Quijano v. United States

Opinion

USCA1 Opinion

UNITED STATES COURT OF APPEALS

                                FOR THE FIRST CIRCUIT



                                                     
                                 ____________________



        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,
             _________________              ____________________      ________

        Mayotte & Singer were on brief for appellants.
        ________________

             Kenneth  W.  Rosenberg,  Attorney,  Tax Division,  Department  of
             ______________________

        Justice, with whom Jay P.  McCloskey, United States Attorney,  Loretta
                           _________________                           _______

        C. Argrett,  Assistant Attorney  General,  Gary R.  Allen and  Richard
        __________                                 ______________      _______

        Farber, Attorneys,  Tax Division, Department of Justice, were on brief
        ______

        for appellee.



                                                     
                                 ____________________



                                   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.
                         _____________



          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
                                      __________



                    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
                      ______________________    ____________



          (1st Cir. 1954), and that  the tax imposed violates the Sixteenth



          Amendment,  see Eisner v. Macomber, 252 U.S.  189 (1920).  In due
                      ___ ______    ________



          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
                                                 ____     _________________

          Service of  the United States, 15  F.3d 203, 205 (1st  Cir. 1994)
          _____________________________

          (citing Lewis v. Reynolds, 284 U.S. 281, 283, 52 S. Ct. 145, 146,
                  _____    ________

          76 L.Ed  293, modified on other grounds, 284  U.S. 599, 52 S. Ct.
                        ________ __ _____ _______

          264, 76  L. Ed. 514  (1932)).  We  review the challenged  summary

          judgment ruling  de novo.   McCabe v. Life-Line  Ambulance Serv.,
                           __ ____    ______    ___________________________

          Inc., 77 F.3d 540, 544 (1st Cir. 1996), petition for cert. filed,
          ____                                    ________ ___ ____  _____



                                          3



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          64 U.S.L.W. 3808 (U.S. May 29, 1996) (No. 95-1929).



                                          4



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
          __



          that  a proper adjustment shall be  made for "expenditures . . .,



          or  other items, properly chargeable to  capital . . .  ."  Id.  
                                                                      __



          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
                                __



          individual United  States taxpayers,  id.    985(b)(1)(A).   With
                                                __



          exceptions not relevant here, section 165(a) permits "a deduction



          [for] any  loss sustained during the taxable year . . . ."  Id.  
                                                                      __



          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.  
                                                                      __



          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
                     _______________                       ________________



          Shoes, Ltd.  v. Commissioner, 24  T.C. 56, 59 (1955),  aff'd, 229
          ___________     ____________                           _____



          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.
                                                               __



                    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
                                                       _______________



          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
                ________________

          purchase of lambskins in New  Zealand for inventory in the United

          States, where both the purchase  and the financing were in pounds



                                          6



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
          ___



          regulations," id., borrowing under a debt instrument in which the
                        ___



          taxpayer  is obligated  to  repay the  loan  in "a  nonfunctional



          currency," id.   988(c)(1), will qualify for treatment as part of
                     ___



          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)
                                          ___                      ___



          identified  the transaction as a section 988 hedging transaction.



          Id.   988(d)(2)(B).  
          ___



                    Even  assuming  their transaction  qualified,  however,

                              
          ____________________



          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
                                    __

          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
                                           __

          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.
          __



                                          7



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
                                    ___ __



          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
                        ____________



          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.  
          __



               2.   Capital Gain on Real Estate Sale 
               2.   Capital Gain on Real Estate Sale 
                    ________________________________



                    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
                                            ___ ______________________



          F.2d at 958.3  Appellants  agree that the 453,374 pounds received

                              
          ____________________



               3In   Willard  Helburn,  the  parties  and  the  court,  sub
                     ________________                                   ___

          silentio, analyzed the purchase and financing of the lambskins as
          ________

          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



                                          8



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.
                                                                      ____



          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
          __________



          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

                              
          ____________________



          exchange rate prevailing at the  date of their purchase, 214 F.2d

          at 818, and their stipulation was  accepted by the court, id.  at
                                                                    __

          819.



                                          9



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
                                            ___ ______



          Since Eisner, the Supreme Court has described "`income' . . .  in
                ______



          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.
                               ____________    __________________



          426, 432 n.11 (1955) (internal  quotation marks omitted), id.  at
                                                                    __



          431.  Their Sixteenth Amendment claim fails as well. 



                              
          ____________________



               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.



                                          10



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
                                                           _____     ______



          States, 750 F.2d 1101, 1106  (1st Cir. 1985) (citing New Colonial
          ______                                               ____________



          Ice. Co. v. Helvering, 292 U.S. 435, 440, 54 S. Ct. 788,  790, 78
          ________    _________



          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
                            ___ ___________________________________________



          v.  Commissioner,  246  F.2d 319,  324  (1st  Cir. 1957)  (citing
              ____________



          Helvering v.  Independent  Life  Ins.  Co.,  292  U.S.  371,  381
          _________     ____________________________



          (1934)).  



               2.   The Capital Gain on the Residence
               2.   The Capital Gain on the Residence
                    _________________________________



                    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
          ________ __



          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.
                                                            ___  _____



          7-9.  As the government points  out, to purchase property with  a


11



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
                                      __________



                    Accordingly, the  district court judgment  is affirmed.



          The parties shall bear their own costs.



                    SO ORDERED.
                    SO ORDERED.
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