## Facts

- In 1969, Allen P. Unvert paid $54,500 to U.S. Financial Corp. in connection with a planned condominium purchase and was told the payment was deductible prepaid interest; he claimed a 1969 interest deduction for the full amount.
- Unvert never received documents establishing the purchase terms or ownership but nonetheless claimed additional condominium-related operating expense deductions in 1970 and 1971.
- In May 1972, U.S. Financial agreed to refund the $54,500 without interest; Unvert received the refund and did not report it as income on his 1972 return.
- The statute of limitations for adjustments to Unvert’s 1969 return expired on April 15, 1973.
- After auditing the 1970 and 1971 returns, the IRS concluded Unvert was never the legal owner of the condominiums and disallowed the related deductions.
- In 1976, the Commissioner issued a 1972 notice of deficiency, treating the 1972 refund as taxable income under the tax benefit rule.
- The Tax Court sustained the deficiency, and the taxpayers appealed.

## Issues

1. Whether the tax benefit rule requires inclusion in gross income of a 1972 refund of an amount previously deducted in 1969, where the 1969 deduction was later determined to be improper and the 1969 year is closed by limitations.
2. Whether an “erroneous deduction” exception bars application of the tax benefit rule to a recovery of a previously deducted item.

## Decision

- The Ninth Circuit affirmed the Tax Court.
- The court held that the 1972 refund was includible in gross income under the tax benefit rule because the taxpayers had taken a prior-year deduction that reduced taxable income and later recovered the same amount.
- The court rejected a categorical “erroneous deduction” exception on these facts, even though the IRS could no longer adjust the 1969 return.

## Legal Principles

- Under the tax benefit rule, a taxpayer who claims a deduction that reduces taxable income must include in income any later recovery of the deducted amount.
- Application of the tax benefit rule turns on whether the prior deduction produced a tax benefit and whether there was a later recovery; the later characterization of the original deduction as improper does not, by itself, prevent inclusion.
- When the year of the deduction is closed by the statute of limitations, taxing the recovery in the year received prevents a tax-free recovery that would otherwise preserve a permanent benefit from the prior deduction and distort annual income measurement.

## Conclusion

The court held that the tax benefit rule required the taxpayers to include the 1972 refund in income because they had received a tax benefit from the 1969 deduction and later recovered the same amount, and the closure of the 1969 year did not exempt the recovery from taxation.


Unvert v. Commissioner, 656 F.2d 483 (9th Cir. 1981)