Opinion
Docket Nos. 7214 7215.
1947-03-19
MARION A. BLAKE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.VIRGINIA BLAKE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
V. H. Wehmeier, Esq., for the petitioners. Wesley A. Dierberger, Esq., and Frank M. Cavanaugh, Esq., for the respondent.
1. Under the facts, held that petitioners continuously retained ownership of certain real estate from 1925 onward. Various transactions subsequent to 1925 constituted purchase money mortgage arrangements and not a loss of the property.
2. Petitioners borrowed $125,000, secured by a first mortgage. The borrowed amount was all spent constructing buildings on the premises. Petitioners further spent $9,213.47 in painting and decorating the buildings after their construction. Petitioners from time to time purchased bonds on the open market at less than their face amount, which bonds were secured by the first mortgage. Petitioners retired the first mortgage indebtedness partly by payment of cash and partly by surrendering the bonds which they had purchased for less than face value. Held, petitioners' basis for depreciating the buildings is $125,000 plus $9,213.47; held, further, that the difference between the cost of the bonds to petitioners and their face value constituted income to petitioners as and when petitioners purchased the bonds.
3. Proper rate of depreciation determined. V. H. Wehmeier, Esq., for the petitioners. Wesley A. Dierberger, Esq., and Frank M. Cavanaugh, Esq., for the respondent.
Respondent determined deficiencies in petitioners' income tax liabilities and added penalties as follows:
+------------------------------------+ ¦ ¦ ¦ ¦Penalty¦ +----------+------+----------+-------¦ ¦Docket No.¦Year ¦Deficiency¦25% ¦ +----------+------+----------+-------¦ ¦ ¦( 1940¦$123.23 ¦$30,81 ¦ +----------+------+----------+-------¦ ¦7214 ¦ ¦ ¦ ¦ +----------+------+----------+-------¦ ¦ ¦( 1941¦478.28 ¦ ¦ +----------+------+----------+-------¦ ¦ ¦( 1940¦227.74 ¦56.94 ¦ +----------+------+----------+-------¦ ¦7215 ¦ ¦ ¦ ¦ +----------+------+----------+-------¦ ¦ ¦( 1941¦484.09 ¦ ¦ +------------------------------------+
By answers to amended petitioners filed at the hearing respondent asserted alternative increased deficiencies as follows:
+--------------------------------------+ ¦Docket No.¦Year ¦Deficiency¦Penalty ¦ +----------+------+----------+---------¦ ¦ ¦( 1940¦$6,913.44 ¦$1,669.00¦ +----------+------+----------+---------¦ ¦7214 ¦ ¦ ¦ ¦ +----------+------+----------+---------¦ ¦ ¦( 1941¦237.43 ¦ ¦ +----------+------+----------+---------¦ ¦ ¦( 1940¦7,347.20 ¦1,776.68 ¦ +----------+------+----------+---------¦ ¦7215 ¦ ¦ ¦ ¦ +----------+------+----------+---------¦ ¦ ¦( 1941¦240.48 ¦ ¦ +--------------------------------------+
The addition of penalties under section 291(a), Internal Revenue Code, is note disputed. The remaining questions are (a) whether petitioners are entitled to any depreciation allowance for the taxable years and, if so, on what basis and at what rate, and (b) did petitioners realize taxable income as a result of purchases at less than face value of bonds secured by a mortgage on the property with respect to which they were mortgagors. Petitioners filed their returns with the collector of internal revenue for the Michigan district at Detroit. The cases, which were consolidated at the hearing, were submitted on oral testimony and exhibits.
FINDINGS OF FACT.
Petitioners are husband and wife, residing in Detroit, Michigan. On August 20, 1925, petitioners, together with Charles O. Ellis and wife, purchased from John P. Vollrath certain unimproved real property in Detroit for the purpose of developing it as a housing property in Detroit for the purpose of developing it as a housing facility. The agreed purchase price was $104,390. Petitioners paid Vollrath $6,351 of the purchase price in cash, the remaining unpaid portion thereof being secured by a second mortgage on the premises. Ellis and wife were included in the conveyance in order to secure Ellis for his anticipated services in supervising the construction of the proposed housing project.
