author: Sternhagen :

text:
    Amy Hutchison Crellin, Petitioner, v. Commissioner of Internal Revenue, Respondent. Amy Hutchison Crellin Trust, Pasadena Methodist Foundation, Trustee, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 106839, 109669.
    Promulgated May 13, 1942.

      Maynard J. Toll, Esq., for the petitioners.

      Harry B. Horrow, Esq., for the respondent.
   OPINION.

Sternhagen :

1. The question in both cases is whether the Crellin trust is within the provisions of sections 1004 (a) (2) (B) and 101 (6), Internal Revenue Code. If it is within the former, the gift of Mrs. Crellin to it is a deduction in determining her gift tax; if it is within the latter, the trust is exempt from income tax.

The approach to the question involves the emphasis to be placed upon one or the other of the coordinate subdivisions A and B, paragraph eighth, of the trust instrument. If the trust had designated as beneficiaries only those stated in subdivision B, the statutory exemption would hardly be doubtful. Such a trust would be a means of providing for education, without personal specification or identification, of the young people of a church of the community, and this would be enough to establish the charitable character of the trust. In re Henderson's Estate, 112 Pac. (2d) 605; In re Willey's Estate, 128 Cal. 1; 60 Pac. 471. On the other hand, if the trust had designated only the fourteen enumerated in subdivision A, it would not be a public charitable trust but a private means of educating the named relatives of the settlor. Henry C. DuBois, 31 B. T. A. 239; James Sprunt Benevolent Trust, 20 B. T. A. 19. But the inclusion of both these divergent provisions in the same trust presents a different question.

There is no doubt that the trust was created for a beneficent purpose, which is expressed in the opening paragraph of eighth. But this alone is not determinative, since it affects equally both divergent subdivisions. Clearly if the opening paragraph of eighth were followed only by a list of three persons who were the children of the settlor, it would not serve to give a charitable character to the trust.

The fact is that two separate and dissimilar groups of beneficiaries are set forth in subdivisions A and B. Those in subdivision A are fourteen named persons, and no descriptions or common attributes are set forth. Evidence dehors the instrument shows that these persons are among the seventeen grandnephews and grandnieces of the settlor, that they are not members of the First Methodist Church of Pasadena and are not residents of that vicinity. Subdivision B designates an entirely different class of beneficiaries, namely, young people who are members of the First Methodist Church. The fourteen relatives named in subdivision A are not within a general class of beneficiaries, and do not present an instance within the doctrine that a trust for a general class is none the less a charitable trust if it provides for a preference to certain members of the class. Cf. Schoellkopf v. United States, 124 Fed. (2d) 982.

Instead of being favored beneficiaries of a more general class, the nominees in group A are the particular persons for whom the trust was primarily created. In the instrument itself they are the first named, and, if their educational demands are sufficient, they may exhaust the fund. While it does not seem likely that the demand will be great enough to have such a result, nevertheless the settlor intended that the fourteen should be provided for even though the fund should thus be exhausted and nothing be left for the young people of the church. Behind the instrument, the evidence shows that the trust was born of the settlor’s desire to provide education for her fourteen grandnephews and grandnieces, and this strengthens the inference as to intention which is drawn from the instrument itself. Only the excess of the fund is to be devoted to the education of young people of the church; and in view of the amount of the fund and the number of primary beneficiaries, it is apparent that the aid provided for the church members is incidental to the main object of the trust.

For this reason, it can not be said that the trust is a public charitable trust; the exemption is defeated by the specific enumeration of the settlor’s grandnephews and grandnieces as the individual beneficiaries. Cap Andrew Tilles, 38 B. T. A. 545; affirmed other point, 113 Fed. (2d) 907, certiorari denied, 311 U. S. 703. For the same reason, it does not help petitioner that the purpose of the trust is entirely educational.

But if the question be approached from the opposite view, and the trust be regarded as predominantly one for the benefit .of young people of the First Methodist Church, it would still be necessary to hold that this was not the exclusive purpose for which it was organized and operated. The private beneficence to the enumerated fourteen relatives was not a mere incident of a larger public charity. Subdivision A and its operation are a major part of the trust. While this may be essentially a question of degree, a trust for the benefit, of thousands of persons in a class not perhaps losing its character if it also benefited fourteen of the settlor’s relatives, the degree in the present case is relatively too great to be ignored.

This is a commendable trust, actuated by the highest motives. It was not impelled by any thought of reducing taxes through, a factitious deduction. If it had been, the instrument would have been drawn quite differently. The instrument was obviously drawn to effectuate the settlor’s purpose primarily to provide her grandnephews and grandnieces with the means of a college education which otherwise they might not be able to procure. This purpose, no matter how commendable, is not the charitable purpose which permits a deduction for gift tax or an exemption to the trust.

2. Mrs. Crellin, believing herself entitled to a deduction under section 1004 (a) (2) (B), Internal Revenue Code, took no deduction under section 505 (a) (1), Revenue Act of 1932, as amended by section 301 (1) (b), Revenue Act of 1935, of any part of the specific deduction of $40,000. She now claims the right to such deduction. We see no ground upon which the deduction can be denied. The statute gave petitioner the right to use up as much of the $40,000 exemption as her gift would absorb. In mandatory language it provides that to this extent the exemption shall be allowed as a deduction. In any year the allowance is only limited to the remainder left after the amounts of previous years’ exemptions have been charged against the total of $40,000. As to the amount, no question is raised. The fact that the taxpayer, in a mistaken view of the law, has omitted to avail herself of the exemption is not an election which operates to deprive her of the exemption when her mistake is disclosed. Richardson v. Commissioner, 126 Fed. (2d) 562.

In Docket 106839 it is held that, although petitioner is not entitled to a deduction under section 1004 (a) (2) (B), Internal Revenue Code, she is entitled to a deduction under the specific exemption, and there is no deficiency. In Docket 109669, it is held that petitioner is not within section 101 (6), Internal Revenue Code, and is therefore not exempt. Decision will be entered under Rule 50.

       SEC. 1004. DEDUCTIONS.
      In computing net gifts for the calendar year 1039 and preceding calendar years, there shall be allowed (except as otherwise provided in paragraph (1) of subsection (a)) such deductions as are provided for under the gift tax laws applicable to the years in which the gifts were made.
      Sec. 505. (a) (2) (B), Revenue Act of 1932, as amended by sec. 517 (a), Revenue Act of 1934:
      In computing net gifts for any calendar year there shall be allowed as deductions:
      (a) Residents. — In the case of a citizen or resident—
      * * * * * * *
      (2) Charitable, etc., guts. — The amount of all gifts made during such year to or for the use of—
      * * * * * * *
      (B) A corporation, or trust, or community chest, fund or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals; no part of the net earnings of which inures to the benefit of any private shareholder or individual and no substantial part of the activities of which is carrying on propaganda, or otherwise, attempting, to influence legislation ;

        SBC. 101. EXEMPTIONS PROM TAX ON CORPORATIONS [as amended by § 217, 1939 Act.].
      The following organizations shall be exempt from taxation nnder this chapter—
      * ******
      (6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals,' no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation.

       Restatement of the Law, Trusts, eh. 11; Scott on Trusts, ch. 11; Paul, Federal Estate and Gift Taxation, ch. 12.

       SEC. 505. DEDUCTIONS.
      In computing net gifts for any calendar year there shall be allowed as deductions:
      (a) Residents. — In the case of a citizen or resident—
      (1) Specific exemption. — An exemption of $40,000 less the aggregate of the amounts claimed and allowed as specific exemption for preceding calendar years.


source: Caselaw Access Project

author: Keen :

license: Public Domain

text:
    The Alfredo Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 106928.
    Promulgated May 19, 1942.

      G. J. McGwire, Esq., for the petitioner.

      E. M. Woolf, Esq., for the respondent.
   OPINION.

Keen :

The sole issue is whether respondent correctly disallowed a $160,500 dividends paid credit in the computation of the surtax on petitioner, a personal holding company, for 1938.

The surtax is imposed on personal holding companies by section 401 of the Revenue Act of 1938, which provides for a levy upon the “undistributed Title IA net income of every personal holding company.” Section 406 of the 1938 Act defines the term “Title IA net income” and section 405 of the same act defines “undistributed Title IA net income.” Section 405 (a) contains the following provision:

SEO. 405. UNDISTRIBUTED TITLE IA NET INCOME.
For the purposes of this title the term “undistributed Title IA net income” means the Title IA net income (as defined in section 406) minus—
(a) The amount of the dividends paid credit provided in section 27 (a) without the benefit of paragraphs (3) and (4) thereof (computed without its reduction, under section 27 (b) (1), by the amount of the credit provided in section 26 (a), relating to interest on certain obligations of the United States and Government corporations); * * *

The provisions of subsections (b) and (c) of section 405 are immaterial to the present discussion, inasmuch as petitioner’s contention must stand or fall under the provisions of subsection (a).

Looking, therefore, to section 27 (a) (1) and (a) (2), we find the following definition of “dividends paid credit.”

SEC. 27. CORPORATION DIVIDENDS PAID CREDIT.
(a) Definition in General. — As used in this title with respect to any taxable year the term “dividends paid credit” means the sum of:
(1) The basic surtax credit for such year, computed as provided in subsection (b) ;
(2) The dividend carry-over to such year, computed as provided in subsection (c).

