Opinion
Docket No. 23608.
1951-09-27
NINA J. ENNIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Thomas J. Bailey, Esq., for the petitioner. Cyrus A. Newman, Esq., for the respondent.
A taxpayer reporting income on the cash receipts and disbursements basis sold property in 1945 in consideration of a down payment in cash and the vendee's contractual obligation to pay the balance of the purchase price in deferred payments extending over a period of years. The obligation was not evidenced by a note or some other evidence of indebtedness such as commonly change hands in commerce. Held, the contractual obligation was not the equivalent of cash, and the only amount realized by petitioner on the sale in 1945 was the sum of cash received. Thomas J. Bailey, Esq., for the petitioner. Cyrus A. Newman, Esq., for the respondent.
Respondent has determined deficiencies in petitioner's income tax for the calendar years 1944 and 1945 in the amounts of $803.79 and $4,104.17, respectively.
The sole issue is whether all or any part of the profit realized by the petitioner from the sale of a business property on August 1, 1945, is includible in her 1945 taxable income.
Petitioner does not contest the deficiency determined by the respondent for 1944, nor the deficiency for 1945 insofar as it relates to the respondent's increase of capital gain realized from the sale of certain stock.
All of the facts have been stipulated.
FINDINGS OF FACT.
Nina J. Ennis, the petitioner herein, is an individual with an address in care of Mr. Reginald Holbrook, 26 Michigan Theatre Arcade, Lansing, Michigan. Her individual income tax returns for the years 1944 and 1945 were filed with the collector of internal revenue for the district of Michigan.
On August 1, 1945, petitioner and her husband, Clarence W. Ennis, as joint owners of a business known as ‘Deer Head Inn,‘ as ‘first parties,‘ agreed to sell the business, including all equipment, furnishing, fixtures and real estate, to Paul and Blanche Figley, as ‘second parties,‘ for $70,000, with a down payment of $8,000. The contract of sale executed by the parties on August 1, 1945, provided in part as follows:
Second Parties, in consideration of the covenants herein made by First Parties agree to purchase of First Parties the above described business known as the ‘Deer Head Inn‘ and the above described fixtures, equipment, furnishings, property, chattels and premises, and to pay therefor to First Parties, or their legal representatives, at Lansing, Michigan, the sum of Seventy Thousand ($70,000.00) Dollars in manner and form as follows: vix: Eight Thousand ($8,000.00) Dollars upon the signing of these presents, receipt whereof is acknowledged by First Parties, Four Hundred ($400,00) Dollars or more on the first day of September, 1945, and Four Hundred ($400.00) Dollars or more on the first day of each and every month to and including the first day of August, A.D. 1946, said payments to be applied, first, on the interest, and the balance on the principal which shall be due from time to time; and beginning on September 1st, 1946, the sum of Six Thousand ($6,000.00) Dollars or more a year, or a sum equal to sixty percent (60 percent) of the annual net profits of the business now known as the Deer Head Inn after payment of Government Income Taxes, whichever sum is greater, said payments to be made as follows: Five Hundred ($500.00) Dollars or more on the first day of September, 1946, and Five Hundred ($500.00) Dollars or more on the first of each and every month thereafter until the full purchase price is paid, and, in the event that in its fiscal years of August 1st to July 31st the annual net profit of the business, after allowance for income tax, is greater than the sum of the monthly payments stipulated for the months in such fiscal years, then an additional payment on or before the 15th day of September of each and every year beginning September 15th, 1947, increasing the annual payment to the sixty percent (60 percent) of the annual net profits, after allowances for income tax as hereinbefore provided, all such payments to be applied, first, on the interest and the balance on the principal which may from time to time be due, with interest on the whole sum that shall be from time tp time unpaid at the rate of five percent (5 per cent) per annum to be computed from August 1st, 1945, and to be paid monthly. Principal or interest not paid when due shall bear interest until paid at the rate of five percent (5 percent) per annum.
Second Parties shall keep all buildings now on, or that may hereafter be placed on said premises, and all fixtures, equipment and furnishings in connection with said business insured in the name of and in manner and amount and by insurers approved by the First Parties and leave the policy or policies with First Parties, and in such case the insurance, unless by mutual agreement used to repair, rebuild or replace, shall be paid to First Parties and endorsed on this Contract to the extent of the amount unpaid thereon, and the balance, if any, shall belong and be paid to Second Parties.
