account of notes held prior to March 1, 1913, their value on that date must be established. (Art. 154.)

Obviously if a taxpayer in 1919 charged off a debt which had been carried as good since March 1, 1913, it would be reasonable to inquire whether or not on that date the debt was deemed to be good. But the mere fact that on that date there was some doubt as to its value would not mean that the deduction was an improper one in 1919. The Treasury has always held and still holds that no debt could be charged off until it was 100 per cent bad. The Treasury's action did not accord with good accounting practice, but it is too late now for it to reverse its regulations in regard to bad debts as of a date long past. Subsequent transactions with debtor would indicate prima facie that debt was collectible at March 1, 1913.

Debts Must Be Actually Ascertained to be Worthless

The law specifies that a debt to be deductible as bad must be "ascertained to be worthless" [section 214 (a-7)].

When is a debt worthless?-In describing the deductions permitted to individuals the regulations set up the following general standard.

REGULATION. An account merely written down or a debt recognized as worthless prior to the beginning of the taxable year is not deductible. Where all the surrounding and attendant circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. . . . . (Art. 151.)

[Former Procedure]

REGULATION. "All debts representing amounts that became due and payable prior to March 1, 1913, and not ascertained to be worthless prior to that date, whether representing income or a return of capital, are held to be allowable deductions, under paragraph B of the law, in a return of income for the year in which they are actually ascertained to be worthless and are charged off." (T. D. 2224, July 13, 1915.)

It should be noted that this statement is couched in terms broad enough to include all debts due the individual whether from corporations or from other individuals.

DEPRECIATION OF COLLATERAL SECURITY.-When a debtor who has put up collateral is known to be unable to pay and the collateral security is worth substantially less than the amount of the debt, there is no good reason why the taxpayer should be compelled to sell the collateral, or make a "wash" sale of it, in order to charge off the loss which has been sustained.

The regulations" to some extent cover the point, but it should be made clear that an accrued loss of 50 per cent of a debt, when determined by recognized methods of accounting, is as deductible as a loss of 100 per cent.

BANKRUPTCY AS A TEST.

REGULATION. . . . Bankruptcy may or may not be an indication of the worthlessness of a debt, and actual determination of worthlessness in such a case is sometimes possible before and at other times only when a settlement in bankruptcy shall have been had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later year confirming the conclusion that the debt is worthless will not authorize shifting the deduction to such later year. In the case of debts existing prior to March 1, 1913, only their value on that date may be deducted upon subsequently ascertaining them to be worthless. .. (Art. 151.)

....

The foregoing regulation is almost humorous. For many years taxpayers claimed deductions on the basis now set forth in article 151, but during as many years the deductions were disallowed and additional assessments were imposed and collected. Any "shifting" of a deduction in the past was due to action by the Treasury, not by taxpayers.

'Art. 151, page 674.

[Former Procedure] Article 8 of Regulations 33, 1918, stated that the "determination of worthlessness in such cases is possible only when settlement in bankruptcy shall have been had."

Foreclosure sale on a mortgage.

REGULATION. Where under foreclosure a mortgagee buys in the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be allowable as a deduction for a bad debt, for the property which was security for the debt stands in the place of the debt. The determination of loss in such a situation is deferred until the property is disposed of, except where a purchase money mortgage is foreclosed by the vendor of the property. . . . . Only where a purchaser for less than the debt is another than the mortgagee may the difference between the debt and the net proceeds from the sale be deducted as a bad debt. (Art. 153.)

When the owner of a real estate mortgage is unable to collect principal and interest and decides that it is necessary to foreclose in order to protect his investment, and at foreclosure sale buys in the property as the highest bidder, it is difficult to understand why it is not a closed transaction. Usually property depreciates in value before foreclosures take place. If the owner could not claim credit for the loss arising from the foreclosure sale it is probable that years would elapse before the actual loss could be shown in any other way.

The law' provides that "when property is exchanged for other property the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any." Therefore when a mortgagee receives in place thereof real property the latter should be valued and the gain or loss, if any, returned.

Compositions and similar settlements.-The following ruling taken from the Bulletin of the National Association of Credit Men is of interest as bearing on the meaning of the word "worthless":

A corporation had its annual statement to the Treasury Department rendered for income tax purposes questioned because of losses charged off through compositions. This seemed so unfair that the

"Section 202 (b).

matter was taken up by the national office which, through its Washington representative, has obtained a ruling as follows:

"If in any or all of the forms of settlement described-1. Where the creditor corporation individually effects a compromise settlement with a debtor; 2. where the judgment creditor is one of a class in a general settlement with an insolvent debtor accepting a certain percentage of his claim; 3. where compositions and compromises are effected by means of bankruptcy or other court proceedings, where the proceedings discharge the debtor from any further liability and the definite amount fixed has been paid, the creditor corporation accepts the amount paid him in pursuance of settlement as full payment of his claim so that no further liability exists on the part of the debtor to the creditor and the excess of the claim over the amount paid is charged off as a loss, it will be permissible for the creditor corporation to deduct from its gross income of the year in which the settlement is made, the amount of the loss thus ascertained and charged off."

Compromises. The preceding paragraph mentions certain compromises under which it is possible to deduct as a bad debt the excess of the claim over the amount paid. This type of compromise, where there is no disagreement concerning the validity of the charge, is to be distinguished from the compromises mentioned in the following article taken from the old regulations.

REGULATION. Where an indebtedness is claimed and contested and a settlement is had by way of compromise whereby an amount, less than the debt claimed, is accepted in full payment and satisfaction of the debt, the difference between the amount paid and that claimed is not allowable as a deduction for bad debts. Where the settlement in compromise consists of a promise to pay an amount less than the debt claimed, the amount promised to be paid forms the basis of a new transaction, and upon failure to make good this promise the question will arise as to the deductibility of the new amount only. (Reg. 33, 1918, Art. 8.)

The foregoing ruling can apply only to compromises in which the amount claimed was in excess of the amount carried on the books as an asset. Of course, if the claim were merely for the amount carried on the books any settlement for a smaller amount would justify the entry of the uncollected balance as a bad debt.

Recoveries. In some cases debts presumably "definitely ascertained to be worthless" have unexpectedly proved to be collectible in whole or in part. The following regulation provides for the taxation of such collections.

REGULATION.

Bad debts or accounts charged off because of the fact that they were determined to be worthless, which are subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless of the date when the amounts were charged off. . . . . (Art. 52.)

An exception to this rule would arise if a collection were made of a debt charged off prior to March 1, 1913, which as of that date could be considered good. If so, it would not be taxable as income when subsequently collected.

Loss of endorser or guarantor-When determined.-Upon the failure of the maker of a note to take it up at maturity, the endorser may have to pay and thereupon a debt due to the endorser arises. Strictly speaking, it may not be "ascertained to be worthless" immediately, but everyone knows that ordinarily the chances are at least 99 to 1 that it will be a bad debt and usually it takes very little time to reach this conclusion. After allowing a reasonable time in which to ascertain why the maker does not make good, the endorser should charge it off as a bad debt, taking credit for it in his return.

The right to deduct the bad debt is governed by the regulations cited. There is no requirement that the obligation to pay a note as endorser or guarantor shall have arisen from business or trade, so that the restrictions of past years as to losses would not apply in any case.

Debts Must Be Charged Off Within the Year

Charging off bad debts.-The 1918 law requires in the case of individuals and corporations that bad debts must be charged off within the taxable year. These words would seem to require that actual book entries be made by both corporations and individuals in case they desire to claim de