author: Mellott :

text:
    Park Chamberlain, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88067.
    Promulgated January 5, 1940.

      Park Chamberlain, Esq., and Joseph H. Moran, Esq., for the petitioner.

      8. U. Milten, Esq., for the respondent.
   OPINION.

Mellott :

The Commissioner determined a deficiency in petitioner’s income tax for the year 1934 in the amount of $1,865.68. The sole question is whether or not petitioner is entitled to the deduction from gross income of $8,497.34 as an ordinary loss.

The petitioned duly filed his return of income for the calendar year 1934 with the collector for the first district of Illinois. At that time he was a resident of Chicago, Illinois, though previously he had been a practicing lawyer at, and a resident of, Anamosa, Jones County, Iowa.

During the year 1919 and the early part of the year 1920 petitioner, his brother, William Chamberlain, and Don Barnes purchased several farms in the State of Iowa. The transactions were entered into for profit, it being contemplated that the farms would be sold at a profit.

William Chamberlain and Don Barnes were law partners and residents of Linn County, Iowa. Linn County adjoins Jones County, in which petitioner resided. Nine farms, most of them in Jones County, were purchased at an aggregate agreed purchase price of approximately $365,000. Of this amount about $100,000 was paid in cash, the balance being evidenced by purchase money mortgages. Petitioner and his associates each contributed one-third of the amount paid in cash. The farms were purchased on contract for delivery on March 1, 1920. The vendor of one farm refused to convey and the contract was never completed. Title to seven of the farms was taken in petitioner’s name and title to one was taken in Barnes’ name. The parties agreed that each was to have a one-third interest in all the farms; that title might be held in the name of any of them; that the one holding title held it in trust for the others in the proportion of one-third each; and that if any of the parties incurred or paid any liability in connection with the farms he would be indemnified by the others to the extent of their proportionate interests. The parties did not file partnership returns of income, but each included in his gross income for the various years his share of the profits and deducted his proportion of the losses sustained.

After the execution of the contracts for the purchase of the farms, efforts were made to sell them. No real estate office was maintained and no real estate salesmen were employed to sell the properties, but they were advertised in some newspapers from 1920 to about 1923. They were listed for sale with various real estate agents and petitioner and his associates personally made some effort to sell them. Of the eight farms acquired in 1920, only one was sold. The sale resulted in a profit and petitioner included $2,000, his proportion, in his return of income for that year. This farm was reacquired by petitioner and his associates in 1926, when the purchaser defaulted on a mortgage which they held; so at the end of 1926 petitioner and his associates still owned the same eight farms which they had acquired in 1920. The farms were rented until such time as they could be sold. The titles to the farms remained in the names of petitioner and Barnes until the maturity of the purchase money mortgages, when it became necessary to refund the indebtedness. At that time petitioner conveyed a two-thirds interest in all of the farms standing in his name to William Chamberlain and Don Barnes.

One of the farms which was in the petitioner’s name was known as the McNamara farm, which had been purchased at a cost of $51,170. A purchase money mortgage had been given by petitioner upon this farm in the amount of $33,670 when it was acquired. This mortgage was paid in full when it became due on March 1,1925, and at the same time, on March 1, 1925, a new mortgage was placed on the farm in the amount of $20,000, due March 1, 1930. Petitioner and his associates joined in the execution of this note and mortgage. On March 31, 1925, petitioner and his wife conveyed by quitclaim deed an undivided two-thirds interest in this farm to Don Barnes and William Chamberlain, the deed being recorded April 21, 1925. The mortgage on this farm was renewed on March 1, 1930, for a further term of five years.

In 1927 William Chamberlain terminated his law partnership with Barnes and left the State of Iowa. He conveyed his undivided interest in all of the farms to petitioner in consideration of petitioner assuming his share of all indebtedness upon them.

In 1930 certain creditors of petitioner attempted to garnishee his earnings as a lawyer. Petitioner, being apprehensive that they might attempt to attach his interest in the farms, on June 23,1930, executed a quitclaim deed to Don Barnes of all his interest in them. This deed was recorded on June 28,1930. It recited that:

* * * the Grantors ior clivers good causes and considerations thereunto moving, and especially for the sum of One Dollar and other valuable considerations ($1.00) received to iny [our] full satisfaction of Don Barnes of Cedar Rapids, Iowa, the Grantee, have given, granted, remised, released and forever quit-claimed, and do by these presents absolutely give, grant, remise, release and forever quit claim unto the said grantee, his heirs, and assigns forever, all such right and title as I [we] the said grantor[s], have or ought to have in the following described pieces or parcels of land, * * *. [The McNamara farm being among the parcels described.]

After the execution of the above deed petitioner continued to assist, in the management of the farms and continued in his efforts to sell them. He left Iowa in 1931, moving to New York. He continued to maintain his office in Jones County, Iowa, until the early part of 1934 and, at least for several months after he left, the accounts in connection with the farms were handled at that office.

In 1933 petitioner became unable to make his share of the payments coming due on the farms. Foreclosure was threatened on the mortgages because of default in the payment of interest and efforts were made to deed the farms to the mortgagees. Two mortgagees accepted deeds but the remainder refused. In 1933 William Chamberlain and Don Barnes took over two farms each, petitioner executing and delivering quitclaim deeds to them. They then executed new mortgages upon these farms.

The only farm in which petitioner had any interest after 1933 was the McNamara farm. In the early part of 1934 the mortgage on this farm was placed in the hands of an attorney for foreclosure because of nonpayment of interest. Some effort was made to get the mortgagee to accept a deed for it, but without success. On December 28, 1934, petitioner and his wife executed and delivered to Barnes a quitclaim deed conveying all of their right, title, and interest in the McNamara farm. This deed was never recorded. It recited in part as follows:

* * * for and in consideration of the sum of One Dollar and other good and valuable consideration, in hand paid by the said party of the second part [Don Barnes], the receipt whereof is hereby acknowledged, do hereby convey, remise, release, and forever Quit Claim unto the second party, his heirs and assigns forever the [real estate thereafter described].

Barnes took over the McNamara farm in 1934 because he felt that he might be able to handle it better and save himself some ultimate loss upon it. He paid petitioner nothing for the quitclaim deed. The mortgage on the farm was renewed March 1, 1935. In a subsequent settlement between William Chamberlain and Don Barnes, William was given an undivided one-half interest in the farm and in 1937 the mortgage was paid off by William and Barnes and they still owned the farm at the time of the hearing.

In his return of income for the taxable year petitioner computed his loss on the McNamara farm as follows:

Purchase price_$51,170.00
Additions_ 844.02
52,014.02
Less depreciation taken- 6, 522.00
45, 492. 02
Less mortgage-1_ 20, 000.00
Total loss to petitioner and his associates_$25,492. 02
One-third loss_ $8, 497.34

The respondent disallowed the claimed loss, stating in his notice of deficiency:

(a) The capital loss in the amount of $8,497.34 representing your share of the excess of cost over mortgage liability on farm property has been disallowed. This transaction represents an exchange of an equity in property for the assumption of liability by another and, therefore, falls within the provisions of section 117 of the Revenue Act of 1934, and the total loss under this section is limited to $2,000.00. Since you have already availed yourself of the maximum deduction of $2,000.00 for losses on other transactions, the entire amount of $8,497.34 has been disallowed.

Petitioner contends that the respondent erred in disallowing the claimed loss; that notwithstanding the recitals in the deed of Jnne 23, 1930, he continued to have an interest in the McNamara farm until the execution and delivery of the quitclaim deed on December 28, 1934; that such interest had then become worthless; that he was unable to make the necessary payments to avoid foreclosure of the mortgage; that he deeded it to Barnes, without consideration, for the purpose of enabling Barnes to handle it in such a way as to save himself from loss; that the execution of said deed terminated the joint venture and resulted in a loss to him of the amount claimed in his return; and that, since he neither sold nor exchanged a capital asset, the deduction should be allowed as an ordinary loss.

Bespondent, though he determined the deficiency upon the theory that the loss was a capital loss because “the transaction represents an exchange of an equity in property for the assumption of liability”, now contends that the proof has shown the loss was actually sustained in 1930; that, if we did not err in receiving evidence tending to show that the 1930 deed was executed purely for the purpose of vesting legal title in Barnes so that petitioner’s creditors could not attach it, nevertheless it must be held that the 1934 transaction was a “sale or exchange” of a capital asset; and that in any event he committed no error in disallowing the claimed loss, for the evidence shows that petitioner made a “gift” of his interest in the farm to his coadventurer, Barnes.

There seems to be no controversy between the parties as to the cost of the McNamara farm. The evidence indicates that petitioner paid his aliquot portion of the agreed purchase price, the amount paid upon the mortgage in 1925 and the improvements placed upon the farm. It therefore appears that the purchase of this farm resulted in an ultimate loss to petitioner of the amount claimed in his return, and we so hold.

