BANKRUPTCY ESTATE MAY EXCLUDE GAIN ON SALE OF DEBTOR'S RESIDENCE.

                 IN THE UNITED STATES DISTRICT COURT

[1] This case is before the Court on appeal from the United States Bankruptcy Court for the Middle District of Tennessee ("Bankruptcy Court"). For the reasons discussed herein, the decision of the Bankruptcy Court is hereby AFFIRMED.

[2] In this Chapter 7 bankruptcy case, the Internal Revenue Service ("IRS") appeals from the July 16, 1998 Order and Memorandum of the Bankruptcy Court. The Bankruptcy Court held, as a matter of law, that capital gain on the sale of a debtor's residence is excluded from the gross income of a Chapter 7 estate to the extent provided by I.R.C. section 121 ("section 121"), as amended by the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, section 312(a), 111 Stat. 836 (1997) ("Amended section 121"). The Bankruptcy Trustee opposes the IRS's position on this appeal.

I. FACTS

[3] Debtor filed Chapter 13 Bankruptcy on October 28, 1996. On April 4, 1997, her case was converted to Chapter 7. The Bankruptcy Trustee sold Debtor's residence on October 3, 1997, resulting in a gain of $77,106. On the bankruptcy estate's 1997 income tax return, the Trustee declared the gain on the sale of this residence but excluded the gain pursuant to section 121. The IRS rejected the return pending a determination as to whether a bankruptcy estate could qualify for this exclusion. The Trustee filed a Motion for Determination of Tax Liability asserting that, under Amended section 121, where a bankruptcy trustee sells a debtor's residence, any resulting capital gain is excluded from income if the debtor would have qualified for the exclusion had the debtor sold the property. The IRS responded that the section 121 exclusion is personal to the debtor and not available to a bankruptcy estate.

II. STANDARD OF REVIEW

[4] "On appeal, the district court may affirm, modify, or reverse a bankruptcy judge's judgment, order or decree or remand with instructions for further proceedings." B.R. 8013. Conclusions of law are subject to de novo review. In re Caldwell, 851 F.2d 852, 857 (6th Cir. 1988), appeal after remand, 895 F.2d 1123 (6th Cir. 1990).

III. DISCUSSION

[5] Section 1398 of the Internal Revenue Code, I.R.C. Section 1398 (1988) ("section 1398"), provides that the taxable income of a Chapter 7 bankruptcy estate shall be computed in the same manner as for an individual. I.R.C. section 1398(c). The estate is to take deductions and credits "as if the amount were paid or incurred by the debtor and as if the debtor were still engaged in the trades and businesses, and in the activities, the debtor was engaged in before the commencement of the case." I.R.C. section 1398(e)(3). The estate succeeds to the tax attributes of the debtor with regard to various items, including, "in the case of any asset acquired. . . by the estate from the debtor, the basis, holding period, and character it had in the hands of the debtor." I.R.C. section 1398(g)(6).

[6] Courts have construed section 121 in light of section 1398 in determining whether the section 121 exclusion is available to a bankruptcy trustee. The first two recorded opinions on this issue, In re Mehr, 153 B.R. 430 (Bankr. D.N.J. 1993), and In re Barden, 205 B.R. 451 (Bankr. E.D.N.Y. 1996), aff'd, 105 F.3d 821 (2nd Cir. 1997), performed their analyses under the predecessor to Amended section 121, which was captioned "One-time exclusion of gain from sale of principal residence by individual who has attained age 55" ("Former section 121"). Former section 121 provided:

     At the election of the taxpayer, gross income does not include

[7] Section 121 was amended, however, by the Taxpayer Relief Act of 1997. Amended section 121 is captioned, "Exclusion of gain from sale of principal residence." It provides, in pertinent part:

     Gross income shall not include gain from the sale or exchange of

[8] The Bankruptcy Court reviewed sections 1398 and 121 in light of the conflicting conclusions of Mehr and Bardon, which disallowed the exclusion, and of Popa, which reached the opposite result. The court concluded that the 1997 amendments to section 121 undermine the policy arguments in Mehr and Barden against use of the exclusion by a bankruptcy trustee. Further, the court concluded that the plain meaning of section 1398 allows the exclusion. Finally, the court concluded that to allow a bankruptcy estate to take the exclusion promotes the public interest in a responsible bankruptcy system.

[9] Appellant objects to these conclusions, alleging that the 1997 Taxpayer Relief Act merely broadened the availability of section 121 to individual taxpayers but did not change the analysis regarding its applicability to bankruptcy estates. This argument is not persuasive. The Taxpayer Relief Act brought broad changes to the Internal Revenue Code, and the new language of section 121 expands its applicability beyond the act's original intent of assisting elderly homeowners. Mehr and Barden are no longer persuasive in light of the substantial changes in the tax code and the policy behind section 121.

[10] Appellant next alleges section 1398 does not authorize a bankruptcy estate to exclude gain under section 121. Instead, appellant asserts section 1398 sets forth an exclusive list of tax attributes that pass from the individual to the bankruptcy estate upon commencement of the bankruptcy case. The Bankruptcy Court, in contrast, interprets section 1398 as effecting the same tax consequence for the estate as it would have had effected for the individual. In light of the plain language of section 1398, the Court finds the Bankruptcy Court's reasoning correct as to that provision.

[11] Finally, the Appellant alleges the Bankruptcy Court's reliance on Popa is misplaced because Popa misconstrued the significance of section 1398. The Bankruptcy Court rejected Appellant's position, agreeing with Popa that, because section 1398 specifies that an asset taken by the estate assumes the "character" it had in the hands of the debtor, section 1398 authorizes the estate to step into the debtor's shoes with regard to section 121 and exclude the gain from income if the debtor could have done so. The Court agrees with the Bankruptcy Court that section 1398 provides the statutory authority for this result.

[12] For the reasons set forth above, the Court AFFIRMS the ruling of the Bankruptcy Court. This appeal is hereby DISMISSED.

                                   Robert L. Echols