Seventh Circuit Review


How much is common sense worth? What you paid is what it's worth, except when it comes to debt-equity swaps in the Seventh Circuit. How much something is worth is very important to taxpayers because it plays a role in determining taxpayers' tax bills. Most people would think that when two people exchange property, both properties must be equal in value. Otherwise, why would the two people have made the trade? Recently, the Seventh Circuit Court of Appeals, in Kohler Company v. United States, advocated for a different approach. The Kohler case involved the taxation of a debt-equity swap: $19 million of pesos, which could only be spent in Mexico on an extremely limited basis, were traded for the retirement of an $11 million debt. How much were the restricted pesos worth? You could ignore the price you paid for the pesos and instead hire an expert to value your pesos, and then spend several years litigating the matter after the IRS disagrees with your expert's opinion. That is exactly what the Seventh Circuit suggested! The court mistakenly found that the Supreme Court's holding in United States v. Davis, that held when property lacks a readily ascertainable value, the value assigned to it should be how much was paid for it, was inapplicable to Kohler. Instead, the court argued, in dicta, that fair market value should be determined through the use of experts. This Note discusses how the gain resulting from a debt-equity swap should be valued for tax purposes and concludes that the Seventh Circuit should have followed the Davis rule.

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