- 19 -
in connection with the financing arrangement, and the Guaderramas
must include interest income in connection with the financing
arrangement.
III. Allocation of Payments Between Principal and Interest
As an alternative argument, the Guaderramas contend that the
obligation owed by Benavidez was speculative and that they are
entitled to first recover their costs of the financing
arrangement. The Guaderramas contend that since Benavidez had
insufficient assets to pay for the property, since his sole
source of funds was dependent on operating the new restaurant
successfully, since his liquor operation was shut down for a
period of time, and since his option to buy was nonassignable,
repayment by Benavidez was risky, and therefore they are entitled
to first recover their costs. We disagree.
The general rule is that “periodic payments are applied
first to interest, with any remaining amount being applied to
principal, absent any agreement of the parties to the contrary”.
Estate of O’Leary v. Commissioner, T.C. Memo. 1986-212, affd. 837
F.2d 1088 (5th Cir. 1988). If, however, the obligation is
speculative, periodic payments may be applied to the principal
until costs are recovered. See Underhill v. Commissioner, 45
T.C. 489, 492 (1966). In Underhill we held that, in determining
whether a particular obligation is “speculative”, the ultimate
test is whether, at the debt’s inception, the creditor cannot be
Page: Previous 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 NextLast modified: May 25, 2011