Respondent has allowed a dividends carry-over credit in the amount of $154.31 and there is no dispute over the provisions of section 27 (a) (2). It is with the provisions of section 27 (a) (1) that we are concerned. To ascertain the meaning of section 27 (a) (1) we are specifically referred to section 27 (b), which defines the term “basic surtax credit” as including, inter alia, the sum of the dividends paid during the taxable year. However, section 27 (i) specifically provides:

(i) Nontaxakle Distributions. — If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, such part shall not be included in computing the Basic surtax credit. [Emphasis ours.]

Consequently, the petitioner can not be allowed the benefits of section 405 (a) if the distributions it made within the taxable year are not taxable dividends in the hands of its four stockholders in the year in which the distribution was made.

Respondent argues that none of the $160,500 received in 1938 by petitioner’s four stockholders in 1938 was taxable to them in that year because these same stockholders (with the exception that the estate of Donna C. Jackson was the successor to Donna C. Jackson’s interest) had already reported as their individual income and paid the tax in prior years on all petitioner’s undistributed income.

Section 220 of the Revenue Act of 1926, under the provisions of which petitioner’s stockholders reported petitioner’s income as their own, imposed a surtax on accumulated surplus of corporations formed or availed of for the purpose of preventing imposition of surtax upon its shareholders. The section provided that the fact that a taxpayer is a holding or investment company was prima facie evidence of such purpose. Petitioner was organized in 1927, when this section was in operation. In order to avoid the corporate surtax, which was then 50 percent of the accumulated profits, petitioner’s stockholders took advantage of the provisions of section 220 (e):

(e) The tax imposed by subdivision (a) of this section shall not apply in respect of any taxable year if all the shareholders of the corporation include (at the time of filing their returns) in their gross income their entire distributive share, whether distributed or not, of the net income of the corporation for such year. Any amount so included in the gross income of a shareholder shall be treated as a dividend received. Any subsequent distribution made by the corporation out of the earnings or profits for such tamable year shall, if distributed to any shareholder loho has so included in his gross income his distributive share, be emempt from tarn in the amount of the share so included. [Emphasis ours.]

Thé same provisions were set forth with only minor corrections of language in section 104 of the Revenue Acts of 1928 and 1982. Although the provisions were changed in 1934, section 351 of the 1934 Revenue Act was made to apply specifically to personal holding companies such as petitioner, and imposed for the first time a surtax on the undistributed adjusted net incomes of such companies, without regard for explanation for such accumulations, and it embodied the provisions of section 220 (d), supra, without material change. In the 1936 Act the surtax rates were changed for the second time, but again the provisions of section 220 (d), supra, for escaping the surtax, were embodied without material change in section 351 of that act. In all the revenue acts in effect from the time of petitioner’s incorporation to and including the year 1937 there was a specific provision declaring that subsequent distributions of the income already reported in prior years by the stockholders would be nontaxable to those stockholders in the subsequent year of distribution.

Since there -were no profits in the taxable year from which distributions could have been made, it follows that all of the $160,500 distributed in 1938 came from the surplus on hand at December 31,1937, on which amount petitioner’s stockholders had in the various prior years paid the tax pursuant to the sections above set forth. By virtue of the provisions affording immunity from subsequent taxation contained in these same sections, the 1938 distributions were nontaxable in the hands of the stockholders. Petitioner has not made a contention that the estate of Donna C. ’Jackson does not succeed to Donna C. Jackson’s immunity’because the estate is not the “shareholder who has so included in his gross income his pro rata share.” Petitioner not having raised any issue on this point, we assume that both parties agree that the estate of Donna C. Jackson received the distribution tax free.

Having, therefore, decided that the $160,500 was a nontaxable distribution, section 27 (i) precludes us from allowing the credit set forth in section 405 (a).

Petitioner has argued that the distribution was, in fact, a taxable dividend, and brings to our attention articles 115-1 and 115-2 of Regulations 101. While it is undoubtedly a correct general statement of the law to say that a distribution, “not regarded as out of earnings and profits of the taxable year, shall be considered a taxable dividend to the extent of the earnings or profits accumulated since February 28, 1913, and available on the date of the distribution”, any general statutory provision must fall in the face of a specific provision. Missouri v. Ross, 299 U. S. 72. As we have shown above the revenue acts have specifically provided otherwise on the facts here demonstrated. Petitioner also argues that subsection (i) of section 27, supra, does not require that the dividend be taxable in the year of actual distribution in order to be included in computing the basic surtax credit. We believe that the wording of section 27 (i) means that the distribution must be a taxable dividend in the distributees’ hands in the year of receipt, in order that it be considered in computing the basic surtax credit.

Petitioner cites Dorothy Whitney Elmhirst, 41 B. T. A. 348, in support of the proposition that, because petitioner’s stockholders annually reported all of petitioner’s current earnings and profits as dividends received, this does not have the effect of diminishing the petitioner’s earnings available for future distribution. Petitioner’s point, though correct, is immaterial, for we are not concerned with what remained for future distribution, but with whether any distribution from accumulated earnings reported for taxation by the corporation’s stockholders in prior years could, in the future, be a taxable dividend within the meaning of section 27 (i).

As to the equity of the situation, petitioner can not rightly be heard to say that it did not receive in prior years a benefit akin to a dividends paid credit by being relieved from paying any surtax on its accumulations, because of the fact that its stockholders reported as their own taxable income their proportionate parts of petitioner’s undistributed profits in those years. It is true that it never received a “dividends paid crédit” as such, but the same result was achieved, since it was able to avoid the surtax pursuant to the provisions of section 220 (e) of the Revenue Act of 1926, section 104 of the Revenue Acts of 1928 and 1932, and section 351 of the Revenue Acts of 1934 and 1936. Having thus' been relieved from the payment of any surtax on • the annual accumulations of its income in the years in which it was accumulated, there is no equity in its contention that it should also be allowed a credit as a result of the physical distribution of such accumulated earnings in the taxable year. See Spokane Dry Goods Co., 43 B. T. A. 793; affd., 125 Fed. (2d) 865.

Respondent did not err in denying the dividends paid credit in 1938.

Decision will be entered for respondent.


author: Haehon :

text:
    Nathaniel Shilkret, Petitioner, v. Commissioner of Internal Revenue, Respondent. Anne Shilkret, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 103773, 103774.
    Promulgated May 19, 1942.

      J. Everett Blrnm, Esq., and Ralph W. Smith, Esq., for the petitioners.

      Samuel Taylor, Esq., for the respondent.
   OPINION.

Haehon :

Nathaniel and Anne Shilkret were domiciled in the State of New York in 1935. They resided in California during 1936 and 1937, when Nathaniel Shilkret, called petitioner as a matter of convenience, was employed by the RKO Studios in Hollywood under a two-year contract of employment. The petitioner contends that he and his wife were domiciled in California during the taxable years. If that contention is sustained, they were entitled to divide between them the net income of petitioner for income tax purposes under Federal recognition of the community property law of California, under which law one-half of the earnings and income of one spouse is the property of the other spouse.

Petitioner asserts that he moved to California with an intention, then, of remaining there for an indefinite time and that he acquired a fixed, present domicile there in 1935, at the earliest, or during 1936. Pie asserts that all of his acts, his state of mind, and his then intentions about the present and the future, were such that he acquired a new domicile.

The question is chiefly a question of fact, but three legal tests must be met by petitioner, in this case particularly, because petitioner’s contention involves proof of abandonment of an original domicile, for it appears that at all times up to the time of this controversy petitioner was domiciled in the State of New York. To establish a change of domicile petitioner must prove that he (1) abandoned the original domicile, (2) moved to and resided in a new domicile, and (3) had an intent of remaining, permanently and indefinitely, in the new domicile. Corpus Juris Secundum, vol. 28, p. 30; Kenna, “Residence and Domicil” (1934), p. 194; Beale, “Conflict of Laws”, vol. 1, p. 145, sec. 18.2; 9 R. C. L. 553. “Mere absence from a fixed home, however, long continued, can not work the change. There must be the animas to change the prior domicil for another. Until the new one is acquired, the old one remains.” Mitchell v. United States, 21 Wall. 350. “A domicil when acquired is presumed to continue until it is shown to have been changed.” Anderson v. Watt, 138 U. S. 694, 706.

