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under section 1.166-6(a)(2), Income Tax Regs. We agree with
respondent.
Section 1.166-6(a)(2), Income Tax Regs., allows a bad debt
deduction on account of accrued interest only if that accrued
interest has previously been “returned as income.” We construe
this language to require the accrued, but unpaid, interest to
have previously been reported by the taxpayer as taxable income
on a Federal income tax return. This is, in our view, consistent
with the purpose of providing a bad debt deduction which is to
account for: (1) The taxpayer’s unrecovered cost or capital
investment, and (2) amounts reported as income but ultimately not
collected because they became worthless. Citizens’ Acceptance
Corp. v. United States, 462 F.2d 751, 756 (3d Cir. 1972).7 We
7See also Dist. Bond Co. v. Commissioner, 39 B.T.A. 739, 746
(1939), affd. in part on this issue, revd. in part on different
grounds 113 F.2d 347 (9th Cir. 1940), a case involving a claimed
bad debt deduction for accrued tax-exempt interest, wherein the
Board of Tax Appeals observed:
Petitioner insists that the deduction should be
allowed in the instant case, notwithstanding the rule
above referred to, for the reason that the amount in
controversy was accrued by petitioner on its books and,
it is argued, thus passed through the “tax mill.” We
can not agree with this argument. So far as concerns
tax liability, a taxpayer on an accrual basis who
accrues an income item on his books but does not
include the amount in taxable income is in no different
position than the taxpayer on a cash basis who does not
include a similar item in income because it has not
been received. To allow the deduction in either of
such events would result in reducing the amount of the
taxable income received or accrued from other sources
by an amount representing not a loss of capital or of
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