On the same date, August 20, 1925, petitioners, together with Ellis and wife, as mortgagors executed a first mortgage on the land purchased from Vollrath and on all improvements to be placed thereon. This first mortgage was in the face amount of $125,000 and was in favor of the United States Trust Co., later known as Equitable Trust Co., as mortgagee and trustee. Bonds in the same face amount as the first mortgage were issued and secured by such mortgage. The $125,000 thus obtained by petitioners was entirely expended for the construction of buildings on the property in question.
The buildings constructed on the property consisted of 73 houses, all but one of which were of frame type construction; the other was a cement brick store building. All of the buildings were completed early in 1926. Shortly after construction of these buildings was completed petitioners spent $9,213.47 for painting and decorating from their own personal funds. Sometime between 1930 and 1934 petitioners arranged to have gas piped into the houses at a cost of approximately $3,900, which amount was paid from rental income derived from the property involved.
Petitioners never paid Vollrath anything more than the initial cash payment of $6,351 on account of the purchase price of the property. At some time in 1927 Vollrath instituted foreclosure proceedings. Petitioners discussed the situation with Vollrath in an attempt to gain more time to complete their payment of the purchase price. As a result of this discussion an agreement was reached and the foreclosure proceedings were discontinued. Pursuant to this agreement petitioners, together with Ellis and wife, reconveyed the property to Vollrath by quitclaim deed dated December 13, 1927. On the same day and pursuant to the same agreement, Vollrath granted an option to petitioners, together with Ellis and wife, to purchase the property for $101,153 plus interest at 7 per cent from the date of such option. The option was to expire August 1, 1930. The intention of the parties in executing the quitclaim deed and option was to allow petitioners more time to arrange for payment of the remaining purchase price, which the option price was intended to represent, and at the same time obviate any foreclosure expense and delay to Vollrath in case of final default by petitioners. Petitioners remained in possession and exercised managerial control of the property at all times material hereto.
The option granted by Vollrath in 1927 was never exercised by petitioners or Ellis and wife. In 1930 and sometime prior to August of that year, petitioners compensated Ellis to the latter's satisfaction for his efforts in connection with supervising the construction of the buildings on the property in question. Ellis thereupon assigned his interest in the option to petitioners. Petitioner Virginia Blake assigned her interest in the option to petitioner Marion Blake. On August 1, 1930, the expiration date of the original option, Vollrath granted to petitioner Marion Blake a new option to purchase the property, which option extended to August 1, 1935. Vollrath, the first party, extended to petitioner Marion Blake, the second party:
1. * * * an option to purchase any one or more of the following described lots,
whenever he desires until August 1, 1935, on the following terms and conditions:
(a) If the lot on which the option is to be exercised has been sold on land contract, the second party will pay to the first party one-half (1/2) of the principal balance due as of the date hereof on such land contract over and above the principal balance due on the said trust mortgage on said lot.
(b) If the lot on which the option is to be exercised is hereafter sold, the second party will pay to the first party one-half (1/2) of the selling price of said lot over and above the principal balance due on the said mortgage on said lots as of the date of such sale.
(c) The payment of Five Hundred ($500.00) Dollars to the first party of any lot not sold to any third person.
Petitioner Marion Blake never exercised this option granted by Vollrath in 1930. Sometime in 1934 petitioners and Vollrath entered into a new agreement, pursuant to which Vollrath quitclaimed to petitioners a one-half interest in the property in consideration of petitioners continuing to operate and manage the property and attempting to work off the first mortgage and otherwise liquidating the property and sharing any profits therefrom equally with Vollrath. This quitclaim deed was dated October 5, 1934. No profits were realized or shared under this agreement.