Second Parties shall enter said business, fixtures, equipment and premises for taxation in their name, and shall well and faithfully pay when due all taxes and assessments, ordinary and extraordinary, that may for any purpose be levied or assessed on said business, fixtures, equipment or premises, and shall not commit or suffer any other party to commit any waste or damage to said business, fixtures, equipment, premises, or to the appurtenances. Should Second Parties fail to pay any tax or assessment when due, or to keep said business, fixtures, equipment and buildings insured, First Parties may pay the same and have the business, fixtures, equipment and buildings insured, and the amount thus expended shall be a lien on said business, fixtures, equipment and premises, be added to the amount then unpaid hereon, be due at once and bear interest until paid at the rate of five percent (5 percent) per annum.
First Parties further agree that upon the full performance by Second Parties of all the covenants and agreements by Second Parties to be performed, and upon the payment by Second Parties of the several sums of money above mentioned, and in the time and manner and at the place mentioned, that thereupon the First Parties shall execute and deliver to Second Parties a good and sufficient Bill of Sale of said business, fixtures, equipment and chattels, and a good and sufficient Abstract and Warranty Deed of the premises, thereby conveying to Second Parties the business, fixtures, equipment and premises above described free and clear of all incumbrances, except taxes after the date hereof, and claims and liens thereon due to any act or neglect of Second Parties.
The business, fixtures, equipment and chattels now in the premises, and any additional fixtures, equipment or chattels, which may be placed on the premises, and all buildings and improvements now on, or that shall be placed or made on said premises, shall remain as security for the performance by Second Parties of this Contract, and the title, ownership and right of possession in and to said fixtures, equipment and chattels shall remain in the First Parties until the full consideration stated is fully paid and the title to said premises shall remain in First Parties until the full consideration herein stated is fully paid, and should default be made and this Contract be forfeited, said business, fixtures, equipment and chattels and said premises and the buildings and improvements and all payments made on said contract shall be forfeited to First Parties as stipulated damages for non-performance of this Contract, or First Parties may at their option declare all sums unpaid immediately due and payable, and enforce the collection thereof at law and make conveyance as aforesaid.
First Parties may at their option elect to enforce said Contract and their right to repossession of the business, fixtures, equipment and chattels covered hereby in any Court of law or equity, and may additionally through summary proceedings for the recovery of land, as in the statute made and provided, secure repossession of the real estate herein described through action before one of the Circuit Court Commissioners having jurisdiction thereof.
Second Parties shall not assign or transfer this Contract, nor shall they sell the business, the fixtures, equipment and chattels in connection therewith, nor shall they lease or sublet said premises or the buildings thereon, or any part thereof, nor shall they transfer or contract to sell or transfer any part of the premises thereof, the same being hereby declared as integral with and necessary to the conduct of the business, nor shall Second Parties add to or change said business, fixtures, equipment of buildings without the previous written assent of First Parties hereto endorsed hereon.
It is further mutually agreed that Second Parties may take possession of said business, fixtures, equipment and premises immediately and remain thereon as long as they shall perform all covenants and agreements herein mentioned on their part to be performed and no longer; and that if Second Parties shall at any time hereafter violate or neglect to fulfill any of said covenants or agreements they shall forfeit all right or claim under this Contract, shall relinquish possession of the business, fixtures and equipment, and be liable to be removed from said premises in the same manner as provided by law for the removal of a tenant that holds over premises contrary to the terms of his lease, and notice to quit and of forfeiture are each hereby waived. And it shall be lawful for First Parties at any time after such default to sell and convey said business, fixtures and equipment and said premises, or any part thereof, to any person without becoming liable to refund any part of the money received on this Contract or for any damages on account of such sale.
And it is hereby expressly understood and agreed that time shall be deemed as the very essence of this Contract, and that unless the same shall in all respects be complied with by Second Parties at the respective times and in the manner above specified, that Second Parties shall lose and be debarred from all rights, remedies and actions, both at law and in equity, upon or under this Contract.
The balance due to the petitioner and her husband under the contract at the end of 1945 was $57,446.41. The adjusted basis of the property in the hands of the petitioner and her husband was $26,514.69, resulting in a profit of $43,485.31. The petitioner's share of the profits from the sale was $21,742.66.
