Memorandum of Decision Re: Value of Assets Seized by IRS

FOR THE NORTHERN DISTRICT OF CALIFORNIA In re RONALD SIDEBOTTOM,                                       No. 1-87-00146      Debtor. ___________________________/
Memorandum of Decision
     This dispute between the debtor and the Internal Revenue Service comes before the court on an agreed statement of facts. The issue to be decided is whether the debtor is entitled to a credit for the full value of a seized asset where the IRS, after seizure, negligently administers the asset.      Prior to bankruptcy, the debtor held two promissory notes secured by deeds of trust. The deeds of trust were "wrap-around" deeds of trust, junior to a deed of trust held by a third party. The debtor was entitled to payment on the notes he held, but was obligated to make the payments to the senior deed of trust holder from those payments. Thus, what the debtor was entitled to keep was the difference between the note payments he received and the payments he was obligated to make to the senior deed of trust holder.      When one holds a note secured by a "wrap-around" deed of trust, there are two unquestionably prudent ways one can realize value from it. First, one can sell the note to a third party for cash, thereby realizing the discounted value of the note in a lump sum. Second, one can continue to collect the payments on the note and, from those payments, continue to service the senior debt, eventually recovering the difference between the note one holds and the smaller balance owed to the senior lienholder.      In this case, the IRS did not take either prudent course. Instead, it elected to keep all of the payments and not service the senior debt. This resulted in the obligors exercising their right to pay the senior debt directly, and rendered the notes seized by the IRS worthless.      The debtor argues that the IRS was obligated to sell the notes, and its failure to sell them automatically entitles him to a credit for their sale value. The court believes that this argument misses the mark, as the statute cited by the debtor does not seem to require a sale, and the IRS had another prudent means of realizing cash from the notes. The court sees the issue not as whether the IRS is responsible for failing to sell, but whether the IRS is responsible for failing to administer seized asset prudently.      It appears clear that the IRS is responsible for the proper care of seized assets. Heck v. Walters, 523 F.2d 23 (9th Cir.1975). Where the IRS has diminished the value of an asset through mismanagement, the taxpayer is entitled to a credit based on the value of the asset, not the amount actually realized by the IRS. United States v. Pittman, 449 F.2d 623, 628 (7th Cir.1971). Since the negligent management of the notes by the IRS after seizure rendered them worthless, the debtor is entitled to a credit for their value on the date of seizure, and not just what was actually collected.      Counsel for the debtor shall submit an appropriate form of order fixing the amount of the IRS claim, which counsel for the IRS has approved as conforming to this decision.
Dated: October 15, 1990                                                                              _______________________                                                                                                                      Alan Jaroslovsky                                                                                                                      U.S. Bankruptcy