off the seller's mortgage liability at the closing.
In the present case, the petitioners' liability on the O'Reilly mortgage was extinguished on the date of closing. Thus, under Maddox and Sallies, the absence of any retained mortgage liability on the part of the petitioners undermines their claim that the conveyance was subject to the O'Reilly mortgage.
Given our finding that the property was not conveyed subject to the O'Reilly mortgage, it follows that the cancellation and payment of the O'Reilly mortgage in the year of sale constitutes a payment to the petitioners for the purposes of Section 453. Sallies v. Commissioner, supra at ; Maddox v. Commissioner,supra, at 858. See Sterling v. Ham,3 F. Supp. 386 (D. Me. 1933). Since the amount of the cancelled mortgage liability ($73,669.64) exceeds 30% of the selling price ($150,000), the installment reporting election under section 453 is not available.
Finally, petitioners maintain that a decision in their favor is warranted on the ground of equity. Without question the purpose of section 453 is to mitigate the hardship that would otherwise occur if tax were immediately imposed upon the gain from an installment sale where the taxpayer has received in cash but a small portion of the sales price. Commissioner v. South Texas Lumber Co.,333 U.S. 496, 503 (1948). The 30% initial payment limitation of section 453(b), however, represents an attempt to differentiate between those cases where the imposition of the tax would pose a hardship and those where it would not. 11 In Maddox,supra, we pointed out that the satisfaction of the petitioners' mortgage liability in the year of sale is equivalent to the petitioners' receiving cash and then paying off the mortgage. In the present case, the extinguishment of the petitioners' liability on the O'Reilly mortgage is equivalent to their receipt of cash. We conclude therefore that our decision herein results in no undue hardship and is consistent with the legislative purpose underlying the statutory limitation. Accordingly,
Decision will be entered for the respondent.