The question must be decided against petitioner because he has failed to show that he abandoned his original domicile. The facts have been fully set forth in the findings. Upon due consideration of all of the evidence, it has been found as a fact that Nathaniel and Anne Shilkret were domiciled in New York State during the taxable years. The considerations which entered into arriving at this conclusion are as follows, as briefly as a summary of the facts permits:

When the lease on the New York apartment expired on September 30, 1936, it was renewed for another year, until September 30, 1937. Again, when the lease expired in 1937, it was renewed for another year, until September of 1938. That appears from the fact that Mrs. Shil-kret returned to the apartment permanently at the end of 1937, petitioner returned there in March of 1938, and both lived there until 1939, when they moved to a new apartment in New York City. Retention of the apartment in New York and failure to move any household goods to California negative petitioner’s assertion that he intended to live in California permanently and indefinitely at the time he went there. There is no convincing or even persuasive explanation for the two renewals of the New York lease in 1936 and 1937. Petitioner entered into the contract with RKO on October 31, 1935. Of course, with due regard for the usual difficulties of lawfully extricating oneself from lease obligations, it would have been only a matter of enforced delay, if the Shilkrets had not moved their household possessions to California until the lease expired in September of 1936 (see Behrensmeyer v. Kreitz, 26 N. E. 704, 712, referring to Louis Steffin), but the renewal of the lease in 1936 and the second renewal, in 1937, strongly indicates that there remained throughout an intention to return to New York. Due consideration has been given to the close proximity in the dates of the expiration of the RKO contract on November 18, 1937, and expiration of the New York lease on September 30, 1937. But, again, leaving out for the moment the question of the second renewal of the lease, it is difficult to understand why the Shilkrets made the first renewal in 1986. On March 15,1937, tax day for the year 1986, they had not taken any of the steps usually taken when persons make a permanent move to a new home in a new locality. If it was a matter of delay in finding a home in California to purchase, as part of petitioner’s testimony suggests, it is not reasonable to believe that the facilities for storing the furniture for a short time in California would not have occurred to persons who had a definite and fixed intent to establish a permanent home in California, as petitioner asks us to believe. Nor is it reasonable to believe that persons who had a present intent to establish a permanent home in California would, after carrying the New York lease well into the autumn of 1936, at a rental of $3,000 a year, consider it cheaper, or more economical to contract to pay another year’s rental of $3,000, on September 30, 1936, rather than to move the household furnishings to California and store them in a warehouse until all requirements were m,et in selecting a new house. Mrs. Shilkret’s explanations, that she was ill at the time the lease expired in September of 1936 and that she was unable to find an unfurnished house to suit her taste, have been considered. But, we believe that they are not entitled to receive much weight in the total considerations. The nature of her illness is not explained. Inability to locate an unfurnished house in or near Hollywood is difficult to believe, and, finally, the general situation does not appear to have been so complex that, if the parties had had a very firm desire to move to California in order to locate there permanently, they could not have found a way of moving their furniture to California and relinquishing the New York lease between October 31, 1935, and September 30,1936, or September 30,1937. If, also, as petitioner asserts, he intended to leave behind him all business activities in New York and to start new professional activities in the motion picture industry in California and devote himself to them for the rest of his life, the record does not provide any explanation of why, as things stood in September of 1936, petitioner did not terminate the New York lease and really move to California.

It appears to be closer to the realities of the whole situation to interpret petitioner’s state of mind in 1936 relating to his future professional work to have been to stay in California if he found it profitable to do so at the end of his two-year contract; otherwise, to return to New York. Petitioner’s retention, throughout the period of the RKO contract, of a place of abode in New York City was certainly a keeping of his “bridges” in New York, and such is indicative of retention of original domicile. See District of Columbia v. Murphy, 314 U. S. 441.

Nor does it appear that in his professional work, petitioner burned his bridges in New York. During the taxable years, and after he returned to New York, he continued to do radio broadcasts, which can be done in any place, New York or elsewhere. He refused to enter into a contract with. MGM because they would not permit him to do radio work. Also, petitioner kept business offices in New York City, as his deductions for office rent in 1936 and 1937 show. Petitioner’s alleged intent is negatived and contradicted by acts inconsistent with the avowed intent of establishing a domicile in California. District of Columbia v. Murphy, supra; In re Beechwood, 254 N. Y. S. 473; Paul & Merten’s Law of Federal Income Taxation, vol. 2, sec. 16.05, p. 60; Rosenberg v. Commissioner, 37 Fed. (2d) 808.

The filing of income tax returns in California lends no weight to petitioner’s argument. He was a “resident” of California, as defined by the state income tax statute, and, as such, he was required to file a return for income from sources within the state, whether or not he was domiciled there. Cal. Stat. 1935, p. 1090, sec. 2 (k), and Cal. Stat. 1937, p. 1831, sec. 2 (k).

The weight of the evidence, in our opinion, supports the conclusion reached. Petitioner has failed to show that he took up residence in California with any present intention of residing there indefinitely and permanently without any actual intention of returning to New York as his permanent home; that he abandoned the original domicile in the State of New York. See United States v. Knight, 291 Fed. 129; affd., 299 Fed. 571; C. M. Weatherwax, 21 B. T. A. 861.

Petitioner contends, also, that regardless of domicile in California the income earned in California is community property for tax purposes. The same contention was made in Herbert Marshall, 41 B. T. A. 1064, 1068. The Board rejected this argument as unsound in the Marshall case and it is not entitled to consideration here.

Decision wild be entered for the respondent in Docket No. 103773. Decision that there is no deficiency will be entered in Docket No. 10377f.


author: Tyson:

text:
    Estate of Frederick L. Alldis, Deceased, Evelyn M. Libby, Administratrix, Petitioner, v. Commissioner of Internal Revenue, Respondent. Evelyn M. Libby, Petitioner, v. Commissioner of Internal Revenue, Respondent. Frank A. Alldis, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 106390, 106389, 106391.
    Promulgated May 19, 1942.

      George L. Cassidy, Esq., for the petitioners.

      Philip M. Claris, Esq., for the respondent.
   OPINION.

Tyson:

The respondent contends that the Chrysler Management Trust is an “employees’ trust” within the meaning of section 165 of the Revenue Act of 1938 and similar provisions of prior acts, citing Chrysler Corporation, 42 B. T. A. 795, as establishing that the corporation’s earnings contributed to the trust constituted additional compensation to the corporation’s executives who became beneficiaries of the trust. He further contends that the amount of $56,472.20 here involved represents an “amount * * * made available” to the decedent as a distributee of the trust in excess of cost of decedent’s 100 shares of beneficial interest and, accordingly, is “taxable to him in the year in which so * * * made available”, pursuant to section 165, supra. He further contends that, the $56,472.20 being income made available by reason of decedent’s death, such amount, under authority of Helvering v. Enright, 312 U. S. 636, constituted ordinary income to the decedent which “accrued up to the date of his death” within the meaning of section 42 of the Revenue Act of 1938 and must be included in decedent’s gross income for the period of January 1 to January 27, 1938. In Chrysler Corporation, supra, the Board did not have before it, and did not decide, the specific question of the character of the trust entity involved in the instant proceeding and the decision there has no application here.

Petitioners contend that the trust is an association taxable as a corporation and that the decedent’s shares of beneficial interest therein were the equivalent of shares in a corporation and thus constituted a capital asset, the mere appreciation in the value of which does not constitute income to the decedent “accrued to the date of his death” within the purview of section 42, supra. Further, if the trust is held not to be an association taxable as a corporation, petitioners contend: (a) That the trust is not an “employees’ trust” within section 165, supra, and, even if it is, that no part of the $56,-472.20 was ever made available out of the trust’s assets either to the decedent or his estate, and (b) that the trust is a pure trust, taxable under section 161 of the Revenue Act of 1938 and prior acts, and for that reason no part of the $56,472.20 here involved constitutes income taxable to the decedent up to the time of his death.

In our opinion, the Morrissey and its companion cases, supra, have no application to the trust here involved, for it was not an association of interested parties organized in a manner similar to corporate form to carry on any business enterprise and, further, the shares of beneficial interest were not freely transferable, but could be assigned only to the Chrysler Corporation in certain events. The trust was essentially a part of a plan with the primary purpose of enabling certain executives of the Chrysler Corporation to become owners of stock of that corporation on a basis favorable to them. It was created and was operated as an ordinary trust, principally to hold and conserve the funds paid over to it by the corporation under that plan and to invest such funds primarily in shares of stock of the corporation for the benefit of those who became beneficiaries of the trust. We hold that the trust was not an “association” taxable as a corporation.

In our opinion, the trust was not an “employees’ trust” within the meaning of section 165, supra. While the trust was created as part of a plan for the benefit of certain persons who continued in the employ of the corporation and were designated by the corporation as beneficiaries of the trust, nevertheless, the important and decisive fact is that the trust was not for the “exclusive” benefit of employees of the corporation within section 165, supra. Cf. W. F. Parker, 38 B. T. A. 989. Here, upon termination, by death or otherwise, of the corporation’s employment of a beneficiary of the trust the corporation not only had the right, but was contractually obligated, to purchase such former employee’s beneficial interest in the trust and thereupon became the owner thereof as a participating beneficiary having the same rights as all other remaining beneficiaries under the specific provisions of the trust indenture. Pursuant to that obligation, and up to and including the year 1938 here involved, it was possible for the corporation, through a series of acquisitions of beneficial interests, to become the principal beneficiary of the trust estate. Furthermore, while it is true that any owner of a beneficial interest living at the termination of the trust term was entitled to certain distributions out of the accumulated trust estate, consisting primarily of shares of stock of the corporation, yet upon his death or the severance of his employment by the corporation prior to the termination of the truss no portion of the trust assets could be “actually distributed or made available” to either the owner of the shares of beneficial interest or his personal representative. Instead, article seven of the trust indenture required that such beneficial interest be sold at its then determinable value to the corporation for cash. The instant case is distinguished on its facts from Estate of Frederick C. Kirchner, 46 B. T. A. 578; Estate of A. M. Berry, 44 B. T. A. 1254; Dillis C. Knapp, 41 B. T. A. 23; and Ralph H. Jackson, 40 B. T. A. 1094, and, accordingly, the principles announced in those cases are not applicable here.

It is our opinion that the trust involved was a pure trust, subject to tax on its income as provided by sections 161 and 162 of the Kevenue Act of 1938 and prior acts.

