Loans Advances by controlled corporation Advance to investors; development of oil and gas leases.

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1 348.1 Advances by controlled corporation. An executive and principal stockholder borrowed funds for the operation of a farm from his controlled corporations, giving them non-interest bearing notes which were reduced through payments and salary credits and ultimately cancelled when the farm was transferred to the corporations. Held, the borrowed funds were bonafide loans and not constructive dividends. (Secs. 312, 316; 86 V. H. Monette & Co., 45 T.C. 15, Acq., C.B Advance to investors; development of oil and gas leases. A group of investors contracted to sell natural gas from its leases to a gas company pursuant to an agreement calling for the interestfree advance of money by the purchaser to develop the leases. No income is realized by a cash method member of the group as a result of the loan. (Sec. 61, 86 Charles E. Marsh, 73 T.C. 317, Nonacq., Advances to clients; business bad debts. Taxpayer, a minority shareholder in the client s business, loaned funds to the client that later became insolvent. Held, the loans were related to the taxpayer s advertising business and the losses thereon were deductible as business bad debts. The loans were made to retain the client, hold other clients who advertised in the insolvent s publication, and to maintain the taxpayer s credit and reputation. (Sec. 23(k), 39 Code; Sec. 166, 86 Stuart Bart, 21 T.C. 880, Acq., C.B Advances to shareholder; bona fide indebtedness. A 50% shareholder withdrew from the corporation over a 5-year period advances totaling in excess of $500,000 evidenced by cumulative non-interest-bearing notes and carried on the corporate books as accounts receivableofficers. The corporation subsequently filed a petition in bankruptcy including in its liabilities an agreed income tax deficiency. Held, the advances were bona fide loans, not constructive dividends; the promises to pay constituted fair consideration under State law thereby relieving the shareholder of transferee liability for the corporate tax obligation. (Acq. in result as to the loan; Acq. as to the transferee liability.) (Secs. 301, 316, 6901; 86 James K. Pierce, 61 T.C. 47, Acq. in result, Acq., Advances to stockholders; controlled corporations. Taxpayer gave non-interest bearing notes for money borrowed from their controlled personal holding company. Held, had interest been paid it would have been deductible; therefore, taxpayers realized no income. (Sec. 301, 86 J. Simmon Dean, 35 T.C. 1083, Nonacq., C.B. 4.

2 348.6 Advances to subsidiary. A whollyowned subsidiary was organized to take over an area of the existing business of its parent which furnished capital to cover a large portion of taxpayer s fixed assets and advanced funds on open account to cover taxpayer s inventory requirements. The advances were initially without interest, but in later years interest was required. Held, under all the circumstances, the advances represented bona fide indebtedness and the interest paid was a proper deduction. (Sec. 163, 86 Malone & Hyde, Inc., 49 T.C. 575, Acq., Bad debt reserve ceilings; small business investment companies. Small business investment companies are allowed bad debt reserve ceilings equal to ten percent of their outstanding loans as reasonable reserves for a period of ten years beginning with 1959, after which the loss experience will be used to determine the reasonableness of further additions to the reserve. After 1968 an average loss experience of the small business investment industry will be used as a basis for such reserves as to a new company or one which is without adequate loss experience data. Clarified to provide that reserves for bad debts in excess of ten percent may be established where reasonable (Sec. 166, 86 Rev. Rul , (Part 1) C.B. 104; Rev. Rul , C.B Bad debt reserves; charged off during taxable year. In determining the annual additions to the reserve for bad debts of a bank, loans outstanding computed at the close of the taxable year do not include loans charged off against the reserve for bad debts during the taxable year (Sec. 166, 86 Rev. Rul , C.B Bad debt reserves; Commodity Credit certificates; banks. Certificates of interest issued by the Commodity Credit Corporation held by commercial banks are considered 100 percent Government guaranteed loans and should be entirely eliminated by such banks from their prior years accounts in computing percentages of their past bad debt losses, and also from their current year loans in computing allowable deductions for additions to their reserves for bad debts. Modified by Rev. Rul to remove reference to Mim and substitute in place thereof reference to Rev. Rul for taxable years ending after (Sec. 166, 86 Rev. Rul , C.B Bad debt reserves; FHA and VA loans; building and loan associations. Residential real property loans insured by the FHA or guaranteed by the VA are qualifying real property loans of a domestic building and loan association to be included in determining the limitation on bad debt reserves additions (Sec. 593, 86 Rev. Rul , C.B Bad debt reserves; FHA