Rev. Rul. 84-95

ISSUE

Does an order of the Comptroller of the Currency, made pursuant to 12 C.F.R. section 7.3025, requiring that the value of "other real estate owned" by a bank be written down and the amount of the write-down be charged off on its books for financial accounting purposes, create a conclusive presumption of worthlessness under section 1.166-2(d)(1) of the Income Tax Regulations that gives rise to a deduction under section 166 of the Internal Revenue Code?

FACTS

The taxpayer is a national bank subject to regulation by the Comptroller of the Currency.

In 1980, the taxpayer entered into a conditional sale contract concerning one of its former banking properties. Both the taxpayer and the purchaser reported this transaction as a sale for federal income tax purposes, with the taxpayer reporting gain. In 1980, the taxpayer received less than 10 percent of the total sales price for this property, and therefore the sale was a "covered transaction" as defined by the Comptroller of the Currency in 12 C.F.R. section 7.3025(b).

The taxpayer, despite reporting a sale of such property for federal income tax purposes, continued to show that property on its financial records as "other real estate owned" as required by the Comptroller of the Currency. In 1981, the Comptroller of the Currency pursuant to the guidelines for "other real estate owned" contained in 12 C.F.R. section 7.3025, required the taxpayer to account for this former banking property at the lower of its net book value or its current appraised fair value. Pursuant to the Comptroller of the Currency's requirements, the taxpayer wrote down the net book value of this property to the lower fair value and, for purposes of the financial accounting records, charged off the excess.

LAW AND ANALYSIS

Section 166(a)(1) of the Code states that a deduction shall be allowed for any debt that becomes worthless within the taxable year. Section 166(a)(2) states that the Secretary, when satisfied that a debt is recoverable only in part, may allow a deduction for such debt in an amount not in excess of the part of the debt charged off within the taxable year. Section 166(c) provides that in lieu of the deduction under section 166(a), there shall be allowed, in the discretion of the Secretary, a deduction for a reasonable addition to a reserve for bad debts.

Section 1.166-2(a) of the regulations provides that the District Director will consider all pertinent evidence, including the value of any collateral securing the debt and the financial condition of the debtor, in determining whether a debt is worthless in whole or in part.

Section 1.166-2(d)(1) of the regulations states that a debt, to the extent charged off during the taxable year by a bank or other corporation that is subject to supervision by federal authorities, or by state authorities maintaining substantially equivalent standards, shall be conclusively presumed to have become worthless, or worthless only in part, during that taxable year, if the debt is charged off, in whole or in part, either-

(i) in obedience to the specific orders of such authorities, or

(ii) in accordance with established policies of such authorities, and, upon their first audit of the bank or other corporation subsequent to the charge-off, such authorities confirm in writing that the charge-off would have been subject to such specific orders if the audit has been made on the date of the charge-off.

Section 1.166-2(d)(1) also states that no debt shall be conclusively presumed to have become worthless, or worthless only in part, if the amount so charged off is not claimed as a deduction by the taxpayer at the time of filing the return for the taxable year for which the charge-off takes place. As stated in Rev. Rul. 80-180, 1980-2 C.B. 66, the purpose of this regulation is to ensure that a taxpayer receives fair and consistent treatment when dealing with the Service and other branches of the federal government.

In 12 C.F.R. section 7.3025, the Comptroller of the Currency has promulgated rules that define several types of real property as "other real estate owned" and that detail the method by which such "other real estate owned" is to be valued for financial accounting purposes. "Other real estate owned" includes real estate acquired by a national bank through a conveyance in satisfaction of previously contracted debt, former banking premises that are no longer used for banking, and real estate sold by a bank in a "covered transaction." 12 C.F.R. section 7.3025(a). "Other real estate owned" is to be accounted for at the lesser of net book value or current fair value. Any excess of net book value over fair value is to be charged off currently. 12 C.F.R. section 7.3025(g).

"Covered transactions" are sales of "other real estate owned" in which less than 10 percent of the total sales price is in cash; when there is financing by the bank of all or a portion of the sales price on terms more favorable than those customarily required by the bank when its only involvement is as lender; or when the transaction does not transfer from the bank to the buyer the usual risks of ownership and all or most of the rewards of ownership. A transaction ceases to be covered when these conditions no longer exist. It will be deemed that 10 percent of the sales price has been paid in cash when the consideration received by the bank in cash, together with that portion of the sales price guaranteed to the bank by private mortgage insurance or an equivalent guarantee, equals or exceeds 10 percent of the total sales price.

Under the present facts, the Comptroller of the Currency required the taxpayer to continue to treat the real estate it sold to the purchaser as "other real estate owned," and not as a loan or debt, because the sale transaction satisfied the definition of a "covered transaction." For purposes of its financial accounting, the Comptroller of the Currency therefore required the taxpayer to write down and charge off the portion of its listed net book value that exceeded the real estate's fair value at the time of the sale.

Under 12 C.F.R. section 7.3025, a write-down of the value of "other real estate owned" is based solely on a mechanical comparison of net book value of real estate with its current appraised value. This is unlike the criteria set forth in 12 C.F.R. section 7.6125 under which the Comptroller of the Currency defines "bad debts" as mature obligations due a national bank on which interest is past due and unpaid for 6 months, unless the obligations are well secured and in the process of collection. The criteria in 12 C.F.R. section 7.3025, in contrast to those in 12 C.F.R. section 7.6125, deal with a broad class of assets rather than particular debts, or bad debts, and are not based on the delinquency or default of a debtor. Therefore, there is no inconsistency between section 1.166-2(d) of the regulations concerning the Service's "bad debt" position and the write-down required by the Comptroller of the Currency on "other real estate owned." In the absence of any evidence produced by the taxpayer to show the worthlessness of the amount charged off, there are no federal income tax consequences from the write-down ordered by the Comptroller of the Currency under section 166 of the Code.

HOLDING

An order of the Comptroller of the Currency made pursuant to 12 C.F.R. section 7.3025 that the value of "other real estate owned" by a bank must be written down and charged off on its books for financial accounting purposes does not create a conclusive presumption of worthlessness under section 1.166-2(d) of the regulations, and therefore, in the absence of evidence produced by the taxpayer to independently establish the worthlessness of the debt, in whole or in part, a bad debt deduction under section 166 of the Code is not allowable.