In the instant proceeding the established facts are that no amount either was or could be distributed or made available in 1938 out of the trust estate by reason of the decedent’s death and his ownership at that time of 100 shares of beneficial interest in the trust. The decedent’s shares were not and could not be surrendered to the trust for cancellation and a pro rata distribution of trust assets to the holder thereof. Instead, those shares represented an interest owned by the decedent in the trust assets, which interest, by the terms of the trust indenture, was specifically made assignable to the corporation for the cash value thereof, and upon the corporation’s acquisition thereof those shares remained outstanding as evidence of its pro rata interest in the undiminished assets of the trust, a taxable entity separate from both the corporation and the decedent herein. In our opinion, the decedent’s pro rata beneficial interest in the assets of the trust evidenced by his 100 shares, at date of death, constituted a property interest and as such a capital asset, which passed to his estate and was sold by the latter to the corporation for a cash consideration of $56,472.20.

We hold that the amount of $56,472.20 involved herein was not “income” to the decedent and for that reason section 42, supra, and Helvering v. Enright, supra, relied upon by respondent, are not applicable in the instant case.

Respondent erred in his determination of the deficiency in question and, further, the petitioner erroneously reported the above mentioned amount of $26,986.10 as a capital gain on the decedent’s income tax return for 1988.

Decision will he entered wnder Rule 60.

       SEC. 165. EMPLOYEES’ TRUSTS.
      (a) Exemption feom Tax. — A trust forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of some or all of his employees—
      (1) if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees the earnings and principal of the fund accumulated by the trust in accordance with such plan, and
      (2) if under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees under the trust, for any part of the corpus or income to be (within the taxable year or thereafter) used for, or diverted to, purposes other than for the exclusive benefit of his employees,
      shall not be taxable under section 161, but the amount actually distributed or made available to any distributee shall be taxable to him in the year in which so distributed or made available to the extent that it exceeds the amounts paid in by him. Such distributees shall for the purpose of the normal tax be allowed as credits against net income such part of the amount so distributed or made available as represents the items of interest specified in section 25 (a).
      (b) Taxable Yeae Beginning Befoee Januaex 1, 1939. — The provisions of clause (2) of subsection (a) shall not apply to a taxable year beginning before January 1, 1939.

       SEC. 12. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.
      The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. In the case of the death of a taxpayer there shall be included in computing net income for the taxable period in which falls the date of his death, amounts accrued up to the date of his death if not otherwise properly includible in respect of such period or a prior period.

       Citing Morrissey v. Commissioner, 296 U. S. 344; Swanson v. Commissioner, 296 U. S. 362; Helvering v. Combs, 296 U. S. 365; and Helvering v. Coleman-Gilbert Associates, 296 U. S. 369, laying down the salient features distinguishing an “association” from a strict trust as being (1) a voluntary association for carrying on a business enterprise, (2) centralized management with title in the trustees, (31 continuity of the business enterprise secure from termination by death of the participants, (4) transferability of participating interests without affecting the continuity of the enterprise, and (5) limitation of personal liability of the participants.


author: Arundell :

text:
    Clarence D. Kerr, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 106488, 106489, 107560.
    Promulgated May 19, 1942.

      Richard W. Wilson, Esq., for the petitioner.

      William, G. Ruymann, Esq., for the respondent.
   OPINION.

Arundell :

Section 25 (b) (2) of the Revenue Acts of 1936 and 1938 provides for credit for dependents in the amount of $400 for each person dependent upon and receiving his chief support from the taxpayer, if such person is under 18 years of age or is incapable of self-support because mentally or physically defective. This provision of the law, which has appeared in substantially the same form for years, has been implemented by regulations of the Commissioner. The allowance of a credit of $400 for dependents under 18 years of age is primarily a recognition of the obligations of parenthood, although the statute does not limit the allowance to dependent children. The fact that the credit stops at 18 years of age except in the case of physical or mental disability is no doubt due to the fact that in the average American family a child after reaching 18 years of age is regarded as capable of self-support.

In order that the credit be allowed it is necessary that the support be given to one who is in fact dependent upon the giver and the financial assistance given must constitute the chief support of the dependent. Each family constitutes a unit and, except in extraordinary circumstances, the dependents of one family are not to be credited as dependents of another. That petitioner’s two sons, John and Clarence, were both legally and morally required to care for their own children seems clear and that those childen were the dependents of their own parents and not of their grandparents we believe to be equally clear.

Petitioner is a well-to-do man. During the years in question he found his two married sons in financial difficulties due to the fact that their earnings were modest, sickness was present, and children had arrived rapidly. Petitioner came to their aid in a liberal way. The earnings of John, who apparently was in most need of funds, while limited in 1937, were more substantial during the years 1938 and 1939 and in fact were greater in amount than the income of the average American family, even though his income did not permit him and his family to live in the manner in which John had been accustomed. Clarence’s income was less, but his obligations were less, and apparently he did not suffer the same degree of hard luck as seems to have followed his brother.

The contributions made by petitioner during the several years were to his two sons and their families as a whole and were not made specifically to or for the benefit of his grandchildren. It is true that petitioner’s generosity permitted the grandchildren to be cared for in a manner that would not have been possible but for his assistance, but this does not, in our opinion, make them dependents of their grandfather, either legally or otherwise. See L. B. Hirsch, 42 B. T. A. 566, 579; affd., 124 Fed. (2d) 24. During all of these years the grandchildren continued to live with their own parents and during the whole period their fathers were gainfully employed. Even though a person may furnish the chief support of a minor, it does not necessarily follow that he is entitled to a dependency credit. It must also appear that the support given is to one who is in fact dependent upon him.

There are no doubt many instances where grandchildren are dependent upon and receive their chief support from their grandparents (I. T. 3226, C. B. 1938-2, p. 148), but it seems to> us that in the instant proceedings the gifts were essentially to John and Clarence for the family as a whole and not to the grandchildren as such. As Congress limits the deduction for dependents to instances where the dependent is under 18 years of age, one may not secure the coveted credit by attempting an entrance by way of the back door when the front door is barred.

Decision will de entered for the respondent.

       Art. 25-6. [Regulations 94 and 101.] Credit for Dependents. — A taxpayer * * * receives a credit of $400 for each person (other than husband or wife), whether related to him or not and whether living with him or not, dependent upon and receiving his chief support from the taxpayer, provided the dependent is either (a) under 18, or (b) incapable of self-support because defective.
      The credit is based upon actual financial dependency and not mere legal dependency. It may accrue to a taxpayer who is not the head of a family. But a father whose children receive half or more of their support from a trust fund or other separate source is not entitled to the credit.


author: Van Fossan :

text:
    Ellene Z. Rosensteel, Petitioner, et al.,
      v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 101995, 102483, 102484, 102676, 102677, 102822, 102823, 103566, 103567, 103568, 103988.
    Promulgated May 20, 1942.

      W. A. Seifert, Esq., Norman D. Keller, Esq., and A. G. Wallerstedt, C. P. A., for the petitioners.

      Orris Bennet, Esq., for the respondent.

       Proceedings of the following petitioners are consolidated herewith: Catherine W. Suppes ; Estate of Samuel B. Waters, deceased, Catherine Suppes, Executrix; Mary Ellis Turner; Hilda Ellis Mayer; Estate of Emma J. Howard, deceased, Charles E. Hager, Administrator c. t. a.; Prank Howard; Alice W. Thomas; Robert S. Waters; Elizabeth W. Waterman; and Charles W. Kunkle and Maude B. Kunkle, husband and wife.

   OPINION.

Van Fossan :

The first issue presents the question whether or not the redemption of the petitioners’ preferred stock in the Water Corporation on November 20, 1936, constituted a partial liquidation taxable under section 115 (c) of the Revenue Act of 1936.

The petitioners assert and attempt to show that the entire procedure, starting with the resolution of the board of directors of the Water Corporation on September 18,1936, to redeem the outstanding $100 par value 6 percent cumulative preferred stock of the corporation on November 20, 1936, and ending with the issue on December 31, 1936, of 19,980 of its new noncumulative no par value preferred stock to Bethlehem, was one entire unified plan whose purpose was to purchase the old preferred stock and to “resell” to Bethlehem the preferred interest in the corporation in the form of a somewhat similar stock, with no concomitant intent to distribute in complete cancellation or redemption of a part of the Water Corporation stock.

The petitioners argue that “as a whole” the transaction took nothing from the Water Corporation and transferred none of the corporate assets to its stockholders. They recite that before the redemption of the petitioners’ 6 percent cumulative preferred stock the Water Corporation had outstanding 18,040 shares of such stock, while after the issuance of the 6 percent noncumulative preferred stock the corporation had outstanding 19,980 shares of the latter stock, a substitute “with some change in the character of the interest”, and assert also that the net worth of the Water Corporation was increased by this maneuver.

The respondent contends that the Water Corporation intended to redeem the preferred stock of the petitioners and others as a complete integral action, and sets forth the following evidentiary facts:

On September 19,1936, the Water Corporation sent to the preferred stockholders its notice of redemption. On November 20, 1936, the corporation redeemed a portion of the stock in cash and completed the redemption by December 15, 1936. On December 15, 1936, the corporation filed a certificate of redemption with the Secretary of State of Delaware, stating that the certificate was filed so that its capital might be deemed to be reduced by the face value of the redeemed stock, or $1,804,000, pursuant to the requirement of the law of Delaware. On December 17, 1936, the Water Corporation stockholders adopted a resolution altering its structure by eliminating therefrom the authorized issue of 6 percent cumulative preferred stock at $100 a share and permitting the issue of noncumulative preferred stock of no par value carrying dividends of $6 per share. On December 21, 1936, a corresponding certificate of amendment was filed with the Secretary of State of Delaware. The corporation made appropriate entries on its books indicating the retirement of the stock. Each petitioner received $105 per share, the redemption price specified in the charter. The 19,980 shares of the new stock were issued to Bethlehem on December 31,1936.

