Walter W. Cruttenden and Fay T. Cruttenden v. Commissioner of Internal Revenue

In this appeal we confront the ambivalent tax characteristics of a practice in the stock brokerage industry: the borrowing of securities by a brokerage firm under a subordination agreement that allows the firm to use the securities to meet its net capital requirements under stock exchange rules. While it is clear that legal title to the securities does not pass from the lender to the brokerage firm by terms of the agreement under review, we must determine whether the agreement so impairs the lender’s title as to bring the lender’s expenses in terminating the agreement within the scope of the rules that costs of defending or perfecting title to property, or recovering property, must be capitalized rather than deducted from ordinary income.

Taxpayer, the lender under a subordination agreement of this type, deducted legal expenses incurred in terminating that agreement and obtaining the return of loaned securities. The Commissioner disallowed the deduction and determined a deficiency in taxpayer’s 1971 income tax payment. On taxpayer’s petition for review, the Tax Court ruled that the disputed expenses were deductible, under section 212(2) of the Internal Revenue Code, as ordinary…