COMMISSIONER OF INTERNAL REVENUE, PETITIONER V. SAN ANTONIO SAVINGS ASSOCIATION AND SUBSIDIARIES (RESOLUTION TRUST CORPORATION, RECEIVER) No. 89-1928 In The Supreme Court Of The United States October Term, 1989 The Acting Solicitor General, on behalf of the Commissioner of Internal Revenue, petitions for a writ of certiorari to review the judgment of the United States Court of Appeals for the Fifth Circuit in this case. Petition For A Writ Of Certiorari To The United States Court Of Appeals For The Fifth Circuit TABLE OF CONTENTS Question Presented Opinions below Jurisdiction Statutory provisions and regulation involved Statement Reasons for granting the petition Conclusion OPINIONS BELOW The opinion of the court of appeals (App., infra, 1a-38a) is reported at 887 F.2d 577. The opinion of the Tax Court (App., infra, 39a-50a) is reported at 55 T.C.M. (CCH) 813. JURISDICTION The judgment of the court of appeals was entered on November 2, 1989. A petition for rehearing was denied on January 18, 1990 (App., infra, 51a-52a). On April 10, 1990, Justice White extended the time within which to file a petition for a writ of certiorari to and including May 18, 1990. On May 4, 1990, Justice White further extended that time to and including June 8, 1990. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). STATUTORY PROVISIONS AND REGULATION INVOLVED The relevant portions of Sections 165 and 1001 of the Internal Revenue Code of 1954 (26 U.S.C. (1982)) and Section 1.1001-1(a) of the Treasury Regulations on Income Tax (26 C.F.R.) are set out in a statutory appendix (App., infra, 53a-55a). QUESTION PRESENTED Whether a financial institution realizes a deductible loss for income tax purposes when it exchanges a group of mortgage loans for a substantially identical group of mortgage loans held by another financial institution. STATEMENT 1. Respondent is a savings and loan association formerly regulated by the Federal Home Loan Bank Board. In 1980, respondent's mortgage loan portfolio was partially comprised of fixed-rate, long-term home mortgage loans that had been issued in the late 1960s at interest rates significantly lower than those charged on more recent loans. As a result of the high interest rates of the early 1980s, the fair market value of these older, low-interest loans fell far below their face amount. App., infra, 3a. For respondent, like other savings institutions holding older, low-interest loans, this situation created a tax incentive for disposing of its depreciated mortgage loans. A disposition of the loans would enable respondent to realize for tax purposes the loss that resulted from these market changes; it could then utilize the resulting loss deductions to offset current taxable income and produce loss carrybacks that would generate tax refunds from prior years. There was, however, a catch. Many of these institutions were in such precarious financial condition that a sale of the loans and consequent recognition of the losses -- however beneficial for tax purposes -- would for regulatory accounting purposes have caused them to fail to meet the Bank Board's minimum reserve and liquidity requirements, raising the prospect of closure by the Bank Board. See App., infra, 3a-4a. On June 27, 1980, the Bank Board's Office of Examination and Supervision (OES) issued Memorandum R-49, a regulatory accounting principle that adopted the rule that savings institutions could make "reciprocal sales" of depreciated "substantially identical mortgage loans" without having to record a loss for regulatory accounting purposes. Memorandum R-49 established a list of criteria that would render loans "substantially identical," including that the mortgages be of similar type with the same terms and interest rates. /1/ The admitted objective of Memorandum R-49 was to allow savings institutions to engage in transactions that would generate deductible losses for federal income tax purposes, but that would not be treated as giving rise to losses for financial reporting and regulatory purposes. See App., infra, 4a-6a. /2/ 2. On September 30, 1980, respondent and two other savings institutions entered into a three-cornered transaction designed to exchange interests in mortgages that satisfied the requirements of Memorandum R-49. Respondent transferred to Farm and Home Savings Association (Farm and Home) a package of 90% participation interests in a group of mortgage loans. Farm and Home transferred to Dallas Federal Savings and Loan Association (Dallas Federal) a package of 90% participation interests in a group of mortgage loans. Dallas Federal transferred to respondent a package of 