Sometime in 1939 petitioners offered Vollrath cash for his, Vollrath's, remaining one-half interest in the property. Before any agreement was reached on account of such offer petitioners went to Florida on a trip. During petitioners' absence in Florida Vollrath conveyed his remaining one-half interest in the property to one Johnson in satisfaction of a debt. On petitioners' return from Florida Johnson contacted them and offered to sell them the property for $5,000. As a result of Johnson's offer petitioners paid him $5,000 cash and received from him a quitclaim deed for his one-half interest in the property, which deed was dated May 3, 1939. After May 3, 1939, petitioners held full title to the property subject to the first mortgage. In 1939 the lots constituting the property in question were worth $3,000 each. Of this amount $200 represented the value of the land and $2,800 represented the value of the buildings thereon.
From the date of the first mortgage petitioners turned over to the first mortgagee the rental income from the property and the proceeds of any sales thereof. Petitioners retained, out of such income, approximately $200 a month for themselves, with the consent of the first mortgagee. Petitioners lived in one of the 73 houses on the property, rent free. The first mortgage fell into default in 1930. On May 9, 1940, the first mortgage was reorganized by a supplemental agreement entered into between petitioners, as mortgagors, and the Equitable Trust Co., as mortgagee-trustee. This supplemental agreement referred to the original first mortgage and recognized that petitioners were the full title holders of the property involved. The supplemental agreement stated that there were then bonds, secured by the mortgage, outstanding in the face amount of $109,000, plus interest from February 20, 1930. The supplemental agreement canceled past due interest and reduced the rate for the future and extended the maturity of the bonds to August 20, 1948. Petitioners, at the time of executing the supplemental agreement, delivered to the mortgagee for cancellation bonds in the principal face amount of $10,000. In other essential respects the original first mortgage agreement remained in effect insofar as not inconsistent with the supplemental agreement.
From 1930 to 1942, inclusive, petitioners purchased bonds secured by the first mortgage from brokers on the open market. Petitioners purchased such bonds for the purpose of cancellation and retirement and not for the purpose of keeping them alive for reissue. Petitioners' bond purchases may be summarized as follows:
+-----------------------------+ ¦Year ¦Face ¦Amount ¦¦¦¦ +---------+------+---------+++¦ ¦purchased¦amount¦paid ¦¦¦¦ +---------+------+---------+++¦ ¦1930 ¦$5,500¦$2,000.00¦¦¦¦ +---------+------+---------+++¦ ¦1931 ¦9,400 ¦1,980.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1932 ¦18,300¦3,386.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1933 ¦10,700¦1,267.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1934 ¦None ¦None ¦¦¦¦ +---------+------+---------+++¦ ¦1935 ¦4,500 ¦900.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1936 ¦6,600 ¦1,410.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1937 ¦3,800 ¦1,320.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1938 ¦1,000 ¦3,285.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1939 ¦600 ¦245.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1940 ¦4,000 ¦1,640.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1941 ¦1,600 ¦1,575.00 ¦¦¦¦ +---------+------+---------+++¦ ¦1942 ¦5,100 ¦4,051.50 ¦¦¦¦ +---------+------+---------+++¦ ¦ ¦ ¦ ¦¦¦¦ +---------+------+---------+++¦ ¦Total ¦79,100¦23,059.50¦¦¦¦ +-----------------------------+
As indicated above, at the time the supplemental agreement was entered into, petitioners, as mortgagors, were indebted in the amount of $109,000. At the time of executing the supplemental agreement petitioners delivered to the mortgagee for cancellation bonds in the face amount of $10,000. During 1941 the mortgagee-trustee purchased bonds aggregating in principal face amount $2,700 at a cost of $1,514.03. From time to time petitioners delivered to the mortgagee-trustee for cancellation bonds in the total principal face amount of $29,700, which amount includes the $10,000 face amount of bonds delivered on execution of the supplemental agreement. On May 4, 1942, petitioners delivered to the mortgagee-trustee for cancellation bonds in the principal face amount of $49,400. On the same date petitioners paid the mortgagee-trustee $27,200 in cash, in addition to interest, trustee fees, and attorney fees in the respective amounts of $295.88, $823, and $400, which transaction completely satisfied the first mortgage indebtedness. These payments may be summarized as follows:
+-----------------------------------------------------------+ ¦Debt as of May 9, 1940 ¦ ¦$109,000¦ +------------------------------------------+-------+--------¦ ¦Bonds surrendered by petitioners ¦$79,100¦ ¦ +------------------------------------------+-------+--------¦ ¦Bonds purchased by first mortgagee-trustee¦2,700 ¦ ¦ +------------------------------------------+-------+--------¦ ¦Cash paid by petitioners ¦27,200 ¦ ¦ +------------------------------------------+-------+--------¦ ¦ ¦_ ¦109,000 ¦ +-----------------------------------------------------------+
Petitioners filed no income tax returns from 1935 to 1939, inclusive. Petitioners' returns for the taxable year 1940 were not filed until February 1942. Petitioners in their returns for 1940 each reported as net income from the property in question the amount of $1,549.98. In arriving at this figure depreciation was taken on 67 houses on a cost basis of $2,000 each at the rate of 5 per cent, or a total depreciation of $6,700, each petitioner taking one-half thereof, or $3,350. Petitioners' returns for 1941 were timely filed. The returns for 1941 accorded the same treatment to depreciation as was accorded it in the 1940 returns.
In arriving at the amount of ‘Other Income‘ reported as item 11 on each of petitioners' returns for 1940, the difference between the face amount and the amounts actually paid by petitioners and the mortgagee-trustee for the mortgage bonds was recognized and treated as income. Schedule L, attached to each of petitioners' returns for 1940, contains the following statement:
+-----------------------------------------------------------------------------+ ¦Income from purchase of mortgage bonds of taxpayer and spouse: ¦ ¦ +------------------------------------------------------------------+----------¦ ¦Principal amount ¦$3,500.00 ¦ +------------------------------------------------------------------+----------¦ ¦Cost ¦1,435.00 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦_ ¦ +------------------------------------------------------------------+----------¦ ¦Total ¦$2,065.00 ¦ +------------------------------------------------------------------+----------¦ ¦Income to taxpayer—1/2 of total ¦$1,032.50 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦_ ¦ +------------------------------------------------------------------+----------¦ ¦Income from cancellation of mortgage bonds of taxpayer and spouse ¦ ¦ ¦out of sinking fund on 11-13-40: ¦ ¦ +------------------------------------------------------------------+----------¦ ¦Principal ¦$12,000.00¦ +------------------------------------------------------------------+----------¦ ¦Interest accrued 8-20-40 to 11-13-40 at 3% ¦83.00 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦_ ¦ +------------------------------------------------------------------+----------¦ ¦ ¦$12,083.00¦ +------------------------------------------------------------------+----------¦ ¦Amounts paid by trustee for above bonds ¦4,800.00 ¦ +------------------------------------------------------------------+----------¦ ¦ ¦_ ¦ +------------------------------------------------------------------+----------¦ ¦Total ¦$7,283.00 ¦ +------------------------------------------------------------------+----------¦ ¦Income to taxpayer—1/2 of total ¦$3,641.50 ¦ +-----------------------------------------------------------------------------+
Schedule I, attached to petitioners' returns for 1941, in arriving at income reported as item 9 on such returns, recognized and treated as income the difference between the face amount and the amounts actually paid by petitioners and the mortgagee-trustee for bonds. These schedules presented the matter as follows:
+-----------------------------------------------------------------------------+ ¦Income form cancellation of mortgage bonds of taxpayer and spouse ¦ ¦ ¦out of sinking fund in July 1941: ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Principal amount canceled ¦$9,900.00¦ +-------------------------------------------------------------------+---------¦ ¦Interest accrued 2-20-41 to 7-20-41 at 3% ¦44.50 ¦ +-------------------------------------------------------------------+---------¦ ¦ ¦_ ¦ +-------------------------------------------------------------------+---------¦ ¦ ¦$9,944.50¦ +-------------------------------------------------------------------+---------¦ ¦Amount paid by trustee for above bonds ¦5,929.67 ¦ +-------------------------------------------------------------------+---------¦ ¦ ¦_ ¦ +-------------------------------------------------------------------+---------¦ ¦Total ¦$4,014.83¦ +-------------------------------------------------------------------+---------¦ ¦Income to taxpayer—1/2 of total ¦$2,006.41¦ +-------------------------------------------------------------------+---------¦ ¦ ¦_ ¦ +-------------------------------------------------------------------+---------¦ ¦Income from purchase of mortgage bonds of taxpayer and spouse: ¦ ¦ +-------------------------------------------------------------------+---------¦ ¦Principal ¦$100.00 ¦ +-------------------------------------------------------------------+---------¦ ¦Cost ¦75.00 ¦ +-------------------------------------------------------------------+---------¦ ¦ ¦_ ¦ +-------------------------------------------------------------------+---------¦ ¦Total ¦$25.00 ¦ +-------------------------------------------------------------------+---------¦ ¦Income to taxpayer—1/2 of total ¦$12.50 ¦ +-------------------------------------------------------------------+---------¦ ¦Net other income ¦* ¦ ¦ ¦$2,019.91¦ +-----------------------------------------------------------------------------+ FN* This figure apparently results from mathematical error and should be $2,018.91.
Respondent in his notices of deficiency increased the income reported by each petitioner by the amount of $3,350 for each of the years 1940 and 1941. This increase resulted from a disallowance of the depreciation claimed in these years by petitioners. In explanation respondent stated:
The deduction for depreciation in the amount of $3,350.00 claimed in connection with certain of your rental properties has been disallowed in full since it appears that your cost basis on such property was fully recovered through deduction for depreciation allowed prior to the taxable year 1940.
By answers to the amended petitions respondent asserts an alternative deficiency in the event this Court determines that the principal amount due at the time of the supplemental agreement of May 9, 1940, is a part of petitioners' cost basis. The amounts of these alternative deficiency determinations have been stated above in the introductory paragraph.
The buildings, 73 in number, cost petitioners $134,213.47, and the land cost petitioners $11,351. Petitioners claimed depreciation deduction on only 67 buildings for the taxable years before us.
OPINION.
HILL, Judge:
Respondent argues that petitioners lost the property in 1927 when they quitclaimed it to Vollrath and that they then might have taken a loss for income tax purposes. Respondent further argues that petitioners reacquired one-half interest in the property in 1934 from Vollrath without the payment of any consideration in money or its equivalent and that therefore petitioners have no cost basis with respect to such one-half interest. Respondent admits that petitioners paid $5,000 to Johnson in 1939 for the remaining one-half interest, but claims that the record affords no basis for allocating any portion of this amount to the buildings. Respondent denies that any basis for the property in petitioners' hands arose on account of the $125,000 borrowed by petitioners and spent by them in constructing the buildings. Alternatively, respondent contends that if the money borrowed does in any way give rise to such basis, such basis should not exceed the actual cost to petitioners of satisfying the face amount of the indebtedness.
Petitioners, on the other hand, contend that there was no loss of the property by them in 1927 or at any other time, but that they retained ownership continuously from 1925. Petitioners in this connection take the position that the quitclaim and option transactions merely constituted a form of mortgage security as to Vollrath, under which arrangement petitioners retained ownership. From this view of the facts petitioners argue that the basis of the property for depreciation purposes is $125,000, being the amount borrowed by them and spent in constructing the buildings, plus the $9,213.47 paid by them for painting and decorating the buildings. Alternatively, petitioners contend that, if it be held that they lost and reacquired the property as contended by respondent, then, in that event, the face amount of the mortgage at the time of reacquisition plus any other considerations actually paid at the time of such reacquisition and properly allocable to the buildings constitute their basis for depreciation purposes.
Realism impels us to hold that petitioners never lost their interest in the property involved from the time of its original purchase in 1925 through the taxable years before us, notwithstanding the subsequent transactions among petitioners, Vollrath, and Johnson, or the reorganization or renewal of the first mortgage.
