Gunther v. Commissioner, 43 T. C. 303 (1964)

Confiscation of property by a foreign government under color of law does not constitute “theft” deductible under Internal Revenue Code section 165(c)(3).

Summary

In Gunther v. Commissioner, the Tax Court ruled that property confiscated by the Communist government of Rumania did not qualify as a theft loss deductible under IRC section 165(c)(3). The petitioner, Gunther, left property in Rumania in 1947, which was later seized by the Communist regime. She sought a deduction for this loss in 1959 after receiving partial compensation. The court, relying on the ‘Act of State’ doctrine and precedent from William J. Powers, held that such confiscation did not constitute theft. However, the court allowed Gunther to offset her basis in the lost property against the compensation received, treating the net amount as a capital gain rather than income.

Facts

Gunther left property in Rumania in 1947, entrusting it to friends opposed to the Communist regime. Between 1947 and 1951, this property was seized by agents of the Communist government under decrees. Gunther claimed a theft loss deduction in 1959, the year she was awarded compensation by the Foreign Claims Settlement Commission. She received $33,782. 40 but spent $10,395. 95 on related expenses, leaving her with a net of $23,386. 45.

Procedural History

Gunther filed a tax return claiming a deduction for the loss of her property in Rumania. The Commissioner disallowed this deduction, leading Gunther to petition the Tax Court. The court, following precedent set in William J. Powers, upheld the Commissioner’s decision regarding the theft loss deduction but ruled in favor of Gunther on the issue of her basis in the property.

Issue(s)

1. Whether the confiscation of Gunther’s property by the Rumanian government constitutes a “theft” deductible under IRC section 165(c)(3)?
2. Whether the net proceeds Gunther received from the Foreign Claims Settlement Commission should be taxed as long-term capital gains?

Holding

1. No, because the confiscation was under color of law by a foreign government, and thus not considered a theft under the ‘Act of State’ doctrine.
2. No, because Gunther’s basis in the property was at least equal to the net amount of her recovery, allowing her to offset this against the compensation received, resulting in no taxable gain.

Court’s Reasoning

The court relied heavily on the ‘Act of State’ doctrine, which precludes U. S. courts from judging the validity of acts by foreign governments. The court cited William J. Powers, which held that confiscations by foreign governments under color of law do not constitute theft. The court also noted that Congress had to pass special legislation in 1964 (IRC section 165(i)) to allow deductions for Cuban expropriations, indicating that without such specific legislation, confiscations by foreign governments were not deductible as thefts. The court rejected Gunther’s argument that the confiscation was a theft, stating, “We think that doubt was removed in 1964 when Congress found it necessary to enact special legislation. . . in order that certain expropriation by the Cuban Government might be deemed casualties or thefts. ” On the second issue, the court determined that Gunther’s basis in the property was at least equal to her net recovery, allowing her to offset this against the compensation received.

Practical Implications

This decision clarifies that confiscations by foreign governments under color of law are not deductible as theft losses under IRC section 165(c)(3) unless specifically allowed by Congress. Tax practitioners must be aware that only specific legislation, like IRC section 165(i) for Cuban expropriations, can provide such deductions. The ruling also demonstrates the importance of establishing a basis in property for tax purposes, as Gunther was able to offset her recovery against her basis, avoiding a taxable gain. This case has been influential in subsequent cases dealing with foreign confiscations and tax deductions, reinforcing the ‘Act of State’ doctrine’s application in tax law.