The respondent maintains that from an analysis of this record, the shift of the parties in interest, and the wide variance in the character of the preferred stocks, the indubitable conclusion must be drawn that the redemption of the petitioners’ preferred stock was a wholly separate transaction from the issuance of the new preferred stock to Bethlehem.

The respondent has overlooked one fact contained in the record which strongly supports his position. Kobert E. McMath (vice president of Bethlehem and president of the Water Corporation), under whose supervision the transactions described were accomplished, testified that the Water Corporation borrowed from Bethlehem the funds needed to redeem the old stock; that the loan and other indebtedness of the Water Corporation to Bethlehem were discharged by an issue of a new class of preferred stock at the end of 1936, and that the plan for the redemption by the issuance of the preferred stock originated “shortly after the old stock was called for redemption and sometime before November 14, 1936.”

This bit of testimony clarifies the facts and clearly leads to the conclusion that the creation of the new stock and its issuance to Bethlehem and the redemption of the petitioners’ preferred stock were not parts of a single integrated plan, but were separate transactions. The procedure of redemption pursued precisely its original and independent course, which terminated in the filing of the required certificate with the Secretary of State of Delaware, stating that the Water Corporation had redeemed all of its outstanding 6 percent cumulative preferred stock at its authorized redemption price and that the certificate was made “in order that * * * the capital * * * shall be deemed to be and shall thereby be reduced by the amount of the capital of the Corporation so applied to the aforesaid redemption of said 18,040 shares of said Six Per Cent Cumulative Stock to wit, $1,804,000.00.”

Although the stock could have been reissued, the purport of the certificate was that a reduction of capital and not a reissuance of the stock was contemplated by means of the process of redemption. Moreover, reissuance was effectively barred by the subsequent amendment to the certificate of incorporation.

We have no doubt, on the facts and in the light of decided cases, that the redemption of the 6 percent cumulative preferred stock by the Water Corporation constituted a partial liquidation within the purview of section 115 (c) and as defined by section 115 (i). See Helvering v. Tex-Penn Oil Co., 300 U. S. 481; Cohen Trust v. Commissioner, 121 Fed. (2d) 689; L. B. Coley, 45 B. T. A. 405.

The later issuance of the 6 percent noncumulative preferred stock was accomplished by a separate and. independent series of actions and events. The expedient was adopted to protect the equity of Cambria, holder of the common stock, against the potential pressure of Bethlehem’s claims as a common creditor and became the more imperative after the Water Corporation had borrowed almost two million dollars from Bethlehem to pay for the redeemed stock of the petitioners and others.

Furthermore, the authorization and the issuance of the new stock were begun after the redemption of the old stock and the proper certification thereof were completed. There was no overlapping such as normally would have occurred if both transactions had been component parts of a single plan. This sharp separation of record and procedure is additionally persuasive that there was no definite unified plan to substitute the new 6 percent noncumulative preferred stock for the old 6 percent cumulative preferred stock. See United States v. Rodgers, 102 Fed. (2d) 335. On the issue here involved we sustain the respondent.

In the second issue we must determine whether or not the exchange of common stock in the Water Co. for common and preferred stock of the Water Corporation was a taxable transaction.

The petitioners concede that under a strictly literal interpretation of the pertinent statutory provisions (sec. 112 (b) (3) and (i), Revenue Act of 1928 ) the exchange was nontaxable, but argue that the transferor of stock must retain a proprietary interest in the enterprise in order to meet the requirements of the statute, citing Le Tulle v. Scofield, 308 U. S. 415. They assert that the preferred stock which they received in the transaction represented no such interest.

In the Le Tulle case the Supreme Court said:

* * * Where the consideration is wholly in the transferee’s bonds, or part cash and part such bonds, we think it cannot be said that the transferor retains any proprietary interest in the enterprise. On the contrary, he becomes a creditor of the transferee; and we do not think that the fact referred to by the Circuit Court of Appeals, that the bonds were secured solely by the assets transferred and that, upon default, the bondholder would retake only the property sold, changes his status from that of a creditor to one having a proprietary stake, within the purview of the statute.

Thus the Court distinguished between the character of a bond and that of preferred stock. The petitioners were either stockholders, and as such the owners of a proprietary interest in the enterprise (the Water Corporation), or were its creditors. In Black’s Law Dictionary, p. 1449, the word “proprietary” is defined as “relating or pertaining to ownership, belonging or pertaining to a single individual owner.” The right of management is only one of the powers incident to ownership and that power may be waived or delegated. Restrictions, voluntary or otherwise, of ownership do not change the inherent character of the right. A creditor is defined as a person to whom a debt is owing by another person, called a debtor. Black’s Law Dictionary, p. 476.

Petitioners possessed no debt due from or claim against the Water Corporation. They owned an interest in the corporation. They could not proceed against it to recover their investment in the preferred stock so long as none of their specified rights were violated, but the creditors could enforce their claims in the customary legal manner.

The distinction between a creditor and a stockholder of a corporation is too clearly defined to merit much discussion. The status of a holder of preferred stock, as compared with that of the owner of common stock, is set forth in Fletcher Encyclopedia of Corporations, Permanent Ed., vol. II, sec. 5290, as follows:

la the absence of special provisions, the holders of preferred stock in a corporation are in precisely the same position, both with respect to the corporation itself and with respect to creditors of the corporation, as the holders of common stock, except only that they are entitled to receive dividends on their shares, to the extent guaranteed or agreed upon, before any dividends can be paid to the holders of common stock.

In Hazel Atlas Glass Co. v. Van Dyk & Reeves, Inc., 8 Fed. (2d) 716, the court said:

The general rule is that a holder of preferred stock, even though the preferred dividend is guaranteed, is not regarded as a creditor of the corporation, and entitled as such to share with the other creditors in the distribution of the assets. He is, like the holders of the common stock, merely a stockholder, but with this difference, that he is entitled to priority of payment out of the assets which remain after all debts are paid; the holders of the common stock sharing in such assets as are left.

In the case at bar the petitioners had all the rights usually reserved to preferred stockholders but lacked only the right to vote. For the purposes of section 112 we believe that the absence of this privilege is immaterial to the issue. It certainly can not convert a stockholder into a creditor.

The cases cited by both the petitioners and the respondent are useful only in an analogical discussion in which we deem it unnecessary to indulge. We hold that the exchange of the Water Co. stock in 1928 for the Water Corporation stock constituted a nontaxable transaction within the meaning of section 112 (b) (8) and (i) and that, consequently, the basis of gain or loss to the petitioners upon the redemption of their Water Corporation stock in 1936 was the cost of the Water Co. stock to them.

In view of our decision in the second issue the question presented in the third issue becomes moot.

The fourth issue involves the propriety of including the G. C. Murphy stock in the distribution of the Hillcrest Foundation, Inc., to petitioners Alice W. Thomas, Bobert S. Waters, and Elizabeth W. Waterman in 1986 and 1937. The circumstances surrounding the transfer of the stock are fully set forth in the findings of fact and need not be repeated.

Both the petitioners and the respondent cite and rely on North American Oil Consolidated v. Burnet, 286 U. S. 417. In that case the Court said :

* * * If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent.

We think the principles so announced apply to the facts before us. Certain individuals acquired the G. C. Murphy Co. stock by inheritance in 1933 from the estate of John H. Waters, who, prior to his death, claimed to have acquired it by purchase in 1931. The stock was contributed as capital to the Hillcrest Foundation, Inc., in 1934 and the shares, increased by a stock split-up, were distributed to the petitioners in 1936; all under the same “claim of right” and “without restriction as to disposition.” At that time no litigation was pending. There is no element of trusteeship or agency in the situation that would exclude the gain from the petitioners’ own income tax liability. See Stoner v. Commissioner, 79 Fed. (2d) 75; Commissioner v. Trinidad Paving Co., 62 Fed. (2d) 85; Commissioner v. Turney, 82 Fed. (2d) 661. The deferment of taxation, pending the final outcome of litigation, later initiated, would distort the taxation of current income within the intendment of the tax statutes.

Therefore, the distribution of the G. C. Murphy Co. stock must be taken into account in determining the gain to the petitioners arising from the distributions made by the Hillcrest Foundation, Inc.. during the years 1936 and 1937.

The fifth issue requires us to determine whether the stock of the Century Co. became worthless in 1936 or at some time before that year. Century was incorporated in 1902. The record does not show what degree of prosperity it enjoyed for the ensuing 32 years, but in 1934 it obtained a loan of $30,000 from the Eeconstruction Finance Corporation. Apparently at that time its business prospects were considered fairly good. .In June 1935 a receiver was appointed for the company. The balance sheet of June 5, 1935, reflects the unsatisfactory condition of the enterprise. In August 1935 a plan of reorganization was proposed whereby the claims of creditors would be adjusted by a cash and stock settlement. In October 1935 a petition to convene creditors was filed. On December 2, 1935, one of the plaintiffs in the receivership proceeding reported that the business showed some improvement and requested a continuance of the receivership for three months. The court thereupon granted the request.

In the meantime the Reconstruction Finance Corporation had taken steps to perfect its preferred rights by seeking a confessed judgment and the authority to foreclose. The affairs of Century remained in suspension until January 21, 1936, when its property securing the Reconstruction Finance Corporation obligation was levied on. On February 15,1936, the property was sold to the Reconstruction Finance Corporation for a nominal sum. On January 30, 1936, the receiver requested authority to sell Century’s remaining assets and on February 18, 1936, sold them for $4,750.