A brief statement of the history of the transactions is considered appropriate. The original purchase price as agreed upon between petitioners and Vollrath was $104,390, of which only $6,351 was paid. The property was unimproved at the time of purchase. The purchase agreement contemplated that petitioners would improve the property as a housing facility. To enable petitioners to finance such improvement, Vollrath took a mortgage on the property for the balance of the purchase price, subject to a first mortgage on the property for the balance of the purchase price, subject to a first mortgage given by petitioners to secure a loan of $125,000. With the money secured on the first mortgage petitioners completed 73 houses on the property early in 1926. Petitioners also expended an additional amount of $9,213.47 for painting and decorating the buildings. It is obvious, we think, that Vollrath and petitioners recognized dependence on the success of the housing development for payment of both the first and second mortgages.
In 1927 petitioners were in default in their payments of the purchase price. In that year Vollrath instituted foreclosure proceedings on his purchase price mortgage because of such default. Following discussions between the parties an agreement was reached whereunder Vollrath granted petitioners more time for making the purchase payments. Under this agreement the foreclosure proceedings were discontinued, petitioners and Ellis and wife gave Vollrath a quitclaim deed to the property and took an option back to purchase the property for an amount intended to approximate the unpaid balance due on the original agreement of purchase, to wit, $101,153. By this option the time for the payment of the price originally agreed upon was extended to August 1, 1930. Petitioners never exercised the option, but remained in possession and control of the property during the period of the option and made payments on their first mortgage indebtedness out of income and sale proceeds from the property.
It is apparent from the record and the facts found that this latter arrangement did not, and was not intended to, terminate petitioners' interest in the property acquired under the original purchase agreement, but that it was made for the purpose (1) to give petitioners more time in which to make payments of the purchase price and (2) to obviate the delay and expense of foreclosure proceedings in the event of final default by petitioners.
At the expiration date of the option, August 1, 1930, Vollrath gave petitioner Marion Blake a new option to purchase the property. Ellis and wife had dropped out of the picture. By this option the terms and method of payment of the purchase price were modified as set forth in our findings of fact. The expiration date of the new option was August 1, 1935. This option was not exercised, but petitioners continued in possession and control of the property and continued to make payments on their first mortgage indebtedness from the income and proceeds from the property.
In 1934 Vollrath and petitioners entered into an agreement which supplanted the last option agreement above described. Under this new agreement the original purchase price was converted from a definite figure to an equal share of the profits from the development project between Vollrath and petitioners upon the liquidation thereof and after payment of the first mortgage. Pursuant to such new agreement, Vollrath quitclaimed to petitioners a one-half interest in the property under date of October 5, 1934, and petitioners were to continue to operate, manage, and liquidate the property in an attempt to pay off the first mortgage and thereafter to pay over to Vollrath one-half of the remaining profits, if any. No profits were realized under this agreement.
Under the terms of this last agreement, as well as in all the recited intermediate transactions between the parties following the original purchase agreement, a continuing interest of the petitioners in the property was recognized by Vollrath.
In 1939 Vollrath conveyed to one Johnson the remaining one-half of the property involved and petitioners paid Johnson $5,000 for a quitclaim deed to such one-half interest. Thereafter petitioners held full title to the property subject to the first mortgage.
These transactions, when considered realistically and in their entirety, amount to a purchase of the land by petitioners from Vollrath and the construction of a housing project by petitioners with money borrowed by them and secured by a first mortgage on the premises. Despite the various forms into which petitioners' relationship with Vollrath was cast, the basic character of that relationship remained constant and consisted of a purchase money mortgagor-mortgagee relationship, with petitioners as the vendees and Vollrath as the vendor of the land.
In this view of the transactions, petitioners, paid $11,351 for the land. This amount is made up of the $6,351 paid to Vollrath in cash in 1925 and the $5,000 paid by petitioners to Johnson in 1939. None of the $5,000 paid Johnson is attributable to the buildings, because we consider the so-called one-half interest acquired from Johnson as in the nature of a mortgage, which mortgage, despite the fact it may have in part covered the buildings, arose from and secured petitioners' indebtedness to Vollrath for the land. Petitioners do not contend otherwise.
