Deed-in-Lieu with Deficiency Waiver Fixes the Year of COD Income; No “Later-Discovery” Exception to the Variance Doctrine — Commentary on Salta v. United States (2d Cir. 2025)

Deed-in-Lieu with Deficiency Waiver Fixes the Year of COD Income; No “Later-Discovery” Exception to the Variance Doctrine — Commentary on Salta v. United States (2d Cir. 2025)

Court: U.S. Court of Appeals for the Second Circuit (Summary Order)

Date: October 6, 2025

Case: Salta v. United States, No. 24-2700-cv

Panel: Circuit Judges Reena Raggi, Gerard E. Lynch, and Michael H. Park

Note: This decision was issued as a Summary Order and therefore does not have precedential effect under Second Circuit rules. It may, however, be cited in accordance with FRAP 32.1 and Local Rule 32.1.1 and is persuasive authority.

Introduction

This appeal arose from a federal tax refund suit brought by joint filers Romeo Salta, Jr. and Phyllis Polega, who paid tax on cancellation-of-indebtedness (COD) income they reported in 2015 after a deed-in-lieu-of-foreclosure transaction on Salta’s Point Lookout, New York property. They later claimed the COD income should have been recognized in 2017, sought an IRS refund, and, when denied, litigated in the Southern District of New York. The district court granted summary judgment to the United States, and the Second Circuit affirmed.

The case presents two central issues:

  • When COD income is recognized for federal income tax purposes in the context of a deed-in-lieu-of-foreclosure where the lender waives any deficiency.
  • Whether taxpayers may advance, in court, a new refund theory (here, contract unenforceability in 2015) that was not presented to the IRS in their administrative refund claim—implicating the “variance doctrine” under 26 U.S.C. § 7422(a).

In a straightforward application of established principles, the Second Circuit held that the deed-in-lieu with a waiver of deficiency in January 2015 was an “identifiable event” that fixed the COD income in the 2015 tax year. The court also reiterated the strictness of the variance doctrine, rejecting the taxpayers’ attempt to introduce a late-arising “unenforceability” argument that had not been presented to the IRS.

Summary of the Opinion

  • COD Timing: The taxpayers’ COD income accrued in 2015. The deed-in-lieu transaction—by which Salta transferred the property to the mortgagee and the lender/servicer waived any deficiency—was an “identifiable event” making it clear the debt would never have to be paid. Accordingly, 2015 was the proper recognition year. See 26 U.S.C. § 61(a)(11); Cozzi v. Commissioner, 88 T.C. 435 (1987); Hohl v. Commissioner, T.C. Memo. 2021-110.
  • Variance Doctrine: The taxpayers’ argument that the 2015 Relocation Agreement was unenforceable could not be entertained because it was not raised before the IRS in their administrative claim. The court found no authority for a “later-discovered facts” exception and emphasized the taxpayers knew or should have known the relevant facts in 2015. See Apollo Fuel Oil v. United States, 195 F.3d 74 (2d Cir. 1999) (per curiam); Magnone v. United States, 902 F.2d 192 (2d Cir. 1990) (per curiam).
  • Result: The Second Circuit affirmed summary judgment for the government.