From this review of the essential facts we see that as late as December 2, 1935, a plaintiff in the receivership action declared to the court that Century’s business was improving and asked that the receivership be continued. Obviously, at that time there was no indication that the stock was worthless even though the Reconstruction Finance Corporation had obtained an absolute rule to foreclose. The establishment and continuation of the receivership does not impute worthlessness. Edward C. Lawson, 42 B. T. A. 1103. Until sale there always was a chance to complete the reorganization plan and to satisfy the Reconstruction Finance Corporation’s demands. Even at that sale the stockholders and creditors might have paid for the buildings and equipment enough to pay off or curtail the Reconstruction Finance Corporation loan and so to continue Century’s business operations.

Of course, the sale to the Reconstruction Finance Corporation at $25 merely indicates that no one was willing to pay for the mortgaged property more than the debt against it. Consequently, the forced sale of Century’s remaining assets did not measure their real worth to a going concern.

From all the facts here presented we conclude that the petitioners’ stock in Century had some potential value in 1935 and that such value was not extinguished until 1936. Sterling Morton, 38 B. T. A. 1270, affd., 112 Fed. (2d) 320.

In the sixth issue the respondent asserts that petitioner Robert S. Waters is estopped from alleging that his Century stock was worthless in 1936. In an amendment to his answer the respondent raised this issue on the ground that the petitioner claimed a deduction in his income tax return for the year 1936 based on the worthlessness of his Century stock; that the respondent disallowed the deduction on the ground that the stock became worthless in 1935; that thereupon the petitioner filed a claim for refund; that his claim was allowed by the respondent; and that the petitioner received and cashed a Treasury check representing that allowance. In his pleadings the respondent does not state that the claim for refund related to the year 1935, but we may assume that to be the situation.

The stipulated facts show that on April 9, 1940, the collector of internal revenue notified the petitioner that he was holding the Treasury check covering the refund. On April 13,1940, the petitioner, through. counsel, notified the collector that the acceptance of the check did not constitute an admission of the correctness of the deduction for the year 1935.

In his brief the respondent does not argue the point, but only cites Alamo National Bank of San Antonio, 36 B. T. A. 402; affd., 95 Fed. (2d) 622; certiorari denied, 304 U. S. 577. The purport of that decision is that “honesty, good faith and consistency are due in tax accounting” and that “the right and wrong of things and equitable principles have a place in tax matters.”

The decision in the Alamo case is neither controlling nor persuasive on the issue before us. Here, the petitioner was not guilty of dishonesty, bad faith, or inconsistency. On the contrary, he claimed that his Century stock became worthless in 1936. The respondent’s action prevented the allowance of the deduction for that year. The petitioner then, in conformity with the respondent’s determination, filed a claim for refund. The claim was allowed and a check issued therefor, but before accepting it the petitioner reiterated his original position and specifically stated that he did not concede the correctness of the respondent’s action.

Under these circumstances we find no grounds on which the respondent can maintain his position on this question. He could not have been misled. If he ultimately should fail to recover the item or its equivalent in income hé can blame only himself. The plea of estoppel is rejected. Decisions will l>e entered under Bule 50.

       SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
      *******
      (e) Distributions in Liquidation. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117 (a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. For the purpose of the preceding sentence, “complete liquidation” includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits.

       SEC. 112. RECOGNITION Off GAIN OR LOSS.
      * * * * * * •
      (b) Exchanges Solely in Kind.—
      *******
      (3) Stock foe stock on eeoesanizAtion. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
      * * * * * * *
      (i) Definition of Reobganization. — As used in this section and sections 113 and 115—
      (1) The term “reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
      (2) The term “a party to a reorganization” includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.


author: Opper:

text:
    Alice V. Gordon, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 103900.
    Promulgated May 20, 1942.

      Watson Washburn, Esq., and Royal E. Mygalt, Esq., for the petitioner.

      Charles D. Leist, Esq., for the respondent.
   OPINION.

Opper:

A long-standing anomaly in the treatment of real estate losses is only now beginning to be rectified. When the decision in De Loss v. Commissioner (C. C. A., 2d Cir.), 28 Fed. (2d) 803; certiorari denied, 279 U. S. 840, announced the rule that a parting with title was not the definitive event marking a deductible loss if all value in the property had previously been extinguished, a line of cases had already been instituted, beginning with A. J. Schwarzler Co., 3 B. T. A. 535, applying to real estate losses the rule that a conclusive separation between the owner and title to his property was necessary to justify a loss deduction and that since under the common law real estate could not be abandoned, such a,separation would fail of recognition in the absence of a sale. Even in that situation, if there remained a vestige of residual title, as for example an equity of redemption, the loss was allowable only when that residue was finally extinguished. J. C. Hawkins, 34 B. T. A. 918; affd. (C. C. A., 5th Cir.), 97 Fed. (2d) 401; Derby Realty Corporation, 35 B. T. A. 335; T. J. Bosquett, 39 B. T. A. 763.

Further confusion was added by the distinction between an ordinary loss deductible in full and a capital loss, and perhaps in order to mitigate the harshness of the earlier cases relating to real property losses, it became established that a forced sale of real property in a mortgage or tax foreclosure or even a voluntary conveyance brought about by the threat of such proceedings would be considered an ordinary loss. (Where petitioner had personal liability) C. Griffith Warfield, 38 B. T. A. 907; H. L. Rust, Jr., 38 B. T. A. 910; Lloyd Jones, 39 B. T. A. 531; (where petitioner had no personal liability) Commissioner v. Freihoffer (C. C. A., 3d Cir.), 102 Fed. (2d) 787, affirming Sol Greisler, 37 B. T. A. 542; Commonwealth, Inc., 36 B. T. A. 850. The recent decisions of the Supreme Court tending to characterize the disposition of real property even in a forced proceeding as a capital transaction, Helvering v. Hammel, 311 U. S. 504; Electro-Chemical Engraving Co. v. Commissioner, 311 U. S. 513, have been fortified by holdings that in comparable situations the same rule applies to personal property, Commissioner v. Coggan (C. C. A., 1st Cir.), 119 Fed. (2d) 504; certiorari denied, 314 U. S. 652, and by the legislative acceptance of the principle that a loss of that nature even without an actual sale, is nevertheless a capital transaction and is to be treated accordingly. Bevenue Act of 1938, sec. 23 (g) and (k). The reason these provisions were limited not only to personal property but to “securities” is not apparent. Here, of course, we are not concerned with the type of loss but only with the year in which it occurred.

At the same time there seems to have been a trend in the direction of restricting the earlier principle that transfer of title to real property was necessary before a loss could be claimed. Rhodes v. Commissioner (C. C. A., 6th Cir.), 100 Fed. (2d) 966; W. W. Hoffman, 40 B. T. A. 459; affd. (C. C. A., 2d Cir.), 117 Fed. (2d) 987; cf. Denman v. Brumback (C. C. A., 6th Cir.), 58 Fed. (2d) 128. Hence, this seems to us an appropriate occasion for clarifying and confirming the treatment of real estate losses apparently justified by the general tendency of the cases noted. Since the sale or abandonment of property has not been accepted as the event establishing loss, if by a practical test and from the standpoint of reality all value had disappeared in a prior year, cf. De Loss v. Commissioner, supra, we think the logic of the situation requires that if, in the case of either real or personal property, it can be shown that no value whatever remains, a deduction for loss may then be permitted even though a sale, abandonment, or other irrevocable loss of title is postponed to a later period.

And in determining whether value has actually disappeared, we see no reason to distinguish between real and personal property or to require that in one case any more than in the other the taxpayer be an “incorrigible optimist.” United States v. White Dental Mfg. Co., 274 U. S. 398. Of course, the necessity of something in the nature of an “identifiable event” may still exist, and in appropriate situations that need may be supplied by a sale or even an “abandonment.” But that is not applicable here where there is ample basis for concluding that the present year furnishes developments having a decisive and unfavorable effect upon value, such as the increased expense of operating the property, the necessity of its extensive rehabilitation, the excess of liens over even potential value, and most important of all the expulsion of the tenants and the resulting total vacancy of the building. If the owner of stock who can show that it has become worthless may take a deduction for loss even though he retains ownership of the shares and possession of the certificates and there may be some slight or remote possibility that an indeterminate future may restore a value to them, De Loss v. Commissioner, supra, it seems to us there is no reason for the application of a different rule to the present question.

Judged by the foregoing considerations, it is clear that in the year 1937 petitioner’s interest in the real property under consideration became worthless; that it was then properly deductible as a loss; and that the action by respondent in disallowing it must be disapproved. The extent of petitioner’s interest and hence of her loss presents no problem, at least if abandonment is not a prerequisite as respondent in effect concedes. Petitioner had a remainder after a life estate as well as her undivided interest in fee. The parties have stipulated the proportion of the entire interest which that remainder represented, and we see no reason why petitioner’s deduction should not include the value of that future interest as well as of her present share. Her loss was as real in the one case as in the other even though, of course, its amount might be less due to the diminished value of an expectancy as compared with a present interest.

Reviewed by the Board.

Decision will be entered wider Rule 50.

Artjndeul, Black, Leech, Arnold, and Keen dissent.

       See however Revenue Act of 1938, sec. 117 (a) (1).


author: Muedock:

text:
    Gustava Kluehn, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 100736.
    Promulgated May 22, 1942.