. The respondent’s argument that the loss was sustained in 1930 is not convincing. The evidence clearly indicates that it was not the intention of the grantors to convey, nor of the grantees to acquire, petitioner’s equitable interest in the farms. Petitioner had been interested in some Iowa banks which had not survived the depression. A substantial judgment had been rendered against him as a stockholder. Efforts had been made to garnishee his earnings and he was apprehensive that an attachment might be made of his real estate. He accordingly conveyed the legal title to his coadventurer, relying upon the agreement then in force that, regardless of the holding of the legal title, each remained the equitable owner of an undivided interest.

Eespondent contends that the evidence upon which this conclusion is based was improperly received, citing Pugh v. Commissioner, 49 Fed. (2d) 76; certiorari denied, 284 U. S. 642; MacDonald v. Commissioner, 76 Fed. (2d) 513; Lindlay v. Raydure, 239 Fed. 928; affd., 249 Fed. 675; certiorari denied, 247 U. S. 513, and other court and Board decisions; but, notwithstanding such misgivings as we had at the hearing, we now think that the ruling admitting the evidence was correct. The present controversy is between a party to the instrument and a stranger. “The courts are practically unanimous that the rule admitting parol evidence to vary written contracts applies only in actions in which a stranger is a party.” Jones on Evidence, Third Edition, sec. 449, and cases cited. This is clearly the law in Iowa, where the property in question is located, as expounded by the highest court in that state. In re Shields Brothers, 134 Iowa, 559; Dilenbeck v. Herrold, 183 Iowa, 264; Aultman Engine & Thresher Co. v. Greenlee, 134 Iowa, 368; Nissen v. Sabin, 202 Iowa, 1362. Cf. Peugh v. Davis, 96 U. S. 332; Valdes v. Central Altagracia, 225 U. S. 58; J. W. Solof, 1 B. T. A. 776, 785; James D. Boone, 27 B. T. A. 1064, 1067, and cases cited. If the question is one of substantive law, as the parties inferentially suggest, and actually is, as petitioner argues, whether under the law of Iowa he had an equitable title which he could assert, then the ruling was proper; but so was it under the statute prescribing that our proceedings “shall be conducted * * - * in accordance with the rules of evidence applicable in courts of equity of the District of Columbia.” Sec. 907 (a), Bevenue Act of 1926. We hold, therefore, that petitioner remained the equitable owner of an aliquot part of the McNamara farm, notwithstanding the execution and delivery of the deed of June 23,1930.

We are of the opinion that the respondent is correct in holding that petitioner’s interest in the McNamara farm constituted a capital asset as such term is defined in section 117 (b) of the Bevenue Act of 1934, which is as follows:

SEO. 117. CAPITAL GAINS AND LOSSES.
*******
(b) Definition of Capital Assets. — For the purposes of this title, “capital assets” means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.

If petitioner sold or exchanged it the loss is limited as provided in 117 (d) and respondent must be upheld in his determination. Our question, therefore, is, first, was there a sale or exchange; and, if we held that there was not, then did petitioner merely make a “gift” of his interest in the farm to Barnes %

It is perhaps unnecessary to refer at any length to decisions under cases somewhat analogous. It may be pointed out, however, that in Commonwealth, Inc., 36 B. T. A. 850, we held that where an owner of property, subject to a mortgage which it had not assumed, chose to deed it to the mortgagee without consideration, it thereby sustained an ordinary loss. In several cases it has been held that where owners of property have lost their equities through foreclosure of mortgages, ordinary losses, rather than capital losses, were sustained. Commissioner v. Freihofer, 102 Fed. (2d) 787, affirming Sol Greisler, 37 B. T. A. 542; C. Griffith Warfield, 38 B. T. A. 907; and Nebraska Bridge Supply & Lumber Co., 40 B. T. A. 40. Recently we held that owners who abandoned real estate to a mortgagee when they “fully realized that their equity was completely and permanently lost,” thereby sustained an ordinary loss. W. W. Hoffman, 40 B. T. A. 459. This conclusion, we felt, was justified and required if a practical, rather than a legal, test be applied. Lucas v. American Code Co., 280 U. S. 445. See also Sherwin A. Hill, Administrator, 40 B. T. A. 376. We have not hesitated to apply the statute literally under facts justifying such application. Betty Rogers, 37 B. T. A. 897, affd., 103 Fed. (2d) 790; certiorari denied, 308 U. S. 580; rehearing denied, 308 U. S. 635; James R. Stewart, 39 B. T. A. 87; Morris Polin, 39 B. T. A. 951, (on appeal, 3 C. C. A., 3d Cir.). But we are of the opinion that the facts before us do not come within that category.

If only the language of the quitclaim deed of December 28,1934, be considered, it would seem that a sale was made by petitioner of his interest in the McNamara farm for $1. But we can not ignore the evidence. Both petitioner and the grantee testified positively that no consideration was paid, demanded, or expected in connection with the execution and delivery of this deed. The evidence also discloses that petitioner did not make the transfer of his interest in the property in consideration of the. assumption of the mortgage indebtedness by Barnes. We are satisfied, therefore, that petitioner did not make a sale or exchange of a capital asset, and hold that the deduction of any loss sustained by him is not limited by the provisions of section 117 of the Revenue Act of 1934.

There remains for our consideration respondent’s alternative contention that petitioner made a gift. Technically, it might be said that this contention is not without merit. The evidence convinces us, however, that petitioner never had any intention of making a gift in the true sense. He and his coadventurer, Barnes, attempted without success to surrender their interest in the property to the mortgagee in consideration for a release of their liability under the mortgage. The mortgagee, however, apparently felt as they did — i. e., that the property was not worth the face amount of the mortgage. It therefore refused to accept a deed and release them from liability under the mortgage. Petitioner then prevailed upon Barnes to take over his interest. In making the transfer to Barnes we are satisfied that petitioner was not actuated by any motive of generosity. He thought, and not without reason, that his interest was worthless. “Although it is held that the motive accompanying a gift is not material, gifts usually proceed from the generosity of the giver; and, where there is any doubt as to the nature of the transaction, the absence of such motive is a pertinent circumstance for consideration.” Noel v. Parrott, 15 Fed. (2d) 669; certiorari denied, 273 U. S. 754.

“In the field of taxation, administrators of the laws and the courts are concerned with substance and realities * * Helvering v. Lazarus & Co., 308 U. S. 252. The substance of the transaction shown in our findings, avo think, was an abandonment by petitioner of what he, and all who were familiar with it, thought was a worthless asset. W. W. Hoffman, supra. This resulted in a loss to him of his entire investment in the McNamara farm. The purchase having been a “transaction entered into for profit,” we hold that the loss is deductible under section 23 (e) (2) of the Revenue Act of 1934.

While all the contentions of the respective parties upon brief have been discussed, it is questionable if any issue is raised by the pleadings save the narrow one whether an ordinary or a capital loss was sustained. In this connection it may be pointed out that the only errors alleged in the petition — except the general one that the Commissioner “erred in finding that there was any deficiency” — are that the Commissioner erred in finding the transaction falls within section 117; in finding that there was any assumption of liability by another; and in failing to find that the loss was incurred in business and hence deductible under section 23 (e). The answer was a general denial. Our decision, however, is the same that it would have been had the evidence been confined strictly to the issues raised by the pleadings.

The respondent erred in determining the deficiency.

Decision will Toe entered for the petitioner.


source: Caselaw Access Project

author: Steen hagen :

license: Public Domain

text:
    Estate of Edgar S. Appleby, Deceased, Edgar T. Appleby and Francis S. Appleby, Co-executors, Petitioner, v. Commissioner of Internal Revenue, Respondent. John S. Appleby, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket Nos. 93886, 94080.
    Promulgated January 5, 1940.

      JohnB. O ornan, Esq., for the petitioner in Docket No. 93886.

      Ba/rdon Moore, Esq., for the petitioner in Docket No. 94080.

      Allen T. Akin, Esq., for the respondent.
   OPINION.

Steen hagen :

1. The Commissioner held that the “operation of a garage by the [two brothers] should be classified as a partnership within the meaning of section 801 of the Revenue Act of 1934.”

The evidence shows that the garage was not operated by the taxpayers, and the postulate of the Commissioner’s determination is not correct. They built it at the suggestion of two automobile dealers, for the purpose of leasing it to them, and the lessees operated it. Petitioners were merely the owners of the property, which was improved and rented primarily to defray the taxes.

The respondent argues that the petitioners, tenants in common of the property inherited from their father, and conceded to be not partners under New York law, were operating the property as a business enterprise and were therefore within the statutory category of partnership. He concedes that petitioners were not a syndicate or a pool; but says that they “constitute a group”, that “by the decision to erect and operate the garage * * * they became engaged in a joint venture”, and that “the all-inclusive ‘other unincorporated organization’ ” is sufficiently broad to include them. The statutory term partnership, he says, “is all embracing of any business or financial operation carried on by two or more individuals other than as a trust, corporation or estate.”