and VA mortgages warehoused; mutual savings banks. A mutual savings bank, part owner of a trust company that is required to purchase VA and FHA mortgages on behalf of the bank with the commitment that the bank will repurchase the mortgages (except any in default) within a specified period or assume any loss suffered by the company, is considered the owner of the mortgages and may include them in its real property loan base in computing its addition to reserve for bad debts (Sec. 593, 86 Rev. Rul , C.B Bad debt reserves; hold-back accounts; banks. In computing annual additions to bad debt reserves, a bank is required, in the case of outstanding installment paper discounted to the bank by certain dealers, to decrease the face amount of the installment paper by the amount of any discount not included in gross income and the amount of any hold-back account. Modified by Rev. Rul to remove reference to Mim and Rev. Rul and substitute in place thereof reference to Rev. Rul for taxable years ending after Clarified by Rev. Rul (Sec. 166, 86 Rev. Rul , C.B Bad debt reserves; includable loans; affiliated corporations. Reg (d) prohibits an affiliated group filing a consolidated Federal income tax return from claiming a current deduction under section 166(c) for additions to reserves for bad debts computed under section 585 to the extent that such additions relate to loans from a member of the group that is a bank to another member , , , (Secs. 166, 581, 585, 1502, 1504; 86 Rev. Rul , C.B Bad debt reserves; includable loans; banks. Banks using the uniform reserve ratio method of computing annual additions to reserves for bad debts must exclude from the loan base for taxable years ending after November 1968, interbank deposits and loans, cash collateral, unearned discount or interest receivable, government insured or guaranteed loans, investments in debt securities, and money market investments; Rev. Rul clarified, Rev. Rul supplemented. Amplified by Rev. Rul to provide that privately insured loans are eligible for inclusion. Further amplified by Rev. Rul , (Secs. 166, 585, 7805; 86 Rev. Rul , C.B , 84; Rev. Rul , C.B Bad debt reserves; mutual savings banks; FHDA notes. Certain notes evidencing long-term loans made by the Farmers Home Administration (FHDA), for purchase, construction, or repair of real property, that FHDA insures and sells under an insurance contract to a mutual savings bank, are the primary obligation of FHDA and do not evidence qualifying real property loans for purposes of computing additions to the mutual savings bank s bad debt reserve under section 593(b)(1)(B) , A. (Secs. 166, 593; 86 Rev. Rul , C.B Bad debt reserves; Title I F.H.A. loans; banks. In computing additions to a reserve for bad debts, a bank will consider Title I F.H.A. loans to be Government insured to the extent of either 90 percent of the amount of such loans outstanding (100 percent on loans prior to October, 1954) or the balance in the bank s insurance reserve account maintained by the Federal Housing Administration, whichever is less. Modified by Rev. Rul to remove reference to Mire and Rev. Rul and substituted in place thereof reference to Rev. Rul for taxable years ending after (Sec. 166, 86 Rev. Rul , C.B Bad debt reserves; Title II F.H.A. loans; banks. In computing percentages of past losses and allowable deductions for additions to a reserve for bad debts, Title II F.H.A. loans are considered 100 percent Government guaranteed loans, and should be eliminated from those computations in their entirety. Government insured loans include all Government insured or guaranteed loans to the extent insured or guaranteed and are eliminated from such computations in proportion to the percentage insured or guaranteed. Modified by Rev. Rul to remove reference to Mim and substitute in place thereof reference to Rev. Rul for taxable years ending after (Sec. 166, 86 Rev. Rul , C.B Commitment fee. In connection with the development of a low-income housing complex, a limited partnership will pay a rent-up fee to an apartment management company to obtain tenants during the rent-up period and a permanent loan commitment fee to a lender for the lender s promise to provide permanent financing upon the completion of the complex. The rent-up fee is a capital expenditure and must be amortized over the terms of the leases obtained and the permanent loan commitment fee must be capitalized and amortized over the loan term (Sec. 461, 86 Rev. Rul , C.B Commitment fee or standby charges. Commitment fees or standby charges incurred pursuant to a bond sale agreement under which funds for construction are made available in stated amounts over a specified period are deductible ratably over the term of the loan. Rev. Rul revoked , , (Secs. 162, 461, 7805; 86 Rev. Rul , C.B Commodity Credit Corporation. An election to include Commodity Credit Corporation loans in gross income in the year received must be made on a timely filed return and may not be applied retroactively. However, the fact that proceeds of prior loans were not taken into income except on the sale of the commodities does not affect the taxpayer s right to make the election (Sec. 77, 