      Stanley Suydam, Esq., for the petitioner.

      Ellyne E. Strickland, Esq., for the respondent.
   OPINION.

Muedock:

The petitioner does not contest the correctness of the amounts involved in the determination made by the Commissioner. She, a nonresident alien, contends that she was not engaged in a trade or business within the United States and did not have a place of business in the United States. If her contention is correct, then she is subject to tax under section 211 (a) of the Revenue Act of 1936 at the flat rate of 10 percent and, furthermore, capital gains are not included in her taxable income. The Commissioner contends that she had a place of business and was engaged in business in the United States and is taxable under section 211 (b) at the normal tax and surtax rates.

The Commissioner advances only two grounds for his conclusion. One is that the petitioner’s dealings in securities amounted to a trade or business. The facts clearly show that under Higgins v. Commissioner, 312 U. S. 212, the few sales of securities did not constitute the carrying on of a trade or business. The other ground advanced by the Commissioner is that the absent petitioner, through her agent, the St. Louis Union Trust Co., participated in the management and operation of the properties making up the residuary estate of Adolphus Busch in which she held an undivided one-thirteenth of a one-eighth interest. We may assume that the activities of the Union Trust Co. in managing the trust created by the will of Adolphus Busch constituted the carrying on of a business in 1936, since the facts do not show the contrary.

The petitioner did not create that trust and had no voice in the management of it. The trust was created by the will of Adolphus Busch, who died in 1913. The corpus of the trust originally constituting all of the residuary estate of Adolphus Busch had not been entirely distributed in 1928, when Lilly Busch died. The petitioner, as a residuary legatee of the estate of Lilly Busch, thus acquired an interest of one-thirteenth of one-eighth of the Adolphus Busch testamentary trust estate. She merely accepted that interest and did nothing about it. She never chose the trustee as her agent. Perhaps she could have demanded a partition, but she did not do so. The Commissioner, in Regulations 94, article 211-7 (b), has provided:

Neither the beneficiaries nor the grantor of a trust, whether revocable or irrevocable, is deemed to be engaged in trade or business in the United States or to have an office or place of business therein, merely because the trustee is engaged in trade or business in the United States or has an office or place of business therein.

The Commissioner’s present contention is in direct conflict with this regulation. We conclude, upon the entire record in this case, that the petitioner was not engaged in a trade or business in the United States and did not have an office or place of business therein.

Decision mil be entered under Bule 50.


author: Hill :

text:
    Estate of Edith M. Findlay, C. E. Merrill, Executor, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 104278.
    Promulgated May 22, 1942.

      Richard P. Jackson, Esq., for the petitioner.

      Zalman N. Diamond, Esq., for the respondent.
   OPINION.

Hill :

This proceeding is for a redetermination of an income tax deficiency of $2,514.07 for the calendar year 1937. Of the several adjustments made by the Commissioner only the disallowance of a claimed loss in the amount of $25,667.40 is in issue. The facts as stipulated are adopted as our findings of fact and only those necessary for an understanding of the issue will be set forth.

Petitioner’s return for the taxable year was filed with the collector for the second district of New York.

On June 21, 1933, Octavia Wilson Merrill, hereinafter referred to as testatrix, died a resident of Florida. On October 3, 1933, her will was duly admitted to probate in the County Judge’s Court for Palm Beach County, Florida.

Edith M. Findlay, hereinafter referred to as decedent, died on December 20, 1936.

Decedent was one of the beneficiaries of the estate of the testatrix. The balance sheet of that estate as of December 20, 1936, at prevailing market prices of securities owned by that estate showed an excess of assets over liabilities in the amount of $740,078.92. The share of the decedent as of the date of her death was $124,463.04.

On April 1,1937, the estate of the testatrix distributed to the estate of the decedent stocks, bonds and cash. The net amount of this distribution was $98,126.99, computed at the fair market value as of the date of distribution. No further distributions were made after June 2, 1937, when the remaining assets were distributed to the other legatee of the will of the testatrix. The assets of that estate had been entirely distributed at that time.

The sole issue of this proceeding is whether or not petitioner is entitled to deduct a claimed loss of approximately $26,000. The petitioner contends that the fair market value of decedent’s interest in the estate of the testatrix at the time of decedent’s death was about $124,000, and that this is the basis of the property in the hands of the petitioner. It then contends that since the fair market value of the property and cash distributed to it in 1937 was only about $98,000, it had a deductible loss upon the liquidation of the estate of the testatrix. Principal reliance is placed by petitioner upon Joseph A. Guthrie, 42 B. T. A. 696.

The position of the respondent is that the receipt of the properly upon the liquidation of the estate of the testatrix is not a disposition within the meaning of the statute and therefore petitioner is not entitled to deduct any loss until there is some disposition of the property received.

We hold that petitioner did not sustain a deductible loss. In reaching this result we find it unnecessary to decide what basis the property has for gain or loss and we expressly refrain from deciding that question. However, assuming for the purpose of discussion that the basis is about $124,000 and even though the fair market value at the date of distribution by the estate of the testatrix was about $98,000, we can see no disposition within the meaning of section 111 (a), Kevenue Act of 1936. At decedent’s death petitioner succeeded to decedent’s undivided share or interest in the residuum of the estate of testatrix and thereby became a distributee of such estate. The estate was not distributed in undivided shares but was partitioned between the distributees in proportion to their respectiva undivided shares on the basis of the fair market value at the time of distribution. The value of the property distributed to each of the distributees was therefore equivalent to the value of his undivided share. No loss recognizable for tax purposes was sustained by petitioner in respect of such property prior to its partitioning and distribution. We do not believe that the distribution of divided shares of the property instead of undivided shares thereof constituted a “sale or other disposition” of the latter within the meaning of the statute. Such operation amounted merely to the segregation of the undivided share of petitioner in the property and the distribution to it of such share so segregated.

Since the property received was not disposed of in the taxable year, we fail to perceive anything other than a mere fluctuation in value which does not give rise to a deductible loss. Greenleaf Textile Corporation, 26 B. T. A. 737; affd., 65 Fed. (2d) 1017; Coalinga-Mohawk Oil Co., 25 B. T. A. 261; affd., 64 Fed. (2d) 262; certiorari denied, 290 U. S. 237.

Petitioner’s reliance upon the Guthrie case is not well founded for in that case the taxpayer purchased a share in an estate. The estate was then liquidated and distributed in cash. That distribution terminated the taxpayer’s interest and did so in cash, resulting in a closed and completed transaction. This is not true in the instant case. The property received by petitioner may well change in value again before any disposition so that no loss or even possibly a gain may be realized at that time.

Decision will Toe entered for respondent.

       SBC. 111. DETERMINATION OE AMOUNT OF, AND RECOGNITION OF GAIN OR LOSS.
      (a) Computation op Gain or Loss. — The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113 (b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.


author: Him: Mukdock, Mellott,

text:
    The Queensboro Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 95628.
    Promulgated May 28, 1942.

      William 8. Siemon, Esq., for the petitioner.

      Walt Mamdry, Esq., for the respondent.
   OPINION.

Him:

The first issue to be determined is whether the loss sustained by the foreclosure sale was an ordinary loss or a capital loss within the meaning of section 117, Revenue Act of 1934, and the deduction limited to $2,000 by section 117 (d) (hereinafter all sections not otherwise specified are from the Revenue Act of 1934). It is settled law that a foreclosure sale is a sale within the meaning of that section. Electro-Chemical Engraving Co. v. Commissioner, 311 U. S. 513; Helvering v. Hammel, 311 U. S. 504; Jacob Abelson, 44 B. T. A. 98. It is also true that the property held for sale to customers in the ordinary course of business does not come within the purview of section 117. Charles H. Black, Sr., 45 B. T. A. 204.

We have found as a fact that the property in question was so held. We feel compelled by the evidence to so find. A short resumé of the evidence upon which this finding is based is pertinent. Petitioner was a corporation which was expressly organized to deal in real estate as well as to carry on numerous other activities in dealing with property. A large “for sale” sign was placed and maintained on the Plaza property and repainted in 1922. Twice the board of directors passed resolutions authorizing the sale of the property by one of the petitioner’s officers. The evidence also shows that petitioner bought and sold large quantities of other real estate. Moreover, petitioner organized and financed various subsidiary corporations for the purpose of purchasing and reselling real estate at a profit. The operation of these subsidiaries was solely for this purpose and, with one exception, the subsidiaries were immediately dissolved when the tract for which each was organized was completely sold. Cf. Samuel D. Leidesdorf, 26 B. T. A. 881. Upon the basis of these facts we hold that petitioner is a dealer in real estate. This holding is not affected by the further fact that petitioner was engaged in other businesses. Florence E. Ehrman, 41 B. T. A. 652. Moreover, it will be noted that all other forms of business carried on by the petitioner related to the general business carried on by real estate dealers and brokers.

Having found that petitioner is a real estate dealer and that the Plaza property was held for sale to customers in the ordinary course of its business, the loss is an ordinary loss and not a capital loss. Charles H. Blacky Sr., supra. The next question which is posed for consideration is the amount of that loss. This question arises under section 113 (b) (1) (A), (B),and (C).

Petitioner and respondent have stipulated the portions of the various charges allocable to the improved and unimproved parts of the Plaza property. For the purpose of adjusting the basis of the property it is necessary to discuss each portion separately. The question relating to the improved property is the amount of depreciation which should be deducted in adjusting the basis.

