## Facts

- Layne and Sue Preslar purchased a 2,500-acre ranch in New Mexico in 1983 for $1 million, intending to subdivide and sell cabin lots.
- The Preslars executed a $1 million promissory note to Moncor Bank, secured by a mortgage on the ranch, payable in annual installments with interest through 1998.
- Moncor used loan proceeds to satisfy prior mortgages, and the Preslars received title free of prior liens.
- The Preslars and Moncor had an informal understanding (not in the loan documents) that repayment could be made by assigning installment contracts from lot sales to the bank.
- In 1985 Moncor became insolvent and the FDIC was appointed receiver; the FDIC refused to honor the informal repayment arrangement.
- The Preslars stopped payments and sued the FDIC for breach of contract.
- In 1988 the dispute settled: the FDIC accepted $350,000 as full satisfaction of the remaining debt (approximately $800,000+), reducing the obligation by about $450,000.
- The Preslars did not report the $450,000 reduction as cancellation-of-indebtedness (COD) income, treating it as a non-taxable purchase-price adjustment.
- The Commissioner asserted a deficiency, treating the reduction as taxable COD income under I.R.C. § 61(a)(12).
- The Tax Court ruled for the Preslars under the contested-liability/disputed-debt doctrine; the Commissioner appealed.

## Issues

1. Whether settlement of the Preslars’ fixed promissory note for less than its face amount produced taxable COD income under I.R.C. § 61(a)(12), or was excluded under the contested-liability/disputed-debt doctrine.
2. Whether the debt reduction could be treated as a purchase-price adjustment under I.R.C. § 108(e)(5) rather than COD income.

## Decision

- The Tenth Circuit reversed the Tax Court and remanded.
- The court held the contested-liability doctrine did not apply because the Preslars did not dispute the amount of the debt; they disputed only the enforceability of a side agreement about the method of repayment.
- The court held the settlement produced taxable COD income equal to the difference between the debt’s face amount and the amount paid.
- The court held § 108(e)(5) did not apply because the FDIC, as receiver for the lender, was not the property’s seller and the debt was a fixed, enforceable obligation; the settlement reflected a creditor compromise rather than a renegotiation of purchase price.
- The case was remanded for recomputation of the Preslars’ tax liability consistent with these holdings.

## Legal Principles

- Discharge of indebtedness for less than full consideration generally creates gross income under I.R.C. § 61(a)(12).
- The contested-liability/disputed-debt doctrine is limited to good-faith disputes over the amount of the underlying obligation; disputes about enforceability or collateral agreements do not prevent COD income when the debt amount is fixed.
- I.R.C. § 108(e)(5) treats certain debt reductions as purchase-price adjustments only when the reduction is between the original buyer and seller (or a narrow functional equivalent), not when a third-party lender or its successor compromises a fixed loan.
- A creditor’s settlement decision, standing alone, does not convert a loan reduction into a retroactive reduction of the property’s purchase price.

## Conclusion

The Tenth Circuit held that settling a fixed loan for less than its face amount created taxable COD income where the debtor disputed only enforceability of a side repayment arrangement, and it rejected treatment of the reduction as a § 108(e)(5) purchase-price adjustment because the compromise was by a third-party creditor rather than the seller.


Preslar v. Commissioner, 167 F.3d 1323 (10th Cir. 1999)