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such interest for tax purposes, could not claim a bad debt
deduction for the accrued interest. See 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). We believe these same principles apply for purposes of
applying section 1.166-6(a)(2), Income Tax Regs. Indeed, section
1.166-6(a)(2), Income Tax Regs., appears to have incorporated the
principles articulated in this prior caselaw. Accordingly, we
hold that the language “returned as income”, as used in section
1.166-6(a)(2), Income Tax Regs., refers to interest that has been
properly accrued for tax purposes and has been reported as
taxable income on a return.
It follows from our interpretation of section 1.166-6(a)(2),
Income Tax Regs., and the precedents cited above, that petitioner
cannot claim a bad debt deduction for interest, which accrued
during a period in which petitioner was tax exempt, which it did
not report as taxable income, and on which it was not subject to
tax.9
Petitioner argues that the regulation is inapplicable to its
situation because it adopted the accrual method of accounting for
9Petitioner does not allege that it filed a “return” in
which it reported its accrued interest as taxable income for the
periods before Jan. 1, 1985. The argument that petitioner makes
is that consistency in accounting requires it to increase its
regular adjusted cost basis in its mortgages for the interest
that accrued on those mortgages before Jan. 1, 1985.
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