90% participation interests in a group of mortgage loans. /3/ Thus, respondent in effect exchanged interests in a group of residential mortgage loans for interests in a group of residential mortgage loans held by Dallas Federal. The participation interests exchanged were in loan packages having almost identical face and market value, and the loans involved were "substantially identical" under the criteria of the Bank Board's Memorandum R-49. App., infra, 6a-7a, 41a-42a. The transaction was arranged as "reciprocal sales" of the mortgage interests among the parties; it was consummated by conveyance of the participation interests together with simultaneous (and largely offsetting) wire transfers of cash. Respondent conveyed participation interests having a face value of $74,774,495 to Farm & Home in exchange for $59,817,597 in cash. At the same time, respondent obtained from Dallas Federal participation interests having a face value of $74,802,167 in exchange for $60,925,730 in cash. In effect, respondent exchanged loans with a face amount (and cost basis) of $74,774,495, but a lower value, for participation interests held by Dallas Federal with a value of $60,925,730. On its federal income tax return for the year ending September 30, 1980, respondent claimed a deduction for a loss on the transaction of $14,956,898, which corresponded to the reduction in value of the mortgage interests originally held by respondent. App., infra, 6a-7a, 41a-42a. Pursuant to Memorandum R-49, however, respondent did not report any loss for financial and regulatory accounting purposes. Doc. 18, at 2. 3. On audit, the Commissioner determined that respondent was not entitled to its claimed deduction for a loss on the mortgage exchange transaction. Respondent sought redetermination of the resulting income tax deficiencies in the Tax Court. While respondent's motion for summary judgment was pending, the Tax Court decided Cottage Savings Ass'n v. Commissioner, 90 T.C. 372 (1988), rev'd, 890 F.2d 848 (6th Cir. 1989), in which the Tax Court allowed a loss deduction on a mortgage swap transaction similar to the transaction in issue here. In ruling on respondent's motion for summary judgment in the instant case, the Tax Court stated that, when the facts here were construed most favorably for the Commissioner, they were essentially the same as those found by the court in Cottage. App., infra, 40a-41a. Accordingly, in deciding the case, the Tax Court assumed that respondent, like the taxpayer in Cottage, "did not investigate individual loan files, employment histories of the individual borrowers, or the underlying value of the real estate securing the individual loans" (90 T.C. at 382), and that the transaction was "motivated solely by the desire of (respondent) and its trading partners to recognize for tax purposes (but not for regulatory purposes) the losses in market values of the loan portfolios" (90 T.C. at 384). See also App., infra, 45a; Cottage, 90 T.C. at 388 n.9. The Commissioner's primary argument was that a loss is "realized" for tax purposes on an exchange of property only if the exchanged properties are "materially different" and that mortgages that were "substantially identical" under the Memorandum R-49 criteria were not materially different. Relying on its decision in Cottage, the Tax Court concluded that the loans transferred by respondent were "materially different" from the loans it received because the loans had different borrowers and different collateral. App., infra, 45a-49a. The court also rejected the government's argument that, because the mortgage exchange lacked economic substance, deduction of the loss was not authorized by Section 165 of the Internal Revenue Code (id. at 44a). 4. The court of appeals affirmed (App., infra, 1a-38a). The court agreed with the government's position that a loss is realized on an exchange only if the properties exchanged are "materially different" (887 F.2d at 581-587). The court then agreed with the Tax Court, however, that the mortgages exchanged in an R-49 transaction are "materially different" because the mortgages have different borrowers and different collateral, even though the Bank Board had identified the mortgages as "substantially identical" (id. at 587-592). The court also rejected the government's additional argument that the exchange lacked economic substance, and therefore no loss could be deducted under Section 165 of the Code (id. at 592-593). REASONS FOR GRANTING THE PETITION This case was heard by the court of appeals together with two other cases involving mortgage exchanges that satisfied the criteria of Memorandum R-49, and all