Analysis

Precedents Cited and Their Role

  • 26 U.S.C. § 61(a)(11): Statutory anchor establishing that “income from discharge of indebtedness” is gross income unless an exclusion applies. The court reaffirmed the baseline rule that COD income is includible when realized.
  • Gitlitz v. Commissioner, 531 U.S. 206 (2001): Cited for the general proposition that COD income is taxable income. The Supreme Court’s recognition of the includibility of COD income frames the conversation; Gitlitz provides background rather than the dispositive timing rule here.
  • Cozzi v. Commissioner, 88 T.C. 435 (1987): The key timing precedent. Cozzi holds that a debt is considered discharged “the moment it becomes clear that the debt will never have to be paid,” and that any “identifiable event” fixing the loss may mark that moment. The Second Circuit leaned on Cozzi to locate the recognition year in the deed-in-lieu transaction itself, not in later paperwork or tax form inconsistencies.
  • Hohl v. Commissioner, T.C. Memo. 2021-110: Reinforces Cozzi’s “identifiable event” framework. The court’s reliance on Hohl underscores that Tax Court guidance remains a strong touchstone for COD timing analyses.
  • Gudmundsson v. United States, 634 F.3d 212 (2d Cir. 2011) and Heublein, Inc. v. United States, 996 F.2d 1455 (2d Cir. 1993): Standards governing review and the approach to cross-motions for summary judgment. They frame how the panel assessed the district court’s grant of summary judgment.
  • Apollo Fuel Oil v. United States, 195 F.3d 74 (2d Cir. 1999) (per curiam) and Magnone v. United States, 902 F.2d 192 (2d Cir. 1990) (per curiam): The controlling Second Circuit variance doctrine cases. They hold that taxpayers must present to the IRS the grounds they later intend to litigate; new and different grounds are barred in court.
  • McDonnell v. United States, 180 F.3d 721 (6th Cir. 1999): Quoted for the purpose of the variance rule—preventing surprise and giving the IRS a fair opportunity to investigate and resolve the claim administratively. The Second Circuit used McDonnell for policy reinforcement.
  • Sherrod v. Mount Sinai St. Luke’s, 204 A.D.3d 1053 (2d Dep’t 2022): A New York agency-law decision, cited in a footnote to emphasize that a person dealing with an agent does so at their peril and must ascertain the agent’s authority. The panel referenced this to reject the taxpayers’ “late discovery” that the loan servicer allegedly lacked authority; their failure to verify in 2015 did not excuse the variance bar.

Legal Reasoning and Application

1) COD Income Timing: The “Identifiable Event” as the Recognition Trigger

COD income is recognized when it becomes clear a debt will not be repaid—marked by an “identifiable event.” Applying Cozzi, the Second Circuit found such an event in January 2015, when Salta executed a deed-in-lieu-of-foreclosure and the lender/servicer waived any right to a deficiency judgment. The court emphasized that the documents contemporaneously signed in January 2015 show that:

  • Salta relinquished possession and transferred the deed to the mortgagee for the Point Lookout property.
  • The mortgagee (and loan servicer) waived any deficiency and accepted the property in full satisfaction of the mortgage debt.

These features are legally decisive: a deed-in-lieu coupled with a deficiency waiver extinguishes the debtor’s remaining personal liability, making it clear the debt will not be paid. That event, not any later administrative issuance or correction of forms by the loan servicer, fixes the tax year for COD recognition. The court’s reliance on Cozzi and Hohl underscores that the controlling inquiry is the substantive transaction that resolves the debt—not the happenstance of later paperwork or reporting inconsistencies.

2) The Variance Doctrine: Preserving Arguments in IRS Refund Claims

Section 7422(a) requires taxpayers seeking refunds to first present their claim to the IRS; the “variance doctrine” enforces that requirement by barring taxpayers from litigating refund grounds that materially differ from those advanced administratively. The taxpayers did not challenge the enforceability of the January 2015 Relocation Agreement in their IRS filings; those submissions focused on the servicer’s “conflicting tax filings” and a statute of limitations theory that was later abandoned. Under Apollo Fuel Oil and Magnone, the court held that the new enforceability argument could not be heard.

The panel rejected two attempted workarounds:

  • No “later-discovery” exception: The court found no legal authority carving out an exception to the variance rule when a taxpayer later learns a private contract might be unenforceable. The policy—preventing surprise and enabling IRS investigation—would be undermined by such an exception.
  • Taxpayers knew or should have known the key facts in 2015: The documents apparently had no lender signature line, and it was clear on their face that the mortgagee did not sign. Moreover, in dealing with an agent (the loan servicer), the taxpayers had the burden to verify authority; failure to do so does not excuse noncompliance with the variance doctrine (citing Sherrod).

In short, even if contract enforceability had merit, it was out of bounds because it was not fairly presented to the IRS at the administrative stage.