The ownership of real property by tenancy in common is an estate so old and well known that it is impossible to believe that it was intended to be included in the statutory catalog of partnerships by such a general term as “group”, “joint venture”, or “other organization.” Never, so far as we are advised, has it been regarded taxable as a unit, although its existence has always been recognized. Cf. I. T. 1604, II-1 C. B. 1 (1923); I. T. 2082, III-2 C. B. 176 (1924). If it were now to be held a statutory partnership because of the close relations of the tenants and their common interest in property it would be difficult to exclude from the statutory term other relations having similar attributes, such as marital communities or tenancies by the entirety, cf. Poe v. Seaborn, 282 U. S. 101; Tyler v. United States, 281 U. S. 497; Champlin v. Commissioner, 71 Fed. (2d) 23. This the Commissioner does not expressly suggest, and there should be some fairly clear authoritative support for such an important and far reaching innovation, even though on the other hand the statutory term is not to be narrowly or rigidly construed. Cf. Morrissey v. Commissioner, 296 U. S. 344; Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462.

Although it will probably continue to be difficult to classify many of the imaginable varieties of businesses and interests in which more than one person share, there is aid in the report of the Senate Finance Committee proposing the 1932 statute. This clearly indicates that the new statute was intended primarily to provide a more definite category for syndicates, and for organizations similar to them, to pools, and to joint ventures, the taxation of the income of which had been troublesome. This is not said as to the income derived by tenants in common from simple ownership. Whether it could be said as to income from the operation of a trade or business by an organized group of tenants in common is not to be decided until the question arises in such a case. Cf. I. T. 2749, XIII-1 C. B. 99 (1934).

The determination that the petitioners are members of a “partnership” under section 801 (a) (3) is reversed. They are not limited in their deductions for capital losses by the ordinary income received from other sources, cf. Johnston v. Commissioner, 86 Fed. (2d) 732; certiorari denied, 301 U. S. 683; Winmill v. Commissioner, 93 Fed. (2d) 494; reversed other point, 305 U. S. 79, but each may offset the income derived by him from property held by them in common by his individual capital losses.

2. The Commissioner determined that the basis of gain to the petitioners from the condemnation award on the garage property must exclude the $14,000 value in 1913 of the structures which were demolished in 1917 and must also exclude the $8,449 cost of the mezzanine in 1925. He now concedes that the $8,449 is properly to be included within the basis.

The property was inherited in 1913 and the old structures were then upon it. They remained there yielding an inadequate return until 1917, when they were demolished to give place to the new garage. The petitioners contend that the original basis continued to be part of the cost of the new structure, and the respondent says that the demolition in 1917 was the occasion for a deduction for loss at that time, with the resulting reduction of basis. The evidence shows that the demolition was necessary in order to construct the new building and that it was done for that purpose. The cost of demolition was therefore-in fact one of the incidents of the cost of the new building, and had the petitioners taken deductions for losses in 1917 by reason of the voluntary destruction of the buildings, such deductions would have been disallowed and the basis of the property would have been carried on undiminished except by depreciation of the new structure. Arthur H. Ingle, 1 B. T. A. 595; Robert B. Griffin, 17 B. T. A. 255; Liberty Baking Co. v. Heiner, 37 Fed. (2d) 703; Spinks Realty Co. v. Burnet, 62 Fed. (2d) 860. In prior cases the purpose when the property was originally acquired to raze the existing structure was not the single controlling factor; the important question was whether the demolition of the old structure was part of the new project so that the cost of the demolished building was reasonably to be regarded as part of the investment in the new capital asset. The rationale of the prior decisions is no less applicable to property acquired by inheritance than to property purchased.

The basis therefore of the garage property should not be reduced by reason of the destruction of the old buildings in 1917.

3. The $67,573.95 which was added by the city to the original award because of the delay in payment is taxed by the Commissioner as interest, and the petitioners contend that it is part of the award and therefore within their capital gain. It is part of the award and not interest. Seaside Improvement Co. v. Commissioner, 105 Fed. (2d) 990; certiorari denied, 308 U. S. 618; cf. Baltimore & Ohio Railroad Co. v. Commissioner, 78 Fed. (2d) 460, 464; Commissioner v. Meyer, 104 Fed. (2d) 155.

4. Petitioner John S. Appleby would have the gain from the condemnation award reduced by a percentage regarded, as allocable to severance or consequential damages applicable to the small part of the land which remained. The amount of the alleged severance damages is arrived at by a mathematical computation of a real estate dealer who was familiar with the condemnation proceeding and purported to analyze the evidence in that proceeding and impute the result of his analysis to the award. It does not appear, however, that the award itself contained such a separation or any classification of its parts. It apparently was a lump sum. No division of it can be made on this record. Cf. Marshall C. Allaben, 35 B. T. A. 327.

5. The $150 which the Commissioner added as interest to John S. Appleby’s income is shown without contradiction to have belonged-to another and not to him. The determination taxing it to petitioner is reversed.

Decision will he entered voider Bule 50.

       SEC. 801. DEFINITIONS.
      (a) When used in this Act—
      * * * * * *
      (3) The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this Act, a trust or estate or a corporation; and the term “partner” includes a member in such a syndicate, group, pool, joint venture, or organization.

       Some confusion has existed over the requirements of the prior acts as to the time and manner of returning income from the operations of joint ventures, syndicates, pools, and similar organizations. If the syndicate was not an association, partnership, or trust within the meaning of the act there was no express requirement in the act or regulations for the filing of a syndicate return, and the sole responsibility of making returns of the annual gains and losses of the syndicate was placed upon the several members. Quite frequently, however, the members of such a syndicate overlooked the necessity of their making returns each year of their shares in the annual gains and losses from syndicate operations and assumed that they were required only to make returns of their shares in the ultimate gain or loss from the entire syndicate operations in the year when the syndicate was wound up or liquidated. Moreover, a strict observance of the letter of the prior acts would have required each member to determine his annual share in the syndicate gains or losses upon the basis of his own accounting period and according to his own method of accounting, irrespective of the accounting period or method of accounting upon which the books or records of the syndicate were kept.
      The bill does away with this uncertainty by placing all joint ventures, syndicates, pools, and similar organizations, which do not constitute associations or trusts, in the category of partnerships, and the members of such syndicates, pools, etc., in the category of partners. This provision will have the effect of requiring the syndicate to file a partnership return and will thus make it easier for the members to determine the distributive shares in the syndicate gains and losses which are to be included in their own returns.


author: Murdock : Keen,

text:
    Dillis C. Knapp and Fay Fitch Knapp, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 88704.
    Promulgated January 9, 1940.

      Stuart D. Barker, Esq., for the petitioners.

      B. E. Nehlett, Esq., for the respondent.
   OPINION.

Murdock :

There was a statutory provision during all of the years material hereto, which was specifically applicable to the reporting of income from employees’ trusts like the one in which this petitioner was a .participant. That provision was to the effect that the trust > itself was not taxable as a-trust, “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.” See section 165 of the Revenue Acts of 1934,1932, and 1928, and section 219 (f) of the Revenue Acts of 1926,1924, and 1921. There were some slight changes in the wording of this provision as it was continued through those acts, cf. Oscar A. Olstad, 32 B. T. A. 670, but the changes do not appear to be vital in so far as this proceeding is concerned. This conclusion on our part is confirmed by the fact that the petitioner makes no contention that .the changes are important. In fact, he never refers to the statutory provisions in his discussion of the case. He makes no claim and the facts do not show that there was ever a time when the petitioner was entitled to withdraw from the fund, as a partial withdrawal, an amount in excess of the amount which he had paid in. Thus it does not appear that he was ever entitled to withdraw any amount from the fund which would be taxable income to him under the provisions of the revenue acts above referred to unless his right to withdraw his entire interest in the fund made it so.

It is upon the latter right that the petitioner makes his argument. He contends that the full amount credited to his account in each prior year was constructively received by him prior to 1934 because, beginning in 1922, when he completed ten years of service, it was un-qualifiedly subject to his demand and could have been withdrawn by him to the very last penny without any obligation upon his part to return any of it, to pay any interest on it, or to do anything else in connection with it. There is no doubt that he had the right to withdraw his full credits. Assuming, for the purpose of this discussion, that he can invoke the doctrine of constructive receipt for his own benefit, nevertheless the facts fail to show that any portion of the amount now being taxed to him in 1934 was constructively' received by him in any prior year. The reason for this is that his right to withdraw his entire participation was given to him upon a condition. The condition was that if he withdrew from the fund he would cease to be a participant and could never become a participant again. The record clearly demonstrates that his right to continue to participate was a valuable one, the loss of which would have been a serious loss. It was unlike the ordinary investment; The company was annually making and was required to make substantial contributions to the credit of each participant based upon the amount of his deposits. Only by surrendering his right to further share in such contributions could the petitioner withdraw all of his participation from the fund. He had to surrender his entire right in what was obviously to him a very profitable and desirable opportunity as long as he could possibly remain a participant in it. It is difficult to conceive of a more important limitation or condition upon a right to receive money than the one which attached to the right of this petitioner.

The petitioner’s'" situation in prior years was somewhat like that of the owner of building and loan shades or of a life insurance policy where the cash surrender value thereof was in excess of the amount paid in by the holder. Yet, it has never been suggested that the excess of that cash surrender value would be income taxable under the doctrine of constructive receipt in the absence of actual surrender. There, as here, the money could be obtained only by surrendering the entire investment and the anticipated valuable future benefits which could be obtained only by continued participation.