three cases were decided by the same panel on the same day. See Centennial Savings Bank v. United States, 887 F.2d 595 (5th Cir. 1989); First Federal Savings & Loan Ass'n v. United States, 887 F.2d 593 (5th Cir. 1989). We are today also filing certiorari petitions in those two cases, presenting the same question regarding the tax treatment of mortgage exchanges under Memorandum R-49 that is presented in this case. As we explain in detail in our petition in Centennial, review of this question by this Court is warranted because there exists a square conflict in the circuits and the issue is of considerable importance to the administration of the federal tax laws. /4/ Although the Fifth Circuit treated this case as the lead case, we do not urge the Court to grant plenary review here. In July 1989, the Bank Board found that respondent was insolvent and appointed the Federal Savings and Loan Insurance Corporation (FSLIC) as receiver. The Resolution Trust Corporation (RTC) later became the receiver. The RTC has advised us that, in its view, respondent does not have (and never will have) sufficient assets to allow collection of any part of the tax deficiency at issue here in the event the Commissioner ultimately were to prevail in the instant case. /5/ The Fifth Circuit, in a case involving a claim by a private creditor against a savings institution that was under FSLIC receivership, recently took the position that a case could be dismissed as moot if there will never be any assets from which to satisfy a judgment. Triland Holdings & Co. v. Sunbelt Service Corp., 884 F.2d 205, 208 (5th Cir. 1989). In light of the uncertainty regarding collection here and the question of possible mootness, we believe that the Centennial case, which also presents a second issue warranting the attention of this Court, and the First Federal case are more suitable vehicles for resolving the conflict in the circuits on the issue that is presented in all three cases. Accordingly, we believe it would be appropriate for the Court to hold this petition pending the outcome of Centennial and First Federal. CONCLUSION The petition for a writ of certiorari should be disposed of as appropriate in light of this Court's disposition of United States v. Centennial Savings Bank (Resolution Trust Corporation, Receiver), No. 89 . . . , and United States v. First Federal Savings & Loan Ass'n, No. 89 . . . . Respectfully submitted. JOHN G. ROBERTS, JR. Acting Solicitor General /6/ SHIRLEY D. PETERSON Assistant Attorney General LAWRENCE G. WALLACE Deputy Solicitor General ALAN I. HOROWITZ Assistant to the Solicitor General RICHARD FARBER BRUCE R. ELLISEN Attorneys JUNE 1990 /1/ Memorandum R-49 specifically provided in part (App., infra, 4a-5a): A loss resulting from a difference between market value and book value in connection with reciprocal sales of substantially identical mortgage loans need not be recorded. Mortgage loans are considered substantially identical only when each of the following criteria is met. The loans involved must: 1. involve single-family residential mortgages, 2. be of similar type (e.g., conventionals for conventionals), 3. have the same stated terms to maturity (e.g., 30 years), 4. have identical stated interest rates, 5. have similar seasoning (i.e., remaining terms to maturity), 6. have aggregate principal amounts within the lesser of 2 1/2% or $100,000 (plus or minus) on both sides of the transaction, with any additional consideration being paid in cash, 7. be sold without recourse, 8. have similar fair market values, 9. have similar loan-to-value ratios at the time of the reciprocal sale, and 10. have all security properties for both sides of the transaction in the same state. /2/ A memorandum from the Director of OES to an officer of the Bank Board described the "objective" of Memorandum R-49 as "to structure a transaction which was as close as possible to the IRS 'materially different' definition which would still not change the economic position of the association after it engaged in the swap." See App., infra, 5a. /3/ Transactions designed to take advantage of Memorandum R-49 often involved exchanges of 90% participation interests, rather than the entire loan, so that the original mortgages could maintain its relationship with the obligor on the loans. See Cottage Savings Ass'n v. Commissioner, 90 T.C. 372, 381 (1988), rev'd, 890 F.2d 848 (6th Cir. 1989). /4/ We are supplying respondent's counsel with a copy of our petition in Centennial. /5/ The question of collectibility is not addressed in the record in this case. /6/ The Solicitor General is disqualified in this case. APPENDIX