Cottage Savings Association V. Commissioner - Majority Opinion

Majority Opinion

Material difference is a requirement for a disposition under §1001. Marshall cited Treasury Regulation §1.1001-1 (26 C.F.R. 1.1001-1), which required that an exchange of materially different properties constitutes a realization under the Tax Code. Congress delegated to the Commissioner the authority to make rules and regulations to enforce the Internal Revenue Code. Because Title 26 of the Code of Federal Regulations represents the Commissioner's interpretation of the Code, the Court deferred to the Commissioner's judgment, holding that the regulation was a reasonable interpretation of the Code and consonant with prior case law.

Material difference defined. Marshall defined what constituted a "material difference" in property under §1001 by examination at what point "realization" had been found in past case law. He started with Eisner v. Macomber, which dealt with exchange of stock in corporations. In several cases after Eisner, the court held that an exchange of stock which occurred when a corporation reorganized in another state was a realization, because corporations have different rights and power in different states. Marshall reasoned that properties materially differ for tax purposes when their respective possessors enjoy different legal entitlements from each. As long as the properties being exchanged were not identical, a realization had taken place. This was a simpler, black letter rule, as compared to what the Commissioner was arguing for, which would have examined not just the underlying substance of the transaction, but also the market and other non-tax regulations.

The properties exchanged were "materially different." Marshall held that the participation interests exchanged by Cottage Savings and the other S&Ls were "materially different" because the loans involved were made to different obligors and secured by different properties. Even though the interests were "substantially identical" for the FHLBB's purposes, that did not mean they were not materially different for taxation purposes. Therefore, the exchange was a "disposition of property," Cottage Savings had realized a loss, and their deduction was appropriate.

The Court agreed that "material difference" is the applicable test of realization under Code § 1001(a), but it did not agree that that test had been flunked merely because the properties exchanged were economic substitutes or equivalents. While the test for regulatory purposes might indeed be one of economic substance, for tax purposes the question was one of administrative convenience only. As the mortgages exchanged were secured by different homes and involved different mortgage borrowers, the banks on either side emerged with "legally distinct entitlements". More important, the swap itself sufficed to meet the administrative aims that underlie the realization requirement. The transaction was an arms-length deal between unrelated parties. As such, it "put both Cottage Savings and the Commissioner in a position to determine the change in the value of Cottage Savings' mortgages relative to their tax bases" and thus to reckon up gain or loss under § 1001(a). —Marvin Chirelstein, Federal Income Taxation, A Law Student's Guide