Impact and Practical Implications

A. COD Timing in Foreclosure Alternatives

For homeowners and borrowers resolving mortgage obligations via deeds-in-lieu, short sales, or similar transactions, this order reinforces a practical rule: the tax year is determined by the substantive event extinguishing the debt—especially a documented waiver of deficiency—not by the date of any lender-issued tax form or later administrative adjustments. Taxpayers should expect that:

  • When a deed-in-lieu is executed and the lender waives remaining liability, COD income is generally recognized in that same year.
  • Conflicting or delayed tax reporting by servicers does not move the recognition year if an earlier identifiable event clearly fixed the discharge.

B. Refund Litigation Strategy: Preserve Every Ground Early

The variance doctrine remains a potent gatekeeper in refund litigation. Taxpayers and counsel should:

  • Present all theories and factual grounds to the IRS in the initial administrative claim, including alternative years and alternative legal theories (e.g., timing, enforceability, exclusions, computational errors).
  • Use protective or alternative claims if facts are uncertain, and supplement the claim as new information emerges—before filing suit.
  • Document agency/authority issues contemporaneously when dealing with servicers or agents to avoid later disputes; do not assume authority without verification.

C. Interplay with Exclusions (Not at Issue Here)

Although not raised or decided in this appeal, COD income can sometimes be excluded under specific provisions (e.g., insolvency, bankruptcy, or, in certain years, qualified principal residence debt). Salta does not address exclusions; it focuses on timing and issue preservation. Practitioners should independently evaluate exclusions in the recognition year fixed by the identifiable event.

D. Persuasive Guidance Despite Non-Precedential Status

Even as a Summary Order, Salta is likely to be cited by litigants and district courts for two propositions:

  • A deed-in-lieu paired with a deficiency waiver is a textbook “identifiable event” for COD timing.
  • The Second Circuit’s variance doctrine bars refund plaintiffs from litigating new theories not fairly disclosed to the IRS, and there is no leniency for “late discovery” arguments where the underlying facts were or should have been known earlier.

Complex Concepts Simplified

  • Cancellation-of-Indebtedness (COD) Income: When a lender forgives or cancels part or all of a borrower’s debt, the borrower generally realizes taxable income equal to the amount forgiven (subject to specific statutory exclusions).
  • Identifiable Event: A concrete occurrence demonstrating that a debt will not be repaid—e.g., a settlement, release, or a deed-in-lieu with a deficiency waiver. This event fixes the tax year for recognizing COD income.
  • Deed-in-Lieu-of-Foreclosure: The borrower voluntarily conveys property to the lender to satisfy the mortgage. If the lender accepts the property “in full satisfaction” and waives any deficiency, the borrower’s personal liability is extinguished, often generating COD income in that year (depending on recourse/nonrecourse status and other facts).
  • Deficiency Judgment: After foreclosure, if sale proceeds are insufficient to cover the loan, the lender might seek a deficiency judgment for the balance. A waiver of that right is central to identifying COD income because it confirms the borrower’s remaining debt will not be collected.
  • Variance Doctrine (Refund Claims): A taxpayer must first present to the IRS the grounds for a refund. In court, the taxpayer cannot vary from those grounds. The rule prevents surprise and allows the IRS to investigate and resolve claims administratively.
  • Agent’s Authority (Power of Attorney/Agency): When dealing with a servicer or agent, the counterparty bears the risk of ensuring the agent has authority to act. A later realization that authority might have been lacking does not, by itself, excuse procedural defaults or revive barred arguments.

Conclusion

Salta v. United States reinforces two durable principles in federal tax administration. First, the timing of COD income hinges on the substantive “identifiable event” that makes nonpayment certain. In mortgage contexts, a deed-in-lieu coupled with a deficiency waiver is precisely such an event, fixing the recognition year when executed. Second, the variance doctrine is unforgiving: refund plaintiffs must present all grounds to the IRS in their administrative claim. Courts will not entertain new theories—such as late-raised contract enforceability arguments—that were not properly preserved, particularly where the relevant facts were or should have been known at the time of the claim.

While non-precedential, the Second Circuit’s Summary Order provides clear, practical guidance: taxpayers should align their COD recognition with the transaction that extinguishes liability and must rigorously preserve every potential refund ground before the IRS. Doing so respects the administrative process, avoids procedural bars, and positions disputes for efficient resolution on the merits.

Case Details

Year: 2025
Court: Court of Appeals for the Second Circuit

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