Congress, in enacting section 219 (f) and section 165, above cited, relieved the participants in employees’ trusts of income tax until they had actually received their profits in cash or its equivalent. Prior to that time they might not have had any funds with which to pay the tax. Although the tax upon the entire profit at final distribution may be in excess of what the tax would have been if imposed upon the annual accretions, this circumstance is unimportant in view of the clear language of the statute. The petitioner here makes no contention that this was a stock subscription plan or that his receipt of stock instead of cash is any reason for relieving him of tax. Cf. Schaefer v. Bowers, 50 Fed. (2d) 689. The petitioner used the cash receipts method of reporting his income. None of the funds now being taxed to him were “made available” to him within the meaning of the statute at any time prior to 1934, when the actual distribution to him was made. We find no error in the determination of the Commissioner.

It becomes unnecessary, in view of what has been said above, to decide whether this taxpayer has any right to invoke the doctrine of constructive receipt. He is on the cash basis and he did not report the income in any prior year. The doctrine of constructive receipt is usually stated as follows: A taxpayer, reporting his income on the basis of cash receipts, may not deny the receipt of income and escape tax on it where it is unqualifiedly subject to his demand. It is in the nature of an estoppel and certainly one may not estop himself to his own advantage. Cf. Asher v. Welch, (U. S. Dist. Ct., Dist. Calif., S. Div., May 24, 1938). We held in the case of Alice H. Moran, Executrix, 26 B. T. A. 1154, that a taxpayer on the cash basis who has consistently followed the pra'ctice over a long period of years of not returning certain income because he did not receive it, may not invoke the doctrine of constructive receipt to escape tax on the income in the year in which it is actually received. The case was affirmed, 61 Fed. (2d) 601. We said in Southern Pacific Co., 21 B. T. A. 990, that the omission of the income in prior years was a substantial matter which deprived the Government of the revenue which it might otherwise have collected, and the taxpayer could not avoid the natural results of the omission and seek justification for the avoidance under a doctrine at variance with the facts. It likewise becomes unnecessary to consider the probative value and effect of the statement attached to the petitioner’s return in which he attempted to show that he would not have had to pay any tax in prior years even if he had reported the income in those years.

Reviewed by the Board.

Decision will he entered for the respondent.

Keen,

dissenting: I respectfully note my dissent herein because I am unable to view the question presented by this proceeding as one to be disposed of by the application of the doctrines of constructive receipt. In my opinion it is solely a question of the construction to be given to the language used by Congress in enacting section 165 of the Revenue Act of 1934, set out in the margin. The question presented is whether, under the facts set out in the findings, the earnings and the principal of the Sears, Roebuck & Co.’s Employees’ Savings and Profit-Sharing Pension Fund, in which petitioner was a depositor, or any part thereof, were “made available” to petitioner as a dis-tributee in a year or years prior to the taxable year as petitioner contends, or were “made available” to him in the taxable year when they were physically received by him as respondent contends.

In order to find the solution to this question it is first necessary to ascertain the meaning of the words “made available” as used in the phrase “but the amount actually distributed or made available io any distributee shall be taxable to him in the year in which so distributed or made available * *

The legislative history of this section of the revenue act throws very little light on this specific question. This section made its first appearance as a part of the taxing statutes in the Revenue Act of 1921 and contained at that time the phrase which we have quoted above. There have been changes in this section which have been made in the Acts of 1926, 1928, 1932, 1934, 1936, and 1938, but the quoted phrase is used without change or comment in all of the acts with the exception of the Act of 1928, and in that act the change was minor and immaterial. However, the changes which were made .in this section in the various Revenue Acts from 1924 to 1938, inclusive, indicated the desire of Congress to encourage and foster employees’ trusts and to minimize the incidence of any tax on the participating employees. See Seidman’s Legislative History of Federal Income Tax Laws, pp. 87, 257, 545, 604, 851.

There is no other section of the revenue acts in which the phrase “made available to” is used. In article 332 of Regulations 74 and 77, and article 44-2 of Regulations 86, the phrase is used in discussing income not reduced to possession in the following sentence: “To constitute receipt in such a case the income must be credited or set apart to the taxpayer without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and mast be made available to Mm so that it may be drawn at any time, and its receipt brought within his own control and disposition.”

Nor are there any cases in which the meaning of this phrase as used in this section of the revenue act has been judicially interpreted.

We should therefore look to the ordinary meaning of the words used, Reinecke v. Smith, 289 U. S. 172, getting what help we can from the context of the section in which they appear. Webster defines “available” as: “Such as one may avail one’s self of; capable of being used to accomplish a purpose; usable; convertible into a resource; as, an available measure; an available candidate.” It would seem that the phrase “made available to”, as used in the regulations which we have set out above, has the same connotation, since it is followed by the explanatory phrase “so that it may be drawn at any time.” Looking to the context of the particular section of the act, we find the phrase “made available” used disjunctively with the phrase “actually distributed.” As the court said in Monroe Cider Vinegar & Fruit Co. v. Riordan, 280 Fed., 624, 626, “the legislative body is not presumed to use meanlingless language, or putting the rule another way, * * * in ascertaining the legislative intent due consideration and weight shall be given to the words and phrases of a statute.” In Gilbert v. Commissioner, 56 Fed. (2d) 361, 362, the court said: “It is a well-settled rule of construction that a statute should, if possible, be so construed as to give meaning to all parts of it.” We may, therefore, conclude that Congress, in using the phrase “made available” meant to provide for a situation different from that covered by the phrase “actually distributed”, and that the former is antonymous to rather than synonymous with the latter. In other words, the statute provides that even though the earnings and principal of the fund accumulated by the trust have not been actually distributed to the employees, nevertheless, the amount shall be taxable to him if it is made available to him and in the year in which so made available. We must conclude that Congress used the phrase “made available” in its ordinary sense of “made usable or convertible into a resource”, as distinguished from the connotation of actual receipt present in the other phrase used in this section of the statute, “actually distributed.”

Since we are here concerned with a definite and express statutory provision, it is not necessary to concern ourselves, as the majority opinion has done, with any fictional doctrine of constructive receipt. The problem as I have seen it is purely one of statutory construction.

Having construed the phrase in question in this way, the remaining question is whether the phrase so construed is applicable to the facts in this case. In my opinion it is.

After petitioner had completed ten years of service with the company he was entitled to withdraw all money and securities credited to his account. The only limitation on that general right was the provision that if he once withdrew he could not reenter the fund. If this proceeding is treated as one involving the application of the doctrine of constructive receipt, it is conceivable that this limitation might be material, but it is not material in considering the question of whether the money and securities credited to petitioner by the trustees of the fund were made usable or convertible into a resource as to petitioner in a year or years prior to the taxable year. Since petitioner had the absolute right of withdrawing the money and securities so credited to him at any time after he had completed ten years of service, they then became available to him within the meaning of this section of the statute and the money and securities credited to his account in subsequent years were made available to him in the years so credited.

The case of Asher v. Welsh, decided by the Federal District Court for the District of California, Southern Division, on May 24, 1938, is not helpful in a consideration of the instant proceeding. In that case the doctrine of estoppel was found to be controlling. There the taxpayer was employed by the same company as that which employed petitioner here. He did not report in his returns as income the money and securities credited to his account by the fund in the years so credited. The respondent relied upon these returns and did not, therefore, collect the taxes which would have been collected had the facts been disclosed. Having paid a tax upon the final distribution of these accumulated moneys and securities in the year in which they were actually received, the taxpayer sought to recover the amount paid in an action against respondent. The court held that he was estopped from doing this. In the instant proceeding no issue of estoppel 'has been raised by respondent and there is no evidence that any tax would have been due from petitioner in any prior year even if the amounts made available to him by the fund had been reported in the year in which they were so made available. Therefore, the respondent can not be said to have relied to his detriment on petitioner’s returns for prior years, and consequently, there can be no estoppel. The only information we have as to the taxes which might have been due from petitioner if his income had been properly reported is in a memorandum attached to his return for the taxable year which indicates that no taxes would have been properly payable by him.

Leech and Hill agree with this dissent.

       SBC. 165. EMPLOYEES’ TRUSTS.
      A trust created by an employer as a part of a stock bonus, pension, or profit-sharing plan for the exclusive benefit of some or all of his employees, to which contributions are made 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, 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 dividends and interest specified in section 25 (a).


author: Leech:

text:
    Kessler Oil and Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 93041.
    Promulgated January 9, 1940.

      R. S. Doyle, Esq., for the petitioner.

      A. H. MonaeeTli, Esq., for the respondent.
   opinion.

Leech:

Petitioner contends, in substance, that it borrowed from the bank and loaned the money to Smith, which loan was secured by collateral, part of which had been originally pledged with the bank on Smith’s loan there, and that Smith used the proceeds of this loan from petitioner to pay his indebtedness to the bank. Petitioned then argues it properly ascertained the then balance owing on this loan to have become worthless in 1984 and charged it off as a bad debt.