86 Rev. Rul , C.B Commodity Credit Corporation. In the case of a taxpayer who has elected to include Commodity Credit Corporation loans in his gross income for the taxable year in which the loan is received, the face amount of a certificate of interest issued by the Corporation does not constitute a loan and is not incudible in gross income until the amounts authorized by the certificate are actually disbursed to him, or as directed by him. A taxpayer who has not made this election derives income when the commodity is sold, irrespective of when the certificator the loan proceeds are received by him. Rev. Rul superseded (Sec. 77, 86 Rev. Rul , C.B Commodity Credit Corporation; cooperatives; advances to patrons. A farmers cooperative that uses the open pool method of accounting elected to include in income price support loans received from the Commodity Credit Corporation (CCC) to cover advances paid to its patrons and other costs. The patrons included the advances in income. The cooperative is deemed to have sold the crop to the CCC and may deduct the advances as costs of products sold , (Secs. 77, 1381; 86 Rev. Rul , C.B Commodity Credit Corporation; cotton producer. The amount of an unpaid loan from the Commodity Credit Corporation to a cotton producer, who has not elected under section 77 to treat the loan as income in the taxable year received, is includable in his gross income in the year in which his inability on the loan is discharged by transferring to the Corporation his ownership of the cotton pledged as security. Any additional amount realized by the producer from the Corporation s sale of the cotton for more than the amount owed is includable in his income in the taxable year received if he uses the cash method or the year his right to the amount becomes fixed if he uses the accrual method. I.T superseded (Sec. 451, 86 Rev. Rul , C.B. 141

3 Commodity Credit Corporation; election; extension of time. Procedures are established for taxpayers to receive a 90-day extension of time for applying for a change in method of accounting under regs , 1.381(c)(4) 1(d)(2) or 1.381(c)(5) 1(d)(2), or for submitting a request for consent to make an election under section (b), (b) or (c)(3)(ii) , 1.381(c)(4)-1, 1.381(c)(5)-1, , , , (Sec , S.P.R.; Secs. 77, 381, 446, 455, 456, 461, 86 Rev. Proc , C.B Commodity Credit Corporation; wheat pledged as collateral. A cash method wheat farmer obtained a loan from the Commodity Credit Corporation pledging that year s crop as collateral. The farmer elected under section 77 to include the loan proceeds in gross income. The next year the loan was repaid and the crop pledged as collateral was redeemed. Thirteen months later, the redeemed crop was sold at a price that exceeded the amount of the loan. The crop was not a capital asset, and the excess sale price for the crop over its basis, as adjusted under section 1016(a)(8), is includible in the farmer s gross income as ordinary income , , , (Secs. 61, 77, 1016, 1221; 86 Rev. Rul , C.B Construction; business improvements; insurance premiums. Insurance premiums paid in connection with a construction loan for business improvements may, at the election of the taxpayer, be capitalized. Such an election is binding until the improvements covered by the loan are completed (a)-6. (Sec. 24(a), 39 Code; Sec. 266, 86 Rev. Rul , C.B Constructive repayment; stockholder s obligation paid by corporation. To acquire the corporation s land contract, two individuals purchased all the taxpayer s stock from a stockholder s group which was paid in part by funds loaned the corporation by the new owners. Held, payments to the previous stockholders to the extent of indebtedness owing by the corporation to the new stockholders, were not taxable as dividends. (Sec. 115(a), 39 Code; Secs. 301, 316, 86 Garden State Developers, Inc., 30 T.C. 135, Acq., C.B Controlled corporation; dividend v. loans. Taxpayer maintained a running non-interest bearing loan account with his wholly-owned corporation. Eventually he executed a non-interest bearing note payable to the corporation for the account balance. The total withdrawals greatly exceeded the corporation s earned surplus and the corporation declared no formal dividends prior to its liquidation. Held, the corporation s loan receivable account was not used to disguise dividend distributions. (Sec. 115(a), 39 Code; Secs. 301, 316, 86 Victor Shaken, 21 T.C. 785, Acq., C.B Copyright holder to composer. A composer assigned copyrights to subsidiaries and their parent loaned him $50,000 for which he executed ten $5,000 non-interest-bearing notes payable one a year for 10 years. The first note was paid by applying $5,000 of royalties due him in the year of the loan. Held, the $50,000 was a loan, not advance royalties, except to the extent of the royalties earned and applied to the note. (Sec. 61, 86 Harold Arlen, 48 T.C. 640, Acq., C.B Corporation; advances by shareholders; bona fide debt. The sole shareholders of a corporation advanced funds to the corporation in the form of loans. All advances, which were repaid after production started, were represented by notes with a fixed maturity date and interest