## Facts

- John S. Rendall and Christobel D. Rendall filed a 1997 federal income tax return that did not report gain from the sale of Solv-Ex Corporation stock and claimed a $2 million worthless-debt deduction.
- John Rendall was a co-founder, CEO, and board chairman of Solv-Ex and acquired multiple lots of its common stock over many years at widely varying prices.
- To finance activities related to Solv-Ex, Rendall borrowed $2 million through a Merrill Lynch margin account, pledging approximately 2.66 million shares as collateral; the margin loans were payable on demand.
- In May 1997, Merrill Lynch issued a margin call; when Rendall did not meet the demand, Merrill Lynch obtained shares and liquidated 634,100 shares, producing $4,229,479 in proceeds.
- The IRS determined a 1997 deficiency of $259,874, attributing taxable gain to the margin-account liquidation and computing basis under Treas. Reg. § 1.1012-1(c) (FIFO) due to lack of adequate share identification.
- The IRS also disallowed the claimed $2 million deduction under I.R.C. § 166(a) for an alleged debt owed by Solv-Ex to Rendall.
- The Tax Court sustained the IRS determinations; the Rendalls appealed.

## Issues

1. Whether gains from Merrill Lynch’s liquidation of Solv-Ex stock pledged in a margin account were taxable to the Rendalls in 1997.
2. Whether the gain had to be computed using the FIFO method under Treas. Reg. § 1.1012-1(c).
3. Whether the Rendalls were entitled to a $2 million worthless-debt deduction in 1997 under I.R.C. § 166(a) for an alleged loan to Solv-Ex.

## Decision

- The Tenth Circuit affirmed the Tax Court’s decision.
- The gains from the broker’s liquidation of pledged shares were taxable to the Rendalls in 1997.
- Because the Rendalls did not adequately identify the shares sold, the IRS properly applied FIFO under Treas. Reg. § 1.1012-1(c) to determine basis and gain.
- The Rendalls were not entitled to the $2 million worthless-debt deduction because they did not establish a bona fide debt and did not prove the debt became worthless in 1997.

## Legal Principles

- A broker’s sale of a taxpayer’s pledged securities to satisfy a margin call is treated as a disposition by the taxpayer for federal income tax purposes, resulting in recognition of gain or loss by the taxpayer-owner.
- Under Treas. Reg. § 1.1012-1(c), when stock is sold from multiple lots and the taxpayer does not adequately identify the shares sold, basis is determined by the mandatory first-in, first-out method.
- A deduction under I.R.C. § 166(a) requires proof of (1) a bona fide debtor-creditor relationship with an enforceable obligation to repay a fixed or determinable sum, and (2) worthlessness occurring in the specific tax year claimed.

## Conclusion

The court held that the forced margin-account liquidation triggered taxable gain to the Rendalls, that gain was correctly computed using FIFO due to inadequate identification of shares sold, and the claimed $2 million worthless-debt deduction failed for lack of proof of a bona fide debt and 1997 worthlessness.


Rendall v. Comm’r, 535 F.3d 1221 (10th Cir. 2008)