Respondent counters with the argument that petitioner bought the Smith note and collateral thereto but that, if this is not so, and petitioner did become a creditor of Smith by the transaction of the bank, the debt was worthless and reasonably ascertainable as such before 1934.

We agree with petitioner. After a thorough consideration of the evidence, we think that petitioner never acquired full legal title to the Smith note to the bank or the collateral securing it. Petitioner became a creditor of Smith and this collateral secured that debt. Kessler, petitioner’s president, testified that he held title to the collateral, consisting of Petroleum stock and Nash Motors stock, only as trustee for the liquidation of Smith’s account. The agreement between Smith and Kessler stated not that Smith assigned these securities to Kessler, but that he would leave- them with Kessler to be sold to liquidate the obligation when, as, and if necessary. It is true that when petitioner took over the obligation from Kessler, the transaction was entered on its books three times as a purchase of the stocks comprising the collateral. But Kessler testified that this was done without his knowledge or authority, while he was away, and by a bookkeeper who did not know how to record the transaction. Respondent introduced no evidence to rebut this explanation except the entries themselves. On the third entry made without Kessler’s knowledge it is expressly stated that the stock was held only as collateral on Smith’s note account.

The allegedly mistaken entries were corrected by Kessler’s order as soon as he learned of them, and this was done in December of 1933, prior to the taxable year. We are satisfied that the correction, which changed petitioner’s records to show that the stocks were held and one of them disposed of only as pledged collateral, was made in good faith. The evidence independent of the book entries shows clearly that a pledge, rather than an outright transfer, of the securities took place, and the book entries can not control where they conflict with the actual facts. Doyle v. Mitchell Brothers Co., 247 U. S. 179; San Joaquin Light & Power Co. v. McLaughlin, 65 Fed. (2d) 677; Ohio Brass Co., 17 B. T. A. 1199.

Respondent insists that petitioner knew Smith was insolvent in 1931, having charged off a debt of his in that year as worthless, and that the bad debt deduction, if such it was, should have been taken in that year. In support of this he cites Dexter v. Commissioner, 99 Fed. (2d) 769. But this argument is beside the point, the Smith note account was at all times secured by collateral, which was not the case in Dexter v. Commissioner, where the notes in question were wholly unsecured.

It may be conceded that petitioner could have reasonably ascertained a part of the Smith debt to have become worthless prior to 1934, but a partial charge-off is not compulsory under the act. Revenue Act of 1934, sec. 23 (k). It may be true that neither Smith’s asset position nor his worth as a debtor improved substantially between 1931 and 1934. It may likewise be true that the value of the collateral did not appreciate during that interval. However, on this record we can not say the basis for a reasonable expectation that such appreciation would occur did not exist throughout that period. And, in any event, the total worthless amount of the debt could not have been ascertained until the disposition and liquidation of the collateral, including the Lucey Products note. This did not occur until 1934, when that note was paid and the stock in petitioner was taken over by petitioner and Smith’s account credited with its par value, which then exceeded its market value — under the contract of June 16,1931. There is nothing in this record indicating that the petitioner was accumulating bad debts to deduct them in a year subsequent to the year of their becoming worthless, as was true in Avery v. Commissioner, 22 Fed. (2d) 6. We have, therefore, found as a fact that petitioner properly ascertained a debt to it in the sum of $17,198.07 to have become worthless in 1934 and charged the same off in that year. It is entitled to that deduction. Fidelity Storage Corporation v. Burnet, 58 Fed. (2d) 526; Alfred K. Nippert et al., Executors, 32 B. T. A. 892.

Decision will be entered for the petitioner.


author:
Black :
      Aenold,

text:
    Columbia Oil and Gas Company, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 90624.
    Promulgated January 10, 1940.

      J. P. Jackson, Esq., for the petitioner.
    . Carroll Walker, Esq., and Irene Feagin, Esq., for the respondent.
   OPINION.

Black :

Issue 1. — Petitioner contends that the respondent erred in his computation of profit in arriving at a “Net remaining cost in leases sold” of $355,940.79 instead of $379,897.78. The parties by stipulation have narrowed this issue to whether the transfer of the oil properties by the Eush brothers to petitioner on May 4, 1931, was a taxable or a nontaxable transaction. This depends upon the effect of section 112 (b) (5) and (j) of the Revenue Acts of 1928 and 1932, which are identical and are as follows:

SEC. 112. RECOGNITION OP GAIN OR LOSS.
(a) General Rule.' — Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.
(b) Exchanges Solely in Kind.—
*******
(5) Transfer to corporation controlled by transferor. — No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
(j) Definition of Contbol. — As used in this section the term “control” means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.

Since this issue concerns the determination of the proper “basis” to be used in computing the gain from the sale to Stanolind in 1933 of the oil properties transferred to petitioner by the Kush brothers solely in exchange for stock at the time of petitioner’s organization, we arrive at the present consideration of the above quoted provisions of section 112 by having first considered in the order named the following provisions of the Revenue Act of 1932, namely, section 111 (a); 113 (b); 113 (a) ; and 113 (a) (8).

Petitioner contends that the persons who in 1931 transferred property to it solely in exchange for petitioner’s stock were not in “control” of petitioner “immediately after” the exchange, and that, therefore, section 112 (b) (5) is not applicable in deciding this issue. The respondent contends otherwise.

The dispute between the parties arises in connection with the 475 shares that were issued to Todd and the 75 shares that were issued to Knight. The respondent contends that since these shares, with the exception of two qualifying shares, were first issued to the Kush brothers, we must consider the Rush brothers as being in control of petitioner immediately after the transfer to petitioner of the oil properties at the time of petitioner’s organization, and that it is immaterial that the Rush brothers later, on the same day, May 7, 1931, transferred these shares to Todd and Knight.

We do not think the transfer of the 550 shares to Todd and Knight can be so disregarded in deciding this issue. This transfer was not a separate and independent transaction, but was an essential part of an integral plan. For income tax purposes this plan must be treated as a single transaction; the component steps thereof may not be treated separately; and control must be determined as of the completion of the plan. Halliburton v. Commissioner, 78 Fed. (2d) 265; Bassick v. Commissioner, 85 Fed. (2d) 8; Hazeltine Corporation v. Commissioner, 89 Fed. (2d) 513; Commissioner v. Schumacher Wall Board Corporation, 93 Fed. (2d) 79; United Light Power Co., 38 B. T. A. 477; affd., 105 Fed. (2d) 866; Sam Pickard, 40 B. T. A. 258.

Since the decision of Halliburton v. Commissioner, supra, we have held that the word “property” as used in section 203 (b) (4) of the Revenue Acts of 1924 and 1926, and section 112 (b) (5) of the Revenue Acts of 1928 and 1932 (all of which provisions arc identical except for the subtitle “Transfer to Corporation Controlled by Trans-feror” contained in the 1928 and 1932 Acts) includes money. Claude Neon Lights, Inc., 35 B. T. A. 424, 430; Cyrus S. Eaton, 37 B. T. A. 715. Therefore, in applying section 112 (b) (5), supra, to the facts in the instant proceeding the cash paid in for stock must also be considered along with the oil properties paid in for stock by the Bush brothers for the purpose of determining whether “immediately after ■ the exchange” the transferors of the property transferred to petitioner pursuant to the plan were in “control” of petitioner within the meaning of that term as defined in section 112 (j). Todd and Knight did not transfer any property to petitioner in exchange for their stock. The only property transferred to petitioner solely in exchange for stock was transferred by the Bush brothers and the cash subscribers, who, upon the completion of the plan only owned 1,450 out of 2,000 shares, or 72.5 percent of petitioner’s outstanding capital stock. Since this is less than the 80 percent required by section 112 (j), supra, it follows that the transferors were not in “control” of petitioner “immediately after” the exchange; that it thus becomes unnecessary to determine whether the amount of stock received by each transferor was substantially in proportion to his interest in the property prior to the exchange (cf. United Carbon Co. v. Commissioner, 90 Fed. (2d) 43); that the entire amount of the gain or loss realized in 1931 upon the transfer of the oil properties by the Bush brothers to petitioner was recognizable at that time; and that the transaction was, therefore, a taxable transaction.

The respondent, in support of his contention that the transfer of the oil properties by the Bush brothers to petitioner was a nontaxable transaction, cites Schmieg, Hungate & Kotzian, Inc., 27 B. T. A. 337; American Compress & Warehouse Co. v. Bender, 70 Fed. (2d) 655; Charles W. Nudelman, 35 B. T. A. 28; and J. Hampton Hoult, 24 B. T. A. 79. The Schmieg case turned on whether the petitioner in that case had met the burden of proving that Hungate, immediately after the transfer of the partnership assets, was the owner of one-third of petitioner’s common stock. We held that the petitioner had not met that burden and that, therefore, immediately after the exchange the transferors were in control of the corporation. Whether we correctly held in the Sehmieg case that the proof was insufficient to show that Flungate was the owner of one-third of the common stock of Schmieg, Hungate & Kotzian, Inc., prior to 1929 when it was actually issued in his name, we need not here decide. The important point is that our decision in that case turned on a lack of evidence as to ownership of stock. We have no lack of evidence in the instant case as to the ownership by Todd and Knight of the stock in petitioner which was issued to them on the first day of the organization of the corporation in pursuance of the plan. In the American Compress case, tire contract to sell the 1,813 shares was entered into subsequent to the plan there involved, and was not a part of the plan. In the instant proceedings, it was a part of the integral plan that the Rush brothers would transfer the 550 shares immediately to Todd and Knight, all of which was done. We do not regard the other two cases cited by the respondent as in conflict with anything we have decided here. Their facts are clearly distinguishable. On issue 1, we sustain petitioner.

