Court rules in favor of thrifts on tax-loss issue

April 18, 1991|By Lyle Denniston | Lyle Denniston,Washington Bureau of The Sun

WASHINGTON -- The Supreme Court gave the financially troubled thrift industry a victory worth more than $400 million over the federal tax collector yesterday.

The court upheld the legal right of federally chartered savings and loan institutions to use a mortgage-swapping device explicitly to gain a tax loss without risking their own financial standing with government regulators.

The decision was by a 7-2 vote.

In a second ruling on a different tax issue, however, the court ruled unanimously that the industry owes the Internal Revenue Service another $128 million. That ruling involved the duty of thrifts to list as taxable income the penalties their depositors pay for early withdrawal of certificates of deposit.

That issue was of less legal importance than the other because Congress has since changed the tax law. The amounts due the IRS are for years

prior to 1986.

The mortgage-swap ruling involves a practice that thrifts began using in 1980, after federal regulators changed their rules to FTC accommodate such arrangements.

Thrifts holding long-term mortgage loans in the late 1970s found them declining in market value when interest rates rose sharply. They wanted to sell off some of those loans, so they could take a tax deduction on the lost value.

Federal rules at that time, however, required them to record the losses on their books, and that would have put many of the savings and loan associations in jeopardy of being closed by regulators as financially risky.

So, in 1980, the federal agency then existing, the Home Loan Bank Board, decided that the thrifts need not report as losses any lost value on mortgages that they swapped for like mortgages. That rule change allowed the swaps to go forward; one pool of mortgages would be swapped for another that had the same current market value.

The thrifts then sought to claim a loss deduction on their federal tax returns for the amount by which the market value of the mortgages they gave up fell below their face value.

IRS ruled, however, that this was only a paper transaction and that no loss had actually been "realized" in such a swap.

That is the result the court overturned yesterday, declaring that the mortgage pools involve different borrowers and different terms, so the loss of value below face amounts did qualify as a loss for federal tax purposes.

That ruling came in the case of Cottage Savings Association vs. Commissioner (No. 89-1965). Justices Harry A. Blackmun and Byron R. White dissented.

The issue settled in the case affects the outcome of some 96 pending cases at IRS, involving at least $419 million in tax revenues represented by the claimed losses.

The second ruling, in the case of U.S. vs. Centennial Savings Bank (No. 89-1926), involves about 108 pending cases with about $128 million in tax liabilities at stake.

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