The cost to petitioners of the buildings amounts to $134,213.47, consisting of the amount of $125,000 borrowed on the first mortgage and spent in construction, and the amount of $9,213.47 spent for painting and decorating the buildings shortly after their construction. On brief, petitioners do not claim that the $3,900 spent in piping gas to the buildings should be included in depreciable basis. The amount of $134,213.47 represents actual cost of the buildings to petitioners and we hold that this amount constitutes petitioners' original basis for depreciation. Respondent's attempt to exclude the $125,000 from basis, or at least to limit the basis on account of such sum to the actual cost to petitioners of retiring their indebtedness, therefore is based on a failure to distinguish between actual cost of constructing the buildings, on the one hand, and the retirement of an indebtedness for less than par, on the other. In this connection it is significant that petitioners' indebtedness was not owing to the building contractors. The building contractors had already been paid in full. The subsequent satisfaction of this indebtedness therefore did not reduce cost, but constituted a satisfaction of indebtedness for less than par, resulting in income to petitioners, which aspect will be discussed below.
The first mortgage was renewed on May 9, 1940, by agreement entered into between petitioners, the mortgagors, and the Equitable Trust Co., as mortgagee-trustee. At the time of such renewal there were outstanding bonds secured by the mortgage in the face amount of $109,000, plus interest from February 20, 1930. In the renewal agreement past due interest was canceled, the interest rate reduced for the future, and the time of the maturity of the bonds extended to August 20, 1948. On May 4, 1942, the mortgage was completely paid and satisfied. The payments were made by application to the mortgage debt of $81,800 face amount of the mortgage bonds and the payment of $27,200 in cash by petitioners. The mortgage bonds had been purchased from brokers on the open market at a total cost of $24,573.53. We hold that the difference between the purchase price and the face amount of the bonds represented income to petitioners. United States v. Kirby Lumber Co., 284 U.S. 1; Helvering v. American Chicle Co., 291 U.S. 426; Lewis F. Jacobson, 6 T.C. 1048. We further hold that such income was realized as and when petitioners bought the bonds at less than face value and not when such bonds were surrendered to the trustee for cancellation. Central Paper co. v. Commissioner, 158 Fed.(2d) 131; Tennessee Consolidated Coal Co. v. Commissioner, 145 Fed.(2d) 631; Montana, Wyoming & Southern R. Co. v. Commissioner, 77 Fed.(2d) 1007; Garland Coal & Mining Co. v. Helvering, 75 Fed.(2d) 663; American Brake Shoe & Foundry Co. v. Interborough Rapid Transit Co., 19 Fed. Supp. 234.
Petitioners, in their returns, have taken depreciation on the buildings at the rate of 5 per cent. On brief petitioners contend that the rate is too high and should be 3 per cent. Respondent insists on a 5 per cent rate. We hold that 5 per cent is the proper rate of depreciation, since, in our opinion, petitioners have not furnished an adequate basis in the record for a lesser rate. It follows that petitioners are entitled to depreciation on account of the property in question for each of the taxable years 1940 and 1941 at the rate of 5 per cent on such part of petitioners' original cost basis of $134,213.47 as is properly allocable to the 67 buildings in respect of which petitioners took deductions for depreciation in such taxable years. The evidence of record does not enable us to determine the basis of such allocation. The parties may stipulate such basis for the computation under Rule 50; otherwise a further hearing will be necessary for the presentation of evidence as to such basis.
Reviewed by the Court.
Decisions will be entered under Rule 50. OPPER, J., dissenting: The present result seems to me irreconcilable in principle with Hilpert v. Commissioner (C.C.A., 5th Cir.), 151 Fed.(2d) 929. That decision, it is true, was a reversal of the Tax Court, but if we are now following the original view expressed in 4 T.C. 473, notwithstanding the reversal, I think we are at least compelled to say so.