Issue ?j. — Under this issue, petitioner’s first point in its argument is that the respondent erred in including as a part of the “amount realized” (see sec. Ill, Revenue Act of 1932) the item labeled in his computation “Fair market value of oil payment received” in the amount of $175,000. This amount represents 50 percent of the maximum of $350,000 which petitioner was to receive from the fractional interests reserved, if, as, and when oil would be produced therefrom. In his brief, the respondent apparently concedes that this treatment was erroneous under the decisions of Commissioner v. Fleming, 82 Fed. (2d) 324, and Thomas v. Perkins, 301 U. S. 655, for he no longer argues that phase of the case. A mere reading of the contract of sale and the assignments clearly shows that the $350,000 was not an additional consideration for the sale but represented the maximum amount which petitioner might or might not receive for the fractional parts of the first oil, gas, and other hydrocarbons which it specifically reserved- for itself. The buyer did not obligate itself personally to pay petitioner the additional sum of $350,000. Such maximum; amount was to be paid petitioner only out of the first runs of petitioner’s reserved oil, if, as and when produced. Petitioner did not receive as consideration for the sale any property in addition to the $550,000. We hold, therefore, that the respondent erred in determining that the amount realized from the sale of the properties was $725,000 instead of the cash consideration of $550,000. Commissioner v. Fleming, supra; Thomas v. Perkins, supra.

The respondent, however, contends that if petitioner’s first point in its argument be sustained, as we have just held, then the “basis” of petitioner’s property should be allocated between the estate sold and the estate reserved. It has been stipulated that the fair market value of the interest owned by petitioner in the properties immediately prior to the sale was $725,000. From this the respondent argues that since petitioner only received a consideration of $550,000, it must have sold property having a value of $550,000 -and reserved property having a value of $175,000, and that, therefore, 175/725 of petitioner’s cost basis of the whole property should be allocated to the property reserved and only 550/725 of petitioner’s basis should be considered in determining the gain or loss upon the property that was sold. Following our holding under issue No. 1 that petitioner’s adjusted basis is $379,897.78, and our holding under the present-issue, No. 2, that petitioner’s amount realized on the sale was no more than the cash consideration of $550,000, then, under the respondent’s present contention, petitioner’s gain on the sale computed under section 111 of the Revenue Act of 1932 would be $243,249.68, computed as follows:

Amount realized (cash payment received)_ $550,000.00 Deduct:
Adjusted basis:
Leasehold_$133,307.78
Tangible well equipment_ 246, 590.00
379,897. 78
Less amount allocated to property reserved:
175/725 of $379,897.78_ 91,699.46
Balance allocated to property sold_$288,198.32
Expenses (stipulated)- 18, 552. 00
- 306,750. 32
Taxable gain- 243,249.68

Petitioner’s second point in its argument under this issue is that the proper method of determining the gain is to allow petitioner the full return of its cost from the cash received in the year of the sale, and that no part of its basis should be allocated to the property reserved. In other words, petitioner contends that there is no justification for reducing its adjusted basis of $379,897.78 by the amount of $91,699.46, shown in the above computation, or by any other amount, and that the correct amount of its taxable gain is, therefore, $151,550.22, computed by subtracting from the cash received, $550,000, petitioner’s entire basis of $379,897.78, together with the expenses of $18,552. In support of this contention, petitioner relies principally upon the cases of Burnet v. Logan, 283 U. S. 404, and Rocky Mountain Development Co., 38 B. T. A. 1303. The taxpayers in the Burnet v. Logan case prior to March 1, 1913, and Until March 11, 1916, were stockholders in the Andrews & Hitchcock Iron Co., a corporation which held 12 percent of the stock of the Mahoning Ore & Steel Co., an operating concern. They sold their shares of stock to the Youngstown Sheet & Tube Co. for a cash consideration and future payments to be measured by the amount’ of iron ore produced by the Mahoning Ore & Steel Co. In selling their shares of stock they sold them in their entirety, with no reservations, and they, of course, made no reservation of ore in the Mahoning mine, because they owned none of it. They had no reserved interest in the iron ore which, they could recover by way of depletion. The situation in that respect is altogether different from what it is in the instant case and therefore, we think Burnet v. Logan is not in point.

In the Rocky Mountain Development Co. case, supra, among other things, we said:

The petitioner’s oil payment contracts called only for certain payments out of oil in consideration for the equipment sold by the petitioner and did not grant or convey to petitioner an interest in the leases themselves or the oil and gas in place.

On these facts we allowed the taxpayer in that case a full return tax free of his cost basis of the oil payments, but denied any depletion deductions because the taxpayer had no interest in the oil in place which would entitle it to depletion.

We do not think that the two cases last mentioned support petitioner’s contention that it is entitled to the full return of its basis in the taxable year without first allocating some part thereof to the property reserved. In neither one of the cases principally relied upon by petitioner did the respective taxpayer reserve out of the property sold any such economic interest as would entitle it to a deduction for depreciation or depletion. In the instant proceeding we think the reservations made by petitioner were unquestionably reservations of such economic interests as would entitle petitioner to depletion under Palmer v. Bender, 287 U. S. 551; Thomas v. Perkins, supra; and Cook Drilling Co., 88 B. T. A. 291, 296. In the latter case, at page 297, we said:

When a taxpayer reserves an interest in oil in place, as did petitioner when it sold the Alford and Shaw leases for $65,032.72 to he paid “out of an undivided three-fourths of seven-eighths of the oil and gas produced, marketed, and sold from the leases, etc.”, it is entitled to recover its eost by way of depletion and not by way of deduction of the cost of the leases from gross income.

Earlier in the same case we disallowed depletion on the Sonbar Corporation and the Bussa Co. oil payments obtained in consideration for drilling the wells which were to produce the oil, where the driller received no assignment of an interest of the oil in place. We said in this connection:

* * * The statutory allowance for depletion is predicated upon the receipt of gross income from the operation of oil and gas wells, by one who has a capital investment in the oil and gas in place and may not be allowed to one who has no such capital investment but only an income derived from production, through a contractual relation or personal covenant with the owner of the mineral deposit. Helvering v. Bankline Oil Co., 303 U. S. 362; Helvering v. O’Donnell, 303 U. S. 370; Helvering v. Elbe Oil Land Development Co., 303 U. S. 372.

In the instant proceeding petitioner had a capital investment in the oil and gas in place, and1 reserved certain fractional parts of that capital investment until certain maximum amounts would be recovered out of future production. Under such, circumstances, petitioner’s cost allocable to the interests reserved must be recovered by way of depletion and not by way of deduction of the entire cost from the cash consideration of $550,000. Cook Drilling Co., supra, as to the Alford and Shaw lease payments there involved. If petitioner were permitted to deduct the entire cost of $319,897.18 during the taxable year in computing the profit on the sale of the leases, and were also permitted to deduct depletion as it receives the future oil payments, it would to that extent be receiving a double deduction, which is not permissible. Cf. Signal Gasoline Corporation, 30 B. T. A. 568, 571; affd., 77 Fed. (2d) 728; certiorari denied, 296 U. S. 657. A simple illustration in this regard will illustrate what we mean. Assuming that petitioner’s oil payments in the instant case pay out, then petitioner’s allowable deductions for percentage depletion will be 27% percent of $350,000 or $96,250. That is $47,486.01 in excess of the $48,763.99 cost which we have allocated herein to the portion of the leaseholds retained. That result will be all right because it is sanctioned by statute. Percentage depletion may greatly exceed the cost. But suppose we should grant petitioner’s request and allow it a full return of its entire cost out of the $550,000 cash received without allocating any part of the cost to the portion of the leaseholds retained. Then it would mean that petitioner would still receive $96,250 percentage depletion on the oil payments, with no remaining costs whatever to recover. We do not think Congress ever intended such a result. Petitioner’s second point in its argument under this issue is, therefore, disapproved.

Petitioner’s third point in its argument under this issue is by way of a first alternative and is that, in any event, the full adjusted cost of the tangible well equipment in the amount of $246,590 must be returned to petitioner out of the cash received, and that any allocation of leasehold costs as between oil sold and oil reserved must be made on the basis of the number of barrels of oil in the ground required to liquidate petitioner’s oil reservation, citing in this latter connection, Ortiz Oil Co., 37 B. T. A. 656. We agree with petitioner that the full adjusted cost of the tangible well equipment in the amount of $246,590 must be returned to petitioner out of the cash received, and that the respondent is in error in contending that part of the adjusted basis applicable to the tangible well equipment must be allocated to the property reserved. The contract and the assignments clearly show that petitioner parted with all of its title to the tangible well equipment. It did not reserve any part of this property. Its reservations were limited only to the first oil, gas, and other hydrocarbons produced, saved, and sold from certain fractional interests in the oil leases until certain maximum amounts had been received. After the sale, petitioner would no longer be entitled to deduct depreciation on any part of this equipment. That right then belonged to Stanolind.