The facts show that the building which was erected on the improved portion cost about $40,000, and its useful life was 35 years. However, petitioner deducted depreciation at a rate which was based upon a longer useful life. Petitioner claims that the basis should be adjusted by the amount of the depreciation which it had actually deducted as an expense item on its income tax returns. Respondent, on the other hand, contends that the basis should be adjusted by the amount of depreciation allowable upon the basis of a useful life of 35 years. Section 113 (b) (1) (B) provides that the basis should be reduced by the depreciation in the amount allowed but “not less than the amount allowable.” We hold that, since the useful life was 35 years, depreciation was allowable to a greater extent than that deducted by the petitioner and the basis for figuring the loss upon the foreclosure sale will be reduced by the amount of depreciation allowable. Herder v. Helvering, 106 Fed. (2d) 153; Kennedy Laundry Co., 46 B. T. A. 70; Beckridge Corporation, 45 B. T. A. 131 (on appeal, C. C. A., 2d Cir., Oct. 21, 1941).

The second question which must be decided in arriving at petitioner’s loss is the amount of carrying charges on the unimproved property which may be capitalized. There is no issue as to the amount of the taxes to be added to the cost basis. The sole issue arises because petitioner capitalized the interest on all of the mortgages. The parties stipulated that petitioner had done this. We understand this to mean that petitioner did not deduct the interest on any of its tax returns. Ultimately the property was encumbered by a $150,000 first mortgage as well as a $75,000 second mortgage. The original $50,000 first mortgage had been paid off out of the proceeds of a later first mortgage. Section 113 (b) (1) (A) provides that the basis of unimproved property shall be adjusted “for expenditures, * * * or other items properly chargeable to capital account, including taxes and other carrying charges.” The question in its final form is whether the interest on the later mortgages is a proper item to be capitalized.

Respondent’s position is that the interest on the original $50,000 mortgage is the only interest item properly capitalized. However, he admits that the interest on the $50,000 from the time of purchase to the foreclosure is the proper amount. This admission is reasonable even though the mortgage was paid, since there was a satisfaction only by a further borrowing. The substance of this action was the same as increasing the original mortgage. Thus, the question is limited to whether petitioner may or may not capitalize the interest on the subsequent second mortgage and the increased first mortgages. This seems to be a question of first impression.

Prior to the 1932 Act taxes and interest were not considered capital items. Central Real Estate Co., 17 B. T. A. 776; affd., 47 Fed. (2d) 1032; Westerfield v. Rafferty, 4 Fed. (2d) 590. The Revenue Act of 1932 and subsequent acts have permitted the capitalization of taxes and interest on unimproved and unproductive real property. Sec. 113 (b) (1) (A), supra. The sole purpose of this subsection appears to be that the taxpayer will be allowed to recover .as costs the money which he pays out of his pocket as taxes and other carrying charges on unimproved and unproductive real property. In the absence of the provisions of such subsection payments of taxes and interest would constitute deductions by which the taxpayer could reduce his current taxable income. To permit capitalization of payments in respect of unimproved and unproductive real property, the payments must be such as are properly chargeable to capital account as carrying charges. If a payment is not properly chargeable to capital account it can not be classified as a carrying charge. We do not believe that interest on a mortgage indebtedness is a carrying charge on the mortgaged property unless such indebtedness was assumed or created as part of the purchase price of the mortgaged property or unless such indebtedness itself represents a carrying charge. Otherwise, such interest would not be properly chargeable to capital account and, hence, would not be a carrying charge. The statute allows an adjustment only “for * * * other items properly chargeable to capital account, including taxes and other carrying charges on unimproved and unproductive real property * * (Italics supplied.) To be “properly chargeable to capital account” an expenditure must bear a reasonable relationship to the property. Paul & Mertens, Law of Federal Income Taxation, vol. II, sec. 18.170.

We fail to perceive how the payment of interest on the further borrowings bore any relationship to the property. Certainly, these borrowings harmed rather than protected or improved the property, since the amount of the liens thereupon was increased. If the borrowings can not be denominated capital expenditures, there is no reason to consider the payment of interest thereupon to be “items properly chargeable to capital account.”

Although there is no evidence in the record to show the purpose of the further borrowing, petitioner intimates that it was to pay the carrying charges. We feel that the evidence itself refutes such a position. About five and one-half years after petitioner purchased the Plaza property it borrowed $75,000 on a second mortgage. The total of the carrying charges at this time did not aggregate $75,000. About one month later petitioner borrowed another $75,000, with which it paid the original mortgage. However, this left an excess of $25,000. It appears obvious that the carrying charges for one month could not have been $25,000. In 1926, over eight years prior to the foreclosure sale, petitioner again borrowed an excess, $75,000, over the amount needed to pay the existing first mortgage. It does not appear that the aggregate of the additional borrowings was needed to meet the carrying charges accrued to the. date of this latter borrowing. This evidence makes patent the fact that the additional borrowings had no relation whatsoever to the property. The property served merely as security for petitioner to raise1 capital. We hold that the interest on such borrowings is not a carrying charge.

The ultimate result reached in this case is that, in computing the basis of the property, petitioner is entitled to capitalize only the stipulated amount of interest attributable to the original $50,000 mortgage and the taxes and special assessments actually paid. The loss thus computed is fully deductible.

Eeviewed by the Board.

Decision will be entered, imder Bule 50.

Mukdock,

dissenting: Interest and taxes are deductible annually under section 23. The law is well settled that carrying charges, such as interest and taxes on unproductive property, are not properly chargeable to capital account. However, section 113 (b) (1) (A) of the Revenue Act of 1932 and corresponding provisions of subsequent acts, as interpreted by the Commissioner (see I. T. 2664, XI-2 C. B. 43, and I. T. 2102, XII-2 C. B. 16), allow the owner of unproductive real estate an alternative method of recovering such carrying charges tax free. If the taxpayer does not care to deduct them annually under section 23, he may charge these items to capital account, thus increasing his basis for gain or loss on the property, and recover the items tax free as a lump sum adjustment upon the disposition of the property in accordance with this new. provision. These carrying charges may be recovered in this way solely because of the statutory provision, not because they are now properly chargeable to a capital account from an accounting standpoint.

The Commissioner, in his interpretation of the statute, has used a peculiar phrase, “interest on real property.” This must mean interest on an obligation encumbering the real property. The interest on any mortgage on the property would answer this description. The economist recognizes that property is carried by whatever investment there is in it, regardless of whether the investment is entirely in cash or is partly represented by a mortgage. Cf. Fraser v. Commissioner, 25 Fed. (2d) 653; Westerfield v. Rafferty, 4 Fed. (2d) 590. Some of the carrying charges simply become crystalized in the form of interest when a mortgage is put on the property. I see no danger in giving the owner this choice of method for recovering interest on any mortgage on the property. Ordinarily, the difficulty of borrowing money on real estate mortgages would limit the amount of the borrowings to substantially less than the value of the property. Congress and the Commissioner were apparently content to allow the alternative method of recovering interest on any mortgage on unproductive real estate.

The prevailing opinion makes the right to the alternative method depend upon the necessity for the loan and the use to which the money is put. I see nothing to justify this in the statute, in the interpretation placed upon it by the Commissioner, or in the subject generally. It invites litigation by imposing a difficult and sometimes insurmountable burden of proof. It introduces a distinction which is unsound from the standpoint of economics. It may be necessary for one man to borrow nothing in the purchase of unproductive real estate while another may have to borrow a great deal. If they both borrowed the same amount, why should Congress want to treat them differently and who could determine the extent to which the borrowing was necessary? The man who originally gives a mortgage for a part of the purchase price may do so because he wants to use his own money for some other purpose and not because of necessity. A subsequent borrowing to pay taxes and interest may have no greater necessity. Interest on any amount which an owner can borrow on unproductive property is, in fact, a part of the cost of carrying that property. The owner can limit the interest by using cash to buy and carry the property, but he does not thereby reduce his expense of carrying the property. It is only a question of whether he loses the use of his own money or pays someone interest for the use of their money. The alternative method should not depend upon the necessity for borrowing money on the property or the immediate use to which money borrowed on the property is put.

Leech agrees with this dissent.

Mellott,

dissenting: In my opinion petitioner has failed to sustain its burden of showing that the property was held primarily for sale to customers in the ordinary course of its trade or business. Respondent’s determination that it sustained a capital loss under section 117 of the Revenue Act of 1934 should therefore be sustained.

Van Fossan, Disney, and Offer agree with this dissent.

       SEC. 1X3. ADJUSTED BASIS EOR DETERMINING GAIN OR LOSS.
      *******
      (b) Adjusted Basis. — The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.
      (1) General rule. — Proper adjustment in respect of the property shall in all cases be made—
      (A) for expenditures, receipts, losses, or other items, properly chargeable to capital account, including taxes and other carrying charges on unimproved and unproductive real property, but no such adjustment shall be made for taxes or other carrying charges for which deductions have been taken by the taxpayer in determining net income for the taxable year or prior taxable years;
      (B) in respect of any period since February 28, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent allowed (but not less than the amount allowable) under this Act or prior income tax laws. Where for any taxable year prior to the taxable year 1932 the depletion allowance was based on discovery value or a percentage of income, then the adjustment for depletion for such year shall be based on the depletion which would have been allowable for such year if computed without reference to discovery value or a percentage of income ;
      (C) in respect of any period prior to March 1, 1913, for exhaustion, wear and tear, obsolescence, amortization, and depletion, to the extent sustained;