## Facts

- Utah Fuel Co. had outstanding mortgage indentures secured by its stock.
- The indentures required Utah Fuel to reimburse the indenture holders (or others enforcing the security) for “costs and expenses” incurred in any foreclosure or sale of the pledged stock following default.
- Utah Fuel entered bankruptcy proceedings.
- During the bankruptcy proceedings, the pledged stock was foreclosed upon and sold, and the foreclosing parties incurred foreclosure and sale expenses (including professional fees and other sale-related costs).
- Denver & Rio Grande Western Railroad Co. (D&RGW) emerged from the bankruptcy reorganization as the successor and assumed Utah Fuel’s obligations under the indentures.
- After the reorganization, D&RGW reimbursed the foreclosing parties for the foreclosure and sale expenses pursuant to the indenture reimbursement clause.
- D&RGW claimed current deductions for these reimbursements as ordinary and necessary business expenses under I.R.C. § 162(a).
- The Commissioner disallowed the deductions, treating the payments as nondeductible capital expenditures (or otherwise not currently deductible), and determined tax deficiencies.
- D&RGW petitioned the United States Tax Court for redetermination.

## Issues

1. Whether D&RGW’s payments reimbursing foreclosure and sale expenses—made pursuant to indenture obligations assumed in the reorganization—were deductible as ordinary and necessary business expenses under I.R.C. § 162(a).
2. Whether the reimbursements instead had to be capitalized under I.R.C. § 263 as part of the cost of acquiring or retaining a capital asset in the reorganization.

## Decision

- The Tax Court held for D&RGW.
- The court concluded the reimbursements were deductible as ordinary and necessary business expenses under § 162(a).
- The court rejected the Commissioner’s position that the payments were required to be capitalized as part of an acquisition cost.
- The Commissioner’s deficiency determinations were not sustained to the extent they depended on disallowing these deductions.

## Legal Principles

- Deductibility turns on the nature and purpose of the expenditure: a payment made to satisfy a contractual liability may be an ordinary and necessary expense even if the liability was assumed in a reorganization.
- Not every payment connected in time to a reorganization is a capital outlay; capitalization generally requires a close link between the expenditure and the acquisition, creation, or improvement of a capital asset.
- Reimbursements of third-party costs (such as foreclosure and sale expenses) required by an assumed agreement can be treated as current business expenses when they function as the discharge of a liability rather than additional purchase price for property.
- The fact that an obligation is assumed as part of a restructuring does not automatically convert later payments on that obligation into capital expenditures; the court looks to whether the payment produced a capital asset or was simply the cost of meeting an existing duty.

## Conclusion

The Tax Court ruled that D&RGW’s payments reimbursing foreclosure and sale expenses required under Utah Fuel’s mortgage indentures, which D&RGW assumed in the bankruptcy reorganization, were ordinary and necessary business expenses deductible under § 162(a) rather than capital expenditures required to be capitalized under § 263.


Denver & Rio Grande Western Railroad Co. v. Commissioner, 38 T.C. 557 (1962)