An examination of the contract of sale and the assignment of .the eight leases shows that petitioner sold to Stanolind, for $550,000 cash, (1) all of petitioner’s interest in the personal property and equipment on the eight leases used in connection with the development and operation of said leases; title to all of petitioner’s interest in said personal property to rest in Stanolind without condition, lien or reservation; and (2) all of petitioner’s right, title and interest in, to, and under the said eight leases except one-fourth of seven-eighths of the first oil, gas, or other hydrocarbons produced, saved and sold from tracts 1 to 5, and one-eighth of seven-eighths from tract 6, and one-sixteenth of seven-eighths from tracts 7 and 8, until the total sum of $850,000 was realized. Thereafter the entire interest in the 8 leases was to belong to Stanolind. No interest in the personal property and equipment was reserved to petitioner. The first part of petitioner’s third point is sustained.

The second part of petitioner’s third point concerns the proper allocation of the adjusted basis of the leaseholds in the amount of $133,807.78 as between the portion sold and the portion reserved. As previously stated, the respondent’s contention is that 175/725 of the entire cost basis of $379,897.78, the cost of the leases, plus the cost of the oil equipment, should Be allocated to the oil payments reserved. Petitioner contends that if an allocation is to be made no more than 350,000/4,453,750 of the $133,307.78 should be allocated to the oil payments reserved for the reasons that it was stipulated that the estimated number of barrels necessary to return to petitioner its reseiwations under the assignments to Stanolind was 350,000 barrels; that the estimated number of recoverable barrels of oil in the ground owned by petitioner prior to the sale was 4,453,750 barrels; and that this method of allocation was adopted by the Board in Ortiz Oil Co., supra. The formula of allocation, following the Ortiz Oil Co. case, would apparently yield results as follows:

350,000_ X $133,307.78=$10,476.05 (cost to be allocated to oil payments 4,453,750 reserved.)

The remainder of the adjusted cost of the leases would be allocated to the portion of the leases sold. This would result in an allocation of $122,831.73 cost to the portion of the leases sold. It seems to us that this sort of allocation results in too much of the cost being allocated to the part of the leases sold and too little to the portion reserved. Under petitioner’s method, only $10,476.05 of the cost basis would be allocated to oil payments having a face value of $350,000.

Under Texas law, oil and gas leases are real property. Stephens County v. Mid-Kansas Oil & Gas Co., 113 Tex. 160; 254 S. W. 290; Texas Co. v. Daugherty, 107 Tex. 226; 176 S. W. 717. One method of allocating cost between real estate sold and real estate retained, both being parts of the same tract, is by apportioning the cost in proportion to the respective values of the part sold and the part reserved. Cf. J. S. Cullinan, 5 B. T. A. 996. The Commissioner has a regulation prescribing the method of allocating costs between lots of real estate which have been subdivided from a larger tract. That regulation prescribes simply that “the cost or other basis shall be equitably apportioned.” See art. 61, Regulations 77 (Revenue Act of 1932). The Commissioner has no regulation which deals specifically with the situation in the instant case, but nevertheless we think there must be an equitable apportionment of cost and such an equitable apportionment will naturally depend upon the facts in each case.

We think petitioner’s second alternative contention suggests an equitable apportionment of costs in the instant case. That suggestion is that the total cost of the leases, exclusive of the cost of the de-preciable propery sold, be allocated on the basis of the relative values of the interests in leases sold, and retained.

It is stipulated that the value of all the properties, including the equipment, at the time of the sale, was $725,000. The equipment was worth $246,590, this being their depreciated cost. Thus, the leases, without the equipment, are to be valued at $478,410. The purchaser paid $550,000 for the equipment and part of the oil rights. Since the taxpayer should have a full return of its equipment cost, and since the price was presumably arrived at on a basis of depreciated cost of this equipment, we are justified in assuming, we think, that of the total consideration, $246,590 was consideration for the equipment. This means that $303,410 represents the agreed value of the interest in oil sold. Since, as stated above, the full oil rights had a value of $478,410, the taxpayer, on the basis of relative values at the time of sale, has sold 303,410/478,410 of its oil, or .6342 of its oil. Since 100 percent of its oil cost $133,307.78, the cost of .6342 was $84,543.79.

A computation of petitioner’s profit according to its second alternative would be as follows:

Selling price. $550, 000.00
Cost:
303,410 478,410 of $133,307.78 $84, 543.79
Equipment 246, 590. 00
Expenses. 331,133. 79' 18, 552.00
-- 349,685.79
Taxable gain. 2001, 314.21

This, we think, presents an equitable apportionment of the cost of the leaseholds between the parts sold and the parts retained, and we therefore, approve it.

Petitioner, although advancing the above method as its second alternative, questions its use because it defers a considerable part of the leasehold costs to be recovered out of depletion on future oil runs. The answer to this objection is that it does not appear to allocate to the retained portion of the leases any more than an equitable portion of the total cost of the leases. Petitioner says that the method would work satisfactorily if the properties continue to produce and pay out, but that, in view of the highly contingent and speculative nature of an oil payment, it will frequently mean that a taxpayer will never recover all his leasehold costs by percentage depletion.

We think petitioner’s fears in this respect are groundless. Percentage depletion is only availed of when it yields a taxpayer a greater deduction than depletion based on cost. We discussed that phase of the depletion allowance in Cook Drilling Co., 38 B. T. A. at page 297, where we pointed out that “a taxpayer is entitled to a return of his full cost by way of depletion, even though depletion figured on the percentage basis will not yield him that much. * * *” The last clause of section 114 (b) (3) of the Revenue Act of 1932 makes certain that result.

For reasons above stated, we approve petitioner’s second alternative in allocating the basis of cost between the portion of the leases sold and the portion retained; It is substantially the same as the method of apportionment advocated by the Commissioner, except that it excludes from the allocation any part of the cost of the tangible, de-preciable property which was sold. We have already held that this part of the property was sold in its entirety and, therefore, there is no reason that any part of its cost should be allocated to the cost of the portion of the lease retained.

It is true that in Ortiz Oil Co., supra, we used the barrel of oil method in allocating the cost basis, urged by petitioner in its first alternative. However, there was no issue in that case between the parties as to the method of allocation. They had differed on other issues and apparently we made the allocation on the best evidence that was before us and it was accepted by both parties. So far as we can see, it yielded an equitable apportionment of costs in that case. In the instant case, as we have already pointed out, the use of the same formula does not result in an equitable apportionment of the costs and we have rejected it for what we conceive to be a better method under the facts of the instant case.

Reviewed by the Board.

Decision will be entered under Rule 50.

Aenold,

dissenting: I respectfully dissent from the conclusion reached in the majority opinion that cost must be allocated between cash received and contingent future payments in order to determine the amount of gain derived from the sale of property. If apportionment is necessary, or practical, the method used in the majority opinion is, perhaps, better than that used in Ortiz Oil Co., 37 B. T. A. 656, or by the respondent here, but, in my opinion, it is unnecessary to allocate cost in order to properly determine the amount of gain realized from the sale of property herein.

The gain from the sale of property is the excess of the amount realized over the cost basis as adjusted, section 111 (a), Bevenue Act of 1932. The amount realized from a sale is the sum of money received plus the fair market yalue of the property (other than money) received, section 111 (b), Bevenue Act of 1932. The amount realized from the present sale was $550,000 cash, and I agree with the majority opinion that petitioner did not receive any additional property as consideration for the sale.

In my opinion the majority’s allocation includes, by indirection, $48,763.99 of the fair market value of future oil payments in petitioner’s taxable income, although prohibited by the decided cases from including therein the entire fair market value of such future oil payments. It seems to ine that the same contingency and uncertainty as to the receipt of the future payments exist in apportioning costs as exist in increasing a taxpayer’s gross income by the estimated present worth of such eontingent future payments. I can see no more justification for its use in apportioning costs than for its use in increasing gross income. The contingent nature of the oil payments remains the same in either event.

In view of the known fugacious nature of oil and the necessarily contingent nature of oil payments to be received from the production of oil, if any, an allocation of cost between cash received and oil payments to be received out of production may result in petitioner’s failure to recover $48,763.99 of its costs. If cost be not recovered the taxation of a portion of the cash received as gain realized from the sale would in effect be a tax upon capital and not upon income. Commissioner v. Laird, 91 Fed. (2d) 498; Commissioner v. Fleming, 82 Fed. (2d) 324; Burnet v. Logan, 283 U. S. 404.

In the last mentioned case the respondent valued the right to receive payments for ore extracted as being the equivalent of cash, and used his valuation as the basis for apportioning subsequent annual receipts between income and return of capital. The Supreme Court held that the promise of future money payments was wholly contingent upon facts and circumstances not possible to foretell with anything like certainty and that the promise was in no proper sense the equivalent of cash.. The Court’s opinion points out that the taxpayer “might never recoup her capital investment from payments only conditionally promised” and that she “properly demanded the return of her capital investment before assessment of any taxable profit based on conjecture.”