rate. The transfer of the notes was not restricted nor were they subordinated to the claims of creditors. Held, the advances constituted bona fide loans not contributions to capital, the repayments were nontaxable to the shareholders and the interest paid was deductible by the corporation. (Secs. 163, 385; 86 Anthony Mennuto, 56 T.C. 910, Acq., CPI adjustment for below market loans; The amount that section 7872(g) permits a taxpayer to lend to a qualifying continuing care facility without incurring imputed interest is published and adjusted for inflation for the years 1987 through Rev. Rul supplemented and superseded. (Sec. 7872, 86 Rev. Rul , C.B Deposit for property exchanged. Taxpayer held an option to purchase certain real property that another corporation wished to acquire. The second corporation advanced taxpayer the funds necessary to purchase the property and, upon the purchase, exchanged another parcel of real property subject to an existing mortgage for the desired property and cancelled taxpayer s indebtedness. Held, the transaction was a valid exchange of property within the meaning of section 1031; the funds advanced to taxpayer constituted a valid loan rather than consideration for the property exchanged. (Nonacq. as to the exchange; Acq. as to the loan.) (Sec. 1031, Front Street, Inc., 65 T.C. 6, Acq., Discounted sale; gain or loss. A savings and loan association sold loan accounts at a discount resulting in a loss. Held, the loans were notes receivable acquired for services rendered in the taxpayers course of business and the loss was an ordinary, not a capital loss. (Sec. 1221, 86 United Associates, Inc., 39 T.C. 999, Acq., C.B Evidence of loan destroyed by fire. Documentary evidence to substantiate a loan made by the taxpayer was destroyed and the borrower disappeared after the loan was made. Held, taxpayer s testimony that a loan was made, that the debt had value when created, and that the debt became worthless in the year claimed was accepted and a short-term capital loss deduction of the loan amount was allowed. (Sec. 166, 86 I. Hal. Milkap, Jr., 46 T.C. 751, Acq., Evidenced by convertible debentures; small business investment companies. Loan agreements which are evidenced by numbered convertible debentures payable to a company licensed under the Small Business Investment Act or to its registered assigns, or which require that such debentures be fully registered, are securities as defined in section 165(g)(2)(C); therefore, section 166 relating to bad debts does not apply to debts evidenced by such loan agreements by reason of section 166(e). However, under section 1243, losses from the sale, exchange, or worthlessness of convertible debentures shall be treated as ordinary losses , , (Secs. 165, 166, 1243; 86 Rev. Rul , C.B Evidenced by mortgage bond. Expenses incidental to securing a loan evidenced by a mortgage bond are not deductible in the year in which the loan is made but must be prorated over the life of the bond. S.M superseded , (Secs. 162, 461; 86 Rev. Rul , C.B Family corporation; bad debt. The taxpayer loaned $92,350 to a corporation controlled by her then husband, for which she took demand notes. In 1944 she was divorced from her husband and received $2,500 in settlement of the notes from the corporation, which had become insolvent prior to that year. Held, the notes were not totally worthless prior to 1944; the settlement was at arm s length and not part of a marital property settlement, and the taxpayer sustained a nonbusiness bad debt loss in (Sec. 23(k), 39 Code; Sec. 166, 86 Miriam C. Pierson, 27 T.C. 330, Acq., C.B FHAor VA mortgages. A lending institution which originates or purchases FHA or VA mortgage loans for sale or resale to permanent investors for the primary purpose of obtaining the servicing contracts may not inventory such mortgages since it does not qualify as a dealer in securities either with respect to the mortgages it originates or with respect to the mortgages it purchases. Further, the discount, so-called points, allowed the institution for making such loans is not includable in gross income the year the mortgage is originated. Modified by Rev. Rul to provide that a dealer in securities may inventory mortgage loans that it originates , , (Secs. 451, 471, 1236; 86 Rev. Rul , C.B FHA orva mortgages; foreclosure by insurance company. A mutual life insurance company s foreclosure on mortgages insured by FHA or guaranteed by VA and the subsequent transfer of the properties to the agencies for amounts exceeding its basis results in income includible in gross investment income and not gains from sale or exchanges of capital assets , (Secs. 804, 1222; 86 Rev. Rul , C.B FHLMC participation certificates. The tax consequences of the purchase of mortgage participation certificates from an insured savings and loan association by the Federal Home Loan Mortgage Corporation (FHLMC) and the sale of corresponding participation sales certificates to other savings and loan associations and exempt employees trusts are set forth , , , 1.501(a)-1, , , , , , A. (Secs. 61, 162, 451, 501, 593, 671, 856, 1232, 7701; 86 Rev. Rul , C.B. 433; Rev. Rul , C.B. 647; Rev. Rul , C.B. 365; Rev. Rul , C.B. 169; Rev. Rul , C.B. 317; Rev. Rul , C.B FNMA participation certificates. Participation certificates which may be sold by the Federal National Mortgage Association pursuant to the Participation Sales Act of 1966 are stock or obligations of an instrumentality of the U.S. for purposes of section 7701(a)(19)(C)(ii), relating to the definition of a domestic building and loan association. A participation certificate so issued is either stock or a security as that term is defined in section 165(g)(2)(C) and is not, therefore, a qualifying real property loan under section 593(e)(1) , , (Secs. 165, 593, 7701; 86 Rev. Rul , C.B Foreclosure by mutual savings bank; FHA and VA mortgages. A foreclosure by a mutual savings bank of a property mortgage insured by FHA or guaranteed by VA is not a taxable event and no gain or loss is recognized by the bank when the security is subsequently transferred to FHA or to VA in order to recover the mortgage insurance. The bad debt loss is recognized at the completion of the transaction when FHA payment

4 is received by the mortgagee, or when a final determination of liability is made by VA (Sec. 166, 86 Rev. Rul , C.B Guaranteed as condition of employment. An employee who, as a condition of his employment, guaranteed a loan obtained by an officer of his corporate employer is entitled to a business bad debt deduction when the loan becomes worthless in his hands (Sec. 166, 86 Rev. Rul , C.B Guaranteed by sole stockholder; interest deduction. Interest paid by the sole stockholder of a corporation on a real estate loan obtained by the corporation and secured by a mortgage on its real estate is not deductible by the stockholder even though he guaranteed the prompt payment of all the obligations under the loan including interest (Sec. 163, 86 Rev. Rul , C.B Home mortgage; loan charge incurred by seller. A loan charge, points or loan placement fee, paid by the seller of a residence as a condition to the arrangement of F.H.A. financing terms for the buyer of his house, is not deductible as interest; such charge is considered a selling expense that reduces the amount realized , (Secs. 163, 1001; 86 Rev. Rul , C.B Home mortgage; origination fee (points). The loan origination fee ( points ) paid by a taxpayer to a lending institution in connection with the acquisition of a home mortgage loan guaranteed by the VA is a charge for services rendered and is not deductible as interest. It is not to be taken into account in computing the taxpayer s gain or loss upon a subsequent sale or exchange , (Secs. 163, 1012; 86 Rev. Rul , C.B Indemnifying payments; loan to sever business relationship. Indemnifying payments made by a guarantor of a loan to his partner in a partnership are not deductible where the proceeds of such loan were used to purchase the guarantor s partnership interest. The decision in Max Axelrod will not be followed (Sec. 166, 86 Rev. Rul , C.B Interest; accounting methods; Rule of 78 s. A permissible method of accounting is set forth for interest on short-term consumer loans when the terms of the indebtedness state that interest is earned in accordance with the Rule of 78 s , , (Sec , S.P.R.; Secs. 163, 451, 461, 86 Rev. Proc , C.B Interest; accounting methods; Rule of 78 s. Even though a loan agreement provides that interest shall be earned in accordance with the Rule of 78 s, no deduction for interest will be allowed for any year in excess of the economic accrual of interest. Rev. Ruls and modified and superseded; Rev. Ruls and modified; Rev. Rul clarified , , , (Secs. 163, 446, 451, 461; 86 Rev. Rul , C.B Interest; below-market rates. For purposes of section 1274(d), relating to certain transactions in which a debt instrument is issued for property, tables set forth the applicable federal short-term, mid-term, and long-term rates for each six-month period ending as indicated. (Secs. 280G, 467, 468, 483, 1274, 7872; 86 Rev. Rul , C.B. 179, (6/84) Rev. Rul , C.B. 179, (12/84) Rev. Rul , C.B. 179, (6/85) Rev. Rul , C.B. 287, (12/85) Rev. Rul , C.B. 186, (6/86) Interest; commitment fee; assumption of construction loan. A commitment fee, paid by a lending bank to the Federal National Mortgage Association in connection with the assumption of an accrual method taxpayer s construction loan and withheld by the bank from the face amount of the loan proceeds received by the taxpayer, is deductible by the taxpayer as interest. If the loan instrument is silent as to what portion of each loan payment is discounted interest, the fee must be deducted ratably by the taxpayer over the entire period of the loan unless the loan instrument requires that prepaid interest is subject to the Rule of 78 s. Rev. Rul distinguished. Modified by Rev. Rul , (Secs. 163, 461; 86 Rev. Rul , C.B Interest; life insurance policy; when deductible. Interest deducted in advance from the amount of a life insurance policy loan, or due and unpaid interest added to the principal of the loan, is deductible as interest paid by a calendar-year, cash-method taxpayer only for the taxable year in which actual payment is made. Rev. Rul distinguished , (Secs. 163, 461; 86 Rev. Rul , C.B Interest; original