Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 70-98

1970-1 C.B. 169

IRS Headnote

The reduction of a mortgage indebtedness on business property with money received from the condemnation of adjacent business property is not an expenditure for like kind property under section 1033(a)(3) of the Code; I.T. 2700 superseded.

Full Text

Rev. Rul. 70-98 /1/

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in I.T. 2700, C.B. XII-2, 73 (1933).

The question presented is whether the application of funds received as a result of a condemnation of property under the circumstances described below is the acquisition of property within the meaning of section 1033(a)(3) of the Internal Revenue Code of 1954.

The taxpayer owns two pieces of improved commercial property, L-1 and L-2, located in a certain city within the United States. Both properties have stores erected on them from which the taxpayer receives rental income. During the taxable year the Federal Government acquired property L-1 from the taxpayer under condemnation proceedings. The remaining property, L-2, is encumbered by a first mortgage held by a bank.

The specific question in the instant case is whether the application by the taxpayer of the money received from the Federal Government to the reduction of the first mortgage on property L-2 is an expenditure in the acquisition of other property similar or related in service or use within the meaning of section 1033(a)(3) of the Code.

Section 1033(a)(3) of the Code provides as follows:

(a) General Rule.--If property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted--

* * * * *

(3) Conversion into money where disposition occurred after 1950.--Into money or into property not similar or related in service or use to the converted property, and the disposition of the converted property (as defined in paragraph (2)) occurred after December 31, 1950, the gain (if any) shall be recognized except to the extent hereinafter provided in this paragraph:

(A) Nonrecognition of gain.--If the taxpayer during the period specified in subparagraph (B), for the purpose of replacing the property so converted, purchases other property similar or related in service or use to the property so converted, or purchases stock in the acquisition of control of a corporation owning such other property, at the election of the taxpayer the gain shall be recognized only to the extent that the amount realized upon such conversion (regardless of whether such amount is received in one or more taxable years) exceeds the cost of such other property or such stock. Such election shall be made at such time and in such manner as the Secretary or his delegate may by regulations prescribe. The discharge of a debt by a debtor is not the acquisition of property except in the sense that it can be said that by discharging the debt the debtor acquires from the creditor the debt and thus extinguishes it. Likewise, when a debt is created the debtor does not dispose of any property except in the sense that the creation of the debt creates a species of property in the hands of the creditor. When the debt is secured by a mortgage the discharge of the debt by the debtor results in no acquisition by the debtor of any property. While it is true that the property that was mortgaged to secure the debt is, by the payment of the debt, discharged from the encumbrance, the property notwithstanding the mortgage has at all times belonged to the debtor or mortgagor beneficially.

Accordingly, it is held that the application by the taxpayer of the money received from the Federal Government, as a result of the condemnation of property L-1, to the reduction of the first mortgage on property L-2 is not an expenditure in the acquisition of other property similar or related in service or use within the meaning of section 1033(a)(3) of the Code.

I.T. 2700 is superseded, since the position set forth therein is restated under current law in this Revenue Ruling.

/1/ Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576.