The Ninth Circuit Court of Appeals has held in Kurt Sollberger v. Commissioner (No. 11-71883) that a purported nonrecourse loan constituted a sale of the property that was collateral related to the loan.
The case involved an individual (Sollberger) who sold stock (the sold shares) to an employee stock ownership plan for approximately $1 million and sought to defer his capital gain under Section 1042 by using the sales proceeds to purchase certain floating rate notes (FRNs) with a face value equal to $1 million.
The FRNs were notes issued by Bank of America and provided for variable rate interest that was paid quarterly to their holder. Sollberger then entered into a master loan financing and security agreement (the agreement) with Optech Limited (Optech). Under the agreement, Optech loaned $900,000 to Sollberger as a nonrecourse loan (the loan) that was secured by the FRNs. The loan had a maturity term of seven years and provided for quarterly interest payments from Sollberger to Optech (the loan interest).
Sollberger agreed to transfer the custody of the FRNs to Optech as collateral for the loan, and Optech had the right to sell or dispose of the FRNs during the loan term without giving notice to Sollberger and without his consent. Optech agreed to return the FRNs to Sollberger at the end of the loan term if Sollberger repaid the loan in full including any amount of outstanding loan interest and late penalties.
Optech had the right to receive the interest payments related to the FRNs and apply them against the loan interest that Sollberger would owe to Optech. Sollberger initially paid the excess of the loan interest and the FRN interest, but Sollberger stopped making such payments after the first quarter of 2005.
The IRS determined that Sollberger sold the FRNs upon entering into the loan, and determined his gain to be equal to $852,251 (i.e., the amount of the loan, $900,000 less Sollberger's basis in the sold shares, $47,749). Sollberger did not report such sale on his 2004 tax return.
The court held that the loan should be treated as a sale of the FRNs by Sollberger to Optech based on the substance and economic reality of the loan. The court looked at the 1981 Tax Court case, Grodt & McKay Realty, Inc. v. Commissioner (77. T.C. 1221). Grodt & McKay established certain factors to determine whether there was a sale of cattle, including:
- whether the legal title passed;
- how the parties treated the transaction;
- whether an equity was acquired in the property;
- whether the contract creates a present obligation on the seller to execute and deliver a deed, and a present obligation on the purchaser to make payments;
- whether the right of possession is vested in the purchaser;
- which party pays the property taxes;
- which party bears the risk of loss or damage to the property; and
- which party receives the profits from the operation and sale of the property.
While the court in Sollberger considered the Grodt factors, the court also stated: "Although we agree that these criteria may be relevant in a particular case, we do not regard them as the only indicia of a sale that a court may consider. . . . To determine whether a sale occurs for tax purposes, we continue to apply a flexible, case-by-case analysis of whether the benefits and burdens of ownership have been transferred."
Thus, the court based its decision on the "economic reality" of the loan, and concluded that the loan constituted a sale of the FRNs because:
- Sollberger transferred the FRNs to Optech;
- Optech was given the right:
- to sell the FRNs,
- to transfer the registration of the FRNs to its name, and
- to keep all interest due from the FRNs; and
- Sollberger would not be personally liable if he did not make payment on the loan, because it was a nonrecourse loan.
The court further noted that the loan was akin to an option rather than a loan.
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