issue discount on 50-year note; financial plan; deposit required; payment for services. A corporation may not deduct the ratable share of original issue discount on a 50-year note under a financial plan that required the corporation to deposit 150 percent of the loan amount with the lender-trust for 20 years. Likewise, a corporation may not deduct the original issue discount on a 50-year note under a financial plan that was part payment for financial planning techniques , (Secs. 163, 1232; 86 Rev. Rul , C.B Interest refund on credit union loan; cash-method taxpayer. A refund of interest received by a cash-method taxpayer in the same taxable year that the interest was paid reduces the interest expense deduction; if received in a subsequent taxable year the refund is includible in gross income unless excludable under section , (Secs. 111, 163; 86 Rev. Rul , C.B Limited partner s interest; basis; nonrecourse loan guaranteed by general partner. A limited partner s basis is not increased by a share of the limited partnership s liability when the general partner has personally guaranteed a loan to the partnership, nor is the limited partner under any obligation to make additional capital contributions to the limited partnership (Sec. 752, 86 Rev. Rul , C.B Limited partnership; advance of funds by nonmember. A so-called loan to a limited partnership by a nonmember, secured by partnership properties and the right to convert the loan for an interest in the partnership profits, is a capital investment in the venture representing the lender s equity interest. It is not considered a bona fide debt but is an equity interest in the venture belonging to the lender. The advance of the funds will have no effect on the bases of the partnership interests of the other parties (Sec. 705, 86 Rev. Rul , C.B Limited partnership; loan from one partner to another. A partnership, a limited partner in another partnership whose general partner was a corporation, received a distribution from the limited partnership and a loan from the parent of its partner at the time that a group of investors acquired a portion of the corporation s interest in the limited partnership under conditions favorable to the corporation. Held, the transaction between the partnership and the corporation s parent constituted a valid loan. Further held, the distribution received from the limited partnership was not taxable as ordinary income. Further held, a loan from the new partners to the limited partnership increased the partnership s basis in the limited partnership to an amount sufficient to prevent any of the distribution from being taxed as capital gain. (Nonacq. to the valid loan, Acq. to the other issues.) (Secs. 702, 731; 86 Milton Falkoff, 62 T.C. 200, Acq. & Nonacq.; C.B Limited partnership; nonrecourse loan by general partner. A nonrecourse loan made by a general partner of a limited partnership to a partnership or to limited partners on the basis of their subscription interest is a contribution to capital to be added to the basis of the general partner s interest in the partnership (Sec. 722, 86 Rev. Rul , C.B Loan processing fee; paid to obtain mortgage loan. A loan processing fee (points) paid by a mortgagor-borrower as compensation to a lender solely for the use or forbearance of money is considered to be interest. Further, a loan processing fee is deductible in full in the year of payment. Rev. Rul modified and Rev. Rul amplified (Sec. 163, 86 Rev. Rul , C.B. 54; Rev. Rul , C.B Membership fees; refundable less delinquent dues. A swimming school operator collects membership fees from members in order to build a new pool. If any member defaults in the payment of his dues, such amount is deducted from his membership fee. The membership fee, minus any deductions, is to be refunded to each member within five years after the pool is put into use. The membership fee arrangement is considered to be a loan since the owner had an obligation to refund. However, any amount deducted from the fee for delinquent dues is gross income derived from business. Distinguished by Rev. Rul (Sec. 61, 86 Rev. Rul , C.B Mortgage; unstated interest. Where a house is purchased from a party who is in the trade or business of selling houses, with a portion of the purchase price represented by a note with no specified interest payable over 84 months, section 483 applies to the purchaser, who will be entitled to a deduction under section 163 for the imputed interest payments to the seller. Where the house is purchased from a party not in the trade or business of selling houses, section 483 applies to both the purchaser and seller. In both situations, the purchaser s basis in the house must be reduced by the amount of interest allocated (Sec. 483, 86 Rev. Rul , C.B Mortgage acquisition costs; commissions to brokers. Finders fees (buying commissions) paid to brokers, title companies, and other third parties by banks in connection with the placement of mortgage loans constitute a part of the mortgage acquisition cost to recapitalized and amortized over the lives of the applicable mortgage loans (b)(1)-4. (Sec. 113(b), 39 Code; Sec. 1016, 86 Rev. Rul , C.B. 520.

