## Facts

- James J. and Laura Gehl, Iowa farmers, owed a recourse loan to Production Credit Association of the Midlands secured by mortgages on a 218-acre farm; the balance was $152,260 as of December 30, 1988.
- The Gehls were insolvent before, during, and after the restructuring and were not in bankruptcy.
- Under a restructuring to avoid foreclosure, the Gehls transferred farm parcels to the lender by deeds in lieu of foreclosure:
  - On December 30, 1988, they conveyed 60 acres (basis $14,384; FMV $39,000) and received a $39,000 credit against the loan.
  - On January 4, 1989, they conveyed 141 acres (basis $32,080; FMV $77,725) and received a $77,725 credit against the loan.
- The Gehls also paid $6,123 cash toward the loan.
- After the land transfers and cash payment, the lender forgave the remaining $29,412 of debt.
- The Commissioner determined deficiencies for 1988 ($6,887) and 1989 ($13,643), treating (i) FMV-minus-basis on the property transfers as taxable gain and (ii) the forgiven $29,412 as discharge-of-indebtedness income excludable due to insolvency under I.R.C. § 108(a)(1)(B).
- The case was submitted to the Tax Court on stipulated facts; the Tax Court sustained the Commissioner, and the Eighth Circuit affirmed.

## Issues

1. When insolvent taxpayers transfer appreciated property to a creditor in partial satisfaction of a recourse debt, is the excess of the property’s FMV over adjusted basis taxable gain under I.R.C. §§ 61(a)(3) and 1001, or discharge-of-indebtedness income under § 61(a)(12) excludable under § 108(a)?
2. Does the taxpayers’ insolvency and the debt-restructuring context change the characterization of FMV-over-basis from sale/exchange gain to discharge-of-indebtedness income?

## Decision

- The Tax Court held that the deeds in lieu of foreclosure were dispositions treated as sales or exchanges to the extent of the property’s FMV.
- The excess of FMV over basis on the transferred land was taxable gain under §§ 61(a)(3) and 1001 and was not recharacterized as discharge-of-indebtedness income.
- Only the portion of cancelled debt exceeding the FMV of the transferred property (plus any cash paid) constituted discharge-of-indebtedness income under § 61(a)(12), potentially excludable under § 108(a) due to insolvency.
- The Eighth Circuit affirmed, approving the split between (i) taxable sale/exchange gain up to FMV and (ii) COD income for the remaining cancelled balance.

## Legal Principles

- A transfer of property to a creditor in satisfaction, in whole or in part, of a recourse indebtedness is treated as a sale or exchange for federal income tax purposes to the extent of the property’s FMV.
- Under I.R.C. § 1001 and Treas. Reg. § 1.1001-2, the amount realized on a disposition includes liabilities from which the transferor is discharged as a result of the disposition, measured (in this setting) by the FMV credit applied against the debt.
- Discharge-of-indebtedness income under I.R.C. § 61(a)(12) arises only to the extent debt is cancelled beyond the value of property (and cash) given in satisfaction of the debt.
- I.R.C. § 108(a) excludes COD income to the extent of insolvency but does not convert gain from a property disposition into COD income.

## Conclusion

The courts treated the debt workout as two tax events: a taxable sale/exchange producing gain equal to FMV minus basis on the conveyed land, and separate COD income only for the remaining cancelled debt beyond the value of the property and cash transferred; insolvency affected only the exclusion of COD income under § 108, not the characterization of the property-transfer gain.


Gehl v. Commissioner, 102 T.C. 784 (1994), aff’d, 50 F.3d 12 (8th Cir. 1995)