In the Fleming case, supra, the court held that in “sales of interests in oil leases a money payment unconnected with production of oil is to be dealt with as representing a conversion of capital by sale * * *.”

In the Laird case, supra, the Fifth Circuit differentiated between oil payments and oil royalties. It held that all payments received on account of the devise of certain “oil payments” were returns of capital until the aggregate capital.sum devised had been recovered, and no question of income would arise until the entire capital value was received. The court pointed out that it would not do to permit the Commissioner to press the analogy between royalty and oil payments “to the point of taxing as income what is inescapably a return of capital.”

I do not believe the holding in Cook Drilling Co., 38 B. T. A. 291, at page 297, respecting the Alford and Shaw leases, is authority for the allocation of costs. Those leases were sold for a consideration to be paid out of oil to be produced. No cash, plus oil payments, was involved. This proceeding is therefore factually different on this point.

The majority opinion states the real essence of its argument when it assumes that the oil payments will pay out the $350,000 reserved and further assumes that petitioner will claim the statutory percentage depletion allowance, and then states that, if both assumptions materialize, the petitioner will secure double deductions, totaling $47,486.01 in excess of cost. These assumptions by the majority overshadow all other considerations. The essential facts are that petitioner sold certain property for cash and reserved the right to participate in future production, if any. The right reserved is so conjectural that its fair market value can not be included as a part of the gain realized from the sale, and the practical solution, in my opinion, is to first permit the recovery of cost to the extent of cash received. This solution guarantees that the taxpayer will at least recover his costs to the extent of cash received, and recovery of cost will not be dependent upon a wholly conjectural and contingent possibility. Thus the constitutional inhibition against the taxation of capital as income is preserved.

If tax laws are to be administered in a practical manner and upon an annual accounting basis, this taxpayer has realized gain on the sale of a capital asset in the taxable year only to the extent of the cash received in excess of its cost. Any formula for the allocation of cost, however, just and equitable it may appear to be, which forces a taxpayer to postpone the recoupment of his investment to the happening of unpredictable future events which may never occur, is a direct violation of the Sixteenth Amendment, and the revenue acts enacted pursuant thereto, which lay a tax upon income and not upon capital.


author: Van Fossan:

text:
    Henry J. Burchell, Jr., Executor Estate of John D. Adams, Deceased, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 92783.
    Promulgated January 10, 1940.

      Roland, N. Tremble, G. P. A., for the petitioner.

      R. H. Transite-, Esq., for the respondent.
   OPINION.

Van Fossan:

The petitioner contends that the taxes in controversy became a lien on the real estate on September 15, 1934, the date on which, under the general law of New York, the assessment roll was delivered. That event occurred prior to the decedent’s death, and hence, he asserts, the taxes are deductible from the decedent’s gross income in the return filed by his executor. He construes the General Tax Laws of New York and chapter 311, Laws of 1920; of that state, governing the assessment and collection of taxes in Suffolk County, New York, as supporting his contention. We are unable to agree.

Section 1 of chapter 311 relates to the preparation of assessment rolls by the boards of assessors of the towns of Suffolk County, under the direction of the board of supervisors. Section 2 refers to the salary of the assessors. Section 3 constitutes the assessment rolls, as prepared by the assessors, the official assessment rolls for the towns and school or other districts therein. Section 4 is not material. Section 5 is as follows :

Sec. 5. Completion, of assessment roll. — All assessments shall be made as of June first. The assessors shall complete the assessment roll on or before the first day of July of each year and shall meet for the hearing of complaints on the third Tuesday of July in each year, and in all other respects except as herein modified1 shall proceed in the' completion and certification of the assessment roll as directed by the tax law.

Section 6 provides that the assessment roll shall be completed, verified and filed (with the two clerks) on or before September 1, of each year. Sections 7, 8, 9, and 10 relate to school taxes and section 11 to town taxes. Section 12 requires the supervisor of the town to complete the extension of the taxes upon the assessment roll and file it with the board of supervisors on or before December 1 of each year. “Such assessment roll shall, when the warrant is annexed thereto, become tbe tax roll” of the town and school or other districts therein.

Section 13 is as follows:

Sec. 13. Taw roll a/nd receiver’s warrant. — On or before tbe first day of December in each year or sucb date as may be designated by a resolution of tbe board of supervisors, tbe board of supervisors of tbe county shall annex to tbe tax and assessment roll of eacb town a warrant under tbe seal of, tbe county, signed by tbe chairman and clerk of the board, commanding tbe receiver of taxes of tbe town to whom tbe same shall be directed, to collect from tbe several persons and on tbe property named and described in tbe tax and assessment roll tbe several sums extended therein as taxes and assessments against the respective names and property, except taxes upon tbe shares of stock of banks and banking associations and further commanding him to pay over from time to time all moneys so collected, as follows:
[Here follow subsections 1, 2, 3, 4, and 5 prescribing tbe method of payment to the county treasurer of tbe taxes collected by tbe receiver of taxes]

Subsection 5 also authorizes the receiver to levy “by distress and sale in case of non-payment.” It further reads as follows:

All taxes in tbe tax roll shall be due and payable on tbe date of, the warrant annexed thereto and shall be payable to tbe receiver at any time on or prior to tbe succeeding tenth day of January without penalty. [Here follow penalty provisions.]

The subsequent provisions of chapter 311 are not pertinent to the issue.

In certain cases the Board has adopted the rule that taxes accrue when they become a lien on the property. See Minnie M. Coward, 39 B. T. A. 1158, and the cases there cited. It is not, however, a test of universal applicability.

There has been brought to our attention, and we can find, no general statute designating a specific time or act of a taxing official as establishing a lien against the property. There is no such provision in chapter 311, Laws of 1920. A later act (chapter 53, Laws of 1937, State of New York) did create a lien on the real estate “when the tax becomes due and payable”, and a still later act (chapter 631, Laws of 1938, State of New York) declared that “after December first next succeeding all taxes upon, real estate in the tax roll shall be due and payable and shall be and become liens on the real estate affected thereby, and shall be construed as and deemed to be charges thereon on December first of each year and not earlier * * *.”

In I. T. 3328, Internal Revenue Bulletin, 1939-49-10,051, in discussing the accrual date for real property taxes in the State of New York and in New York City, the Commissioner held as follows:

In view of the foregoing, it is held that under tbe general laws of the State of New York, real property taxes accrue, for Federal income taxi purposes, as of July 1 of eacb year. It appears, however, that the procedure for taw collection in some villages, towns, and, cities is governed l>y special legislation or 6y charter. The principles set fortli aboye do not necessarily apply in such eases. The determination of the accrual date of tases, for Federal income tax purposes, in such cases will depend upon the particular circumstances involved.
**#«■*#*
Likewise, the charter of the city of fflew York now under consideration provides that tames on real estate shall he construed as and deemed to he charged on the real estate on the respective days when they become due and payable “and not earlier.’’ The charter specifically provides that the tax for the six months’ period, January 1' to June 30, 1939, shall be due and payable on the 1st day of April, 1939. Accordingly, it is held that the taxes for such period accrued, for Federal income tax purposes, on April 1, 1939. The charter provides generally that taxes upon real estate .for each fiscal year shall be due and payable in two equal installments, the first due and payable on October 1, and the second due and payable on April 1.. Accordingly, it is held, with respect to the fiscal year beginning July 1, 1939, and subsequent fiscal years, that one-half of the real estate taxes accrues on October 1 and one-half accrued on April 1. [Emphasis supplied.]

The Supreme Court, in United States v. Anderson, 269 U. S. 422, stated:

* * * In a technical legal sense it may be argued that a tax does not accrue until it has been assessed and becomes due; but it is also true that in advance of the assessment of a tax, all the events may occur which fix the amount of the tax and determine the liability of the taxpayer to pay it. * * *

Although the quoted ruling of the Commissioner is subsequent in date to the taxable year and by its terms not controlling here, we believe the Commissioner suggests certain considerations which, in the light of the Anderson decision, are pertinent in the instant case. We have seen above, that by section 13 of chapter 311 of the statute governing tax procedure in Suffolk County, on or before the first day of December, unless otherwise fixed by the board of supervisors of the county, the board was obliged to annex to the assessment roll a warrant, commanding collection “from the several persons and on the property named and described” in the tax and assessment roll the* sums extended in such roll. The section further provided that “all taxes on the tax roll shall be due and payable on the date of the warrant annexed thereto.” The annexing of the warrant was the act of finality in the. tax procedure. It was, in our opinion, the event “which fixted] the amount of the tax and determine[d] the liability of the taxpayer to pay it.” (United States v. Anderson, supra.) It was thus the event which fixed the date of accrual of such taxes. The warrant in the instant case was dated November 26, 1934. Petitioner’s decedent died November 12, 1934. On that date the taxes had not accrued and hence were not deductible from gross income.

Decision will be entered for the respondent.