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Security Bank S.S.B. v. Commissioner Of Internal Revenue

June 24, 1997




Appeal from the United States Tax Court. Nos. 472-92 & 15464-93 Arthur L. Nims, Judge.

Before RIPPLE, DIANE P. WOOD and EVANS, Circuit Judges.

RIPPLE, Circuit Judge.



Security Bank S.S.B. and its subsidiaries ("SSB") seek review of a decision of the Tax Court. SSB made loans secured by mortgages on real property. When the borrowers defaulted, SSB acquired the real property through, or in lieu of, foreclosure. The Tax Court held that the gain realized in the subsequent sale of the real property ought to be treated as unpaid interest, and therefore income, by SSB. In accord with the other circuits that have addressed the issue, we now affirm the judgment of the Tax Court.


SSB is a savings and loan association that made loans secured by interests in real property located in Wisconsin. When a borrower defaulted, Wisconsin law permitted SSB to begin a judicial foreclosure action or to accept the deed on the property in lieu of foreclosure. Later, SSB sold the property and, in some instances, realized a gain on the transaction. At issue in this case is the appropriate tax treatment of gains realized by SSB when it resold the foreclosure properties over a four-year period (fiscal years 1985 through 1988).

When SSB sold foreclosure properties, it credited the entire amount of gain realized on that sale to its reserve for bad debts. It did not treat any portion of the gain as interest on the debt that had accrued but had not been paid to SSB. *fn1 If treated as interest, these amounts would have been taxable income. The Internal Revenue Service ("IRS") issued deficiency notices for those years. The Commissioner took the position that SSB was required to include in its gross income the gain from the sale of foreclosed property to the extent that it represented accrued but unpaid interest up to the date of judgment in foreclosure. The Tax Court, relying primarily on the language of sec. 595 of the Tax Code, 26 U.S.C. sec. 595, *fn2 agreed with the position advocated by the IRS. In its view, "unpaid interest, to the extent recovered on the sale of the Foreclosure Properties, is required by the language of sec. 595(b) to be treated as interest paid on an indebtedness. . . . As such, it must be reported currently as ordinary income." 105 T.C. 101, 112 (1995).


This case requires us to decide an issue that, although not decided in this circuit, has already confronted our colleagues in two other circuits. See Gibraltar Fin. Corp. v. United States, 825 F.2d 1568 (Fed. Cir. 1987); First Charter Fin. Corp. v. United States, 669 F.2d 1342 (9th Cir. 1982). These holdings do not bind us. Indeed, we have the obligation to exercise our independent judgment. Nevertheless, we owe the efforts of our colleagues in the other circuits our respectful and careful study. As the Federal Circuit pointed out in Gibraltar, it is "particularly desirable in tax cases to ensure equal application of the tax system to our citizenry." 825 F.2d at 1572.

In studying the opinions of our colleagues in the other circuits, we believe that the concurring opinion of Judge Sneed in First Charter provides the most sure-footed starting point to our analysis. Like the Tax Court in this case, Judge Sneed emphasized the language of the governing statute. Because that language is central to our analysis, we set forth the text in full.

Sec. 595. Foreclosure on property securing loans.

(a) Non-recognition of gain or loss as a result of foreclosure. -- In the case of a creditor which is an organization described in section 593(a), no gain or loss shall be recognized, and no debt shall be considered as becoming worthless or partially worthless, as the result of such organization having bid in at foreclosure, or having otherwise reduced to ownership or possession by agreement or process of law, any property which was security for the payment of any indebtedness.

(b) Character of property. -- For purposes of sections 166 and 1221, any property acquired in a transaction with respect to which gain or loss to an organization was not recognized by reason of subsection (a) shall be considered as property having the same characteristics as the indebtedness for which such property was security. Any amount realized by such organization with respect to such property shall be treated for purposes of this chapter as a payment on account of such indebtedness, and any loss with respect ...

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