5 Mortgage-backed certificates; residential pools. Tax consequences associated with straight pass-through mortgage-backed certificates, representing undivided interests in a pool of residential mortgage loans created by the Federal National Mortgage Association and sold to investors are explained. Rev. Ruls and clarified , , , , , , , , , A. (Secs. 61, 162, 171, 212, 593, 671, 856, 1232, 1232A, 7701; 86 Rev. Rul , C.B Mortgage commitment fee. The nonrefundable fee a corporation paid, under a loan agreement for construction and permanent mortgage financing and on or before initial receipt of funds, as compensation for the cost of specific legal, architectural, and engineering services incurred by the lender is a cost to be deducted ratably over the duration of the loan (Sec. 461, 86 Rev. Rul , C.B Mortgage premium; FHA insured; amortization. The Bayshore Gardens, Inc. decision involving the amortization of the premium received by an accrual method taxpayer from a lending bank in connection with a FHA insured loan, which was secured by a mortgage note, will be followed (a)-17, 39.22(a)-17. (Sec. 22(a), 39 Code; Sec. 61, 86 Rev. Rul , C.B Premium charge; Pennsylvania savings and loan association. A premium charge of one half percent per annum authorized by section 5901 of the Pennsylvania Building and Loan Code, for the privilege of being granted a loan by a Pennsylvania savings and loan association is deductible as interest (Sec. 163, 86 Rev. Rul , C.B Premium on mortgage; property sold in bankruptcy. The taxpayer secured non-interest bearing notes with a first mortgage on real property. The borrower, after partially reducing the principal, defaulted and was forced into involuntary bankruptcy where the property was sold subject to the mortgage. Held, the principal balance was not received and is not includible in the taxpayers income. (Sec. 61, 86 Edna Morris, 59 T.C. 21, Acq., C.B Real estate mortgages; Government insured; banks. Gains or losses resulting from continuing and substantial sales by a bank of F.H.A. and VA insured mortgages, for the purpose of obtaining additional funds with which to cover increasing demands for loans, are considered ordinary gains or losses rather than gains or losses from the sales of capital assets , (Secs. 582, 1221; 86 Rev. Rul , C.B Real estate mortgages; points; accrual-method lender. Points representing interest in construction loans received by an accrual-method taxpayer engaged in making such loans, either discounted from the loan proceeds with no rebate for prepayment or repaid at the end of the loan, are includable in gross income ratably on a straightline basis over the life of the loan unless they are received or become due earlier. Rev. Rul clarified and Rev. Rul amplified. Clarified by Rev. Rul (Sec. 451, 86 Rev. Rul , C.B Real estate mortgages; points, commitment and service fees. Examples illustrate the rule for determinating the taxable year in which leading institutions should include in their income the points, commitment fees, and service fees charged by them in connection with real estate mortgage loans. Amplified by Rev. Rul (Sec. 451, 86 Rev. Rul , C.B Real property; acquired by foreclosure; gain on sale; building and loan association. Amounts realized upon the sale of real property previously acquired by foreclosure by a domestic building and loan association using the reserve method of computing bad debts, which are in excess of the adjusted basis of such property and are credited to the appropriate bad debt reserve account, in accordance with reg (e)(6)(i), would not be reflected in earnings and profits accounts of the taxable year of sale or in accumulated earnings and profits accounts after December 31, However, such amounts would be reflected in gross income if, in any year, the bad debt reserve account is required to be restored to gross income , , (Secs. 312, 593, 595; 86 Rev. Rul , C.B Real property; acquired by foreclosure; unpaid interest; building and loan associations. A cash-method building and loan association using the reserve method for bad debts realized interest income on its sale, for more than the adjusted basis, of a property acquired through foreclosure on a loan for which the delinquent interest had not been included in gross income or in the adjusted basis of the property. However, no interest income was realized on another property sold for less than its adjusted basis (Sec. 595, 86 Rev. Rul , C.B Real property; participating interest. Under certain circumstances, the term qualifying real property loan as defined in section 593(e) and reg (b) includes the purchase by a taxpayer, which is an organization to which section 593 applies, of a participating interest in such a qualifying real property loan (Sec. 593, 86 Rev. Rul , C.B Real property; refinanced; escrow fees; liquidation. All the corporate stock was placed in escrow to which taxpayer advanced monies to purchase one share of the stock and provide funds. The corporation refinanced its sole asset to obtain funds, redeemed the remaining shares, and deducted the loan and escrow fees incurred. Taxpayer received part of the excess advance prior to the corporation s liquidation and the balance in the year of liquidation. Held, taxpayer had no personal obligation