Deceased Wife's Unrecovered Basis in Annuity May Be Deducted

[3] Field Service Advice is not binding on Examination or Appeals and is not a final case determination. Such advice is advisory and does not resolve Service position on an issue or provide the basis for closing a case. The determination of the Service in the case is to be made through the exercise of the independent judgment of the Field office with jurisdiction over the case.

[7] On * * *, * * * entered into four private annuity contracts with her children. Under the contracts, each child agreed to pay her $* * * a month for the rest of her life. Her rights to any payments terminated at her death. Under the agreements, * * * agreed to transfer $* * * to each child. The parties used the section 72 annuity tables to calculate the monthly payments. When * * * entered into the agreements, she was undergoing treatment for a relapse of cancer. Although the treatments forestalled the disease temporarily, she died on * * *.

[8] From * * * through * * * the four children paid * * * the monthly payments required under the private annuity agreements. * * * reported the appropriate portion of private annuity payments as income in accordance with section 72. When she died, * * *'s unrecovered bases in the private annuity contracts was $* * *. For * * *, her husband filed a joint return as a surviving spouse. Under section 72(b)(3), he deducted his wife's private annuity contracts as miscellaneous deductions on Schedule A.

[9] The Service challenged the section 72 deduction for reasons that were later dropped by the Appeals Office. Appeals, however, found a new basis for challenging the deduction, concluding that the deduction was prohibited by section 267(a)(1). The notice of deficiency cited this as the sole reason for disallowing the deduction.

[11] Section 267(a)(1) disallows a deduction for a loss incurred from the sale or exchange of property, directly or indirectly, between certain related parties. Under section 267(b)(1), by reference to section 267(c)(4), a mother and her children are related parties for purposes of section 267(a)(1). Thus, there is no question that * * * and her children are related parties for purposes of section 267(a)(1). Accordingly, section 267(a)(1) would prohibit the deduction if the cancellation of the annuity contracts at * * * death were construed as sales or exchanges.

[12] We agree with the conclusion you reached in your advice request, that the transactions were not sales or exchanges within the meaning of section 267(a)(1). As you note, courts have generally held that the cancellation or termination of contract rights does not constitute a sale or exchange. Leh v. Commissioner, 260 F.2d 489 (9th Cir. 1958); Commissioner v. Starr Bros., 204 F.2d 673 (2d Cir. 1953); Commissioner v. Pittson Co., 252 F.2d 344 (2d Cir. 1958); General Artists Corp. v. Commissioner, 205 F.2d 360 (2d Cir. 1953). Additionally, in a case with facts similar to those here, the Court of Claims held that a loss was not a loss from a sale or exchange but a loss occasioned by death. National Metropolitan Bank v. United States, 111 F.Supp. 422, 427 (Ct. Cl. 1953).

[13] Furthermore, as you also note, precedent in the Tenth Circuit, where petitioners resided when they filed their petition, does not favor the government. Although an early case, Jones v. Corbyn, 186 F.2d 450 (10th Cir. 1950), established precedent that favors the government, a later case undercuts the holding in Jones. Wiseman v. Halliburton Oil Well Cementing Co., 301 F.2d 654 (10th Cir. 1962). Indeed, as you further note, the Tenth Circuit went on to reverse its position in Jones. Elliott v. United States, 431 F.2d 1149 (10th. Cir. 1970).

[14] We conclude that this case presents severe litigating hazards. Furthermore, based on the case law cited above, we are not certain that the government's position is correct. We therefore have no objections to your conceding the case. If you have any questions or need more information, contact Michael A. Nixon at 622-7920.