Fender v. US
1978 U.S. App. LEXIS 9829, 577 F.2d 934, 42 A.F.T.R.2d (RIA) 5552 (1978)
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Rule of Law:
A tax loss deduction under I.R.C. § 165 is disallowed for a sale and subsequent repurchase of an asset if the taxpayer maintained sufficient dominion and control over the buyer to ensure the repurchase, thereby eliminating any genuine economic risk and rendering the sale not bona fide.
Facts:
- In 1969, two trusts managed by Harris R. Fender had significant capital gains they wished to offset for tax purposes.
- To generate a loss, Fender arranged for the trusts to sell an installment of unrated Bender Road Improvement District bonds, which had declined in market value.
- On December 26, 1969, the trusts sold the bonds to the Longview National Bank & Trust Company, where Fender and the trusts collectively owned 40.7% of the stock, the largest single block.
- Fender had a strong relationship with the bank, having recently assisted it with significant financial difficulties, and another bank where he lacked such influence had refused to purchase the bonds.
- The bank's president testified that the transaction was an "accommodation" to Fender with the understanding that the bonds would be repurchased.
- On February 6, 1970, 42 days after the sale, the trusts repurchased the same bonds from the bank for a nearly identical price.
Procedural Posture:
- The Fender trusts claimed a loss deduction on their 1969 federal income taxes from the sale of the Bender Bonds.
- The Internal Revenue Service disallowed the deduction and assessed additional taxes.
- The trusts (plaintiffs) filed suit against the United States (defendant) in the United States District Court for the Eastern District of Texas, seeking a refund of the taxes paid.
- The district court, as the court of first instance, found for the plaintiffs and ordered a refund.
- The United States (defendant-appellant) appealed the district court's decision to the United States Court of Appeals for the Fifth Circuit.
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Issue:
Does a sale and subsequent repurchase of municipal bonds generate a deductible tax loss under I.R.C. § 165 when the seller exercises sufficient dominion and control over the buyer to remove any real risk of being unable to repurchase the asset?
Opinions:
Majority - Ainsworth, J.
No. The sale and repurchase of the bonds does not generate a deductible tax loss because the transaction was not a bona fide sale that resulted in a genuine economic loss. For a loss to be deductible under I.R.C. § 165, it must be bona fide, a determination governed by substance over form. The central question is whether the taxpayer was exposed to a real risk of not being able to repurchase the assets and thus recover the apparent loss. Here, even without majority stock ownership, the taxpayers exercised sufficient dominion and control over the Longview Bank to remove any substantial risk of being unable to repurchase the bonds. This control was demonstrated by the taxpayers' 40.7% stock ownership, Fender's personal influence over the bank's management, the bank president's testimony that the deal was an accommodation, and the fact that another bank without such a relationship refused the transaction. Because the taxpayers could ensure the recapture of the bonds, they did not suffer the real economic loss required for a deduction.
Analysis:
This decision reinforces the 'substance over form' doctrine in tax law, particularly concerning the requirement that a loss be 'bona fide' to be deductible. The court clarified that the statutory disallowance for sales to related parties (I.R.C. § 267) is not the exclusive basis for denying a deduction. It established that informal but effective control over a 'sympathetic vendee' can invalidate a loss, even when the seller owns less than 50% of the buyer. This precedent requires courts to scrutinize the entire context of a transaction, including personal relationships and informal understandings, to determine if a taxpayer truly and permanently parted with an asset and its associated economic risk.