to purchase the escrowed shares; the corporation was entitled to amortize a portion of the financing fees over the life of the loan; and the amounts distributed to the taxpayer were not liquidating dividends but loan repayments since the funds advanced by the taxpayer were loans, not capital contributions. (Secs. 161, 316; 86 Herbert Enoch, 57 T.C. 781, Acq., C.B Registered subordinated debentures. Registered subordinated debentures issued by a member firm of the New York Stock Exchange represent, under the circumstances, a valid indebtedness for income tax purposes. Interest paid or accrued on the debentures is allowable as a deduction and repayment of the debentures will not be treated as distributions with respect to stock or redemptions of stock. Distinguished by Rev. Rul , , l. (Secs. 163, 301, 302; 86 Rev. Rul , C.B REIT; deed in lieu of foreclosure; property value exceeding basis. A real estate investment trust that engaged primarily in short term financing activities, such as making Loans construction and development loans, made a construction loan to a borrower who later defaulted. The trust accepted a deed in lieu of foreclosure when the fair market value of the property exceeded the trust s basis in the mortgage note. The gain realized by the trust, the difference between its basis in the note and the value of the property, is ordinary income, and such income qualifies under section 856(c)(2)(D) and (3)(C) , , , 1.l (Secs. 61, 857, 1221, 1232; 86 Rev. Rul , C.B REIT; foreclosure; property value exceeding bid. A real estate investment trust that engaged primarily in short term financing activities, such as making construction and development loans, made a construction loan on which it later foreclosed. At the foreclosure sale the trust bid in the property for less than its fair market value. The trust s basis in the mortgage note exceeded the property s value, and the balance due on the note was wholly uncollectable. The gain realized by the trust, the difference between the fair market value of the property and the bid price, is ordinary income , , (Secs. 166, 856, 1221; 86 Rev. Rul , C.B Servicing fees; mortgage servicing contract. An accrual method mortgage company agreed with a bank to service mortgages for compensation to be finally determined on the basis of a basic rate but to be paid monthly on a level payment rate. Taxpayer accrued compensation at the basic rate but reported as income only the amounts actually received. Held, taxable income included only the amounts actually due under the level payment rate. (Sec. 451, 86 Etheridge and Vanneman, Inc., 40 T.C. 461, Acq., (Part 1) C.B Small business corporation; repayment to shareholder-creditor. Where a shareholder-creditor of an electing small business corporation has reduced his basis in the corporation s note by the amount by which his share of the corporation s net operating loss sustained in a prior year exceeded his basis in the corporation s stock, the repayment of the note (exclusive of interest) is considered to be an amount received in exchange for a capital asset, where the note is a capital asset in the shareholder s hands. Installments received in retirement of the note must be allocated in part to a return of the shareholder s basis in the loan and in part to income , (Secs. 1232, 1376; 86 Rev. Rul , (Part 1) C.B Small business corporation; repayment to shareholder-creditor. A shareholdercreditor of an electing small business corporation derives ordinary income from the repayment of a loan made on open account to the extent that the repayments exceed his basis in the loan (Sec. 1376, 86 Rev. Rul , C.B Student; interest paid by bank to State. Interest paid on student loans to a commercial bank by a State or political subdivision is not excludable from the bank s gross income (Sec. 103, 86 Rev. Rul , C.B Student; interest paid by cosigner. Interest paid by a student s father on a loan made to a student, evidenced by a negotiable promissory note cosigned by the father, is deductible by the father for the taxable year in which it is paid (Sec. 163, 86 Rev. Rul , C.B Thin corporation. The principal shareholder in a corporation formed to develop his property enabled the corporation to complete the project by advancing funds in exchange for inter-

6 est bearing notes with definite due dates which were retired within a year of issuance. Held, the advancements were bona fide loans with the deductible interest, not capital contributions with distributions of dividends. (Secs. 61, 163; 86 Lots, Inc., 49 T.C. 541, Acq., Withdrawals by controlling shareholders. Withdrawals from a wholly owned corporation by shareholders, who were amply able to repay, to discharge the debt incurred in purchasing the stock of such corporation were loans, not dividends. (Sec. 115(a), 39 Code; Sec. 301, 86 Isadore Benjamin, 28 T.C. 101, Acq., C.B Withdrawals by controlling shareholders. Taxpayers withdrew money from their wholly-owned corporation using loan accounts that revealed a history of repayment of the unsecured amounts without interest for substantial portions of the sums withdrawn, which were not in proportion to ownership interest. Held, the amounts withdrawn were loans, not dividends. (Sec. 316, 86 Joseph Miele, 56 T.C. 556, Acq., C.B.