The business of the Deer Head Inn was that of a Class ‘C‘ liquor establishment licensed by the Michigan Liquor Control Commission under the laws of the State of Michigan. The Michigan Liquor Control Commission approved the transfer of the license in 1945 to the Figleys, and thereafter each year has granted licenses to the Figleys.
The petitioner did not report the sale nor any profit thereon in her 1945 income tax return. In 1947, the adjusted basis of the property was recovered. In her income tax returns for 1947 and subsequent years, the petitioner reported her proportionate share of the profit recovered in each year.
The petitioner filed her returns on the cash receipts and disbursements basis of accounting in the years here involved.
Respondent, in the notice of deficiency, made the following determination:
Under the provisions of Section 117 of the Internal Revenue Code, it is held that you realized a long-term capital gain in the taxable year 1945, $10,871.33 resulting from sale of the business known as Deer Head Inn.
The contractual obligation to pay the balance of the purchase price in deferred payments over a period of years was not the equivalent of cash. The only amount realized on the sale of the property in 1945 was the sum of cash received as a down payment. Since this sum was not in excess of petitioner's basis no gain was realized on the sale in 1945.
OPINION.
ARUNDELL, Judge:
Respondent has increased petitioner's income for the calendar year 1945 by the sum of $10,871.33 on the ground that the petitioner, who reported her income on the cash receipts method, was required under sections 42, 111(a), and 111(b) of the Internal Revenue Code,
to include in her 1945 income the full amount of her one-half interest in the profit realized from the sale of the Deer Head Inn. See also Regulations 111, section 29.41-1.
SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.(a) GENERAL RULE.— The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. * * *SEC. 111. DETERMINATION OF AMOUNT OF, AND RECOGNITION OF, GAIN OR LOSS.(a) COMPUTATION OF GAIN OR LOSS.— The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in section 113(b) for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining loss over the amount realized.(b) AMOUNT REALIZED.— The amount realized from the sale or other disposition of property shall the sum of any money received plus the fair market value of the property (other than money) received.
Respondent contends that since the sale is a completed transaction in 1945 the entire profit on the sale is taxable in that year.
Regulations 111:SEC. 29.41-1. COMPUTATION OF NET INCOME.— Net income must be computed with respect to a fixed period. Usually that period is 12 months and is known as the taxable year. Items if income and of expenditure which as gross income and deductions are elements in the computation of net income need not be in the form of cash. It is sufficient that such items, if otherwise properly included in the computation, can be valued in terms of money. The time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer's income. * * *
We agree that in every practical way the sale was complete in 1945. In that year the vendee went into possession of the property and at the same time assumed all the burdens and benefits of ownership. The purchase price was definitely fixed and the vendee was under an unconditional obligation to pay it under the terms set forth in the contract. Nibley-Mimnaugh Lumber Co., 26 B.T.A. 978, affd. 70 F.2d 843; Union Pacific Railroad Co., 32 B.T.A. 383, affd. 86 F.2d 637.
It does not follow, however, that the entire purchase price in excess of the basis constituted gain taxable in the year 1945. Since petitioner reported her income on the cash receipts and disbursements basis she realized gain from the sale of property only to the extent that the ‘amount realized‘ therefrom is in excess of her basis. Section 111(a). Section 111(b) of the Internal Revenue Code provides that the ‘amount realized‘ shall be ‘any money received plus the fair market value of the property (other than money) received.‘
Upon the sale petitioner received as a down payment a sum of cash not in excess of her basis for the property, plus the vendee's contractual obligation to pay the balance of the purchase price in deferred payments extending beyond the year in question. This contractual obligation cannot be considered an ‘amount realized‘ unless it is the equivalent of cash. In John B. Atkins, 9 B.T.A. 140, we stated: ‘ * * * in the case of one reporting income on the receipts and disbursements basis only cash or its equivalent constitutes income.‘ This basic rule has been consistently followed. Charles C. Ruprecht, 16 B.T.A. 919; Dudley T. Humphrey, 32 B.T.A. 280; C. W. Titus, Inc., 33 B.T.A. 928; Alice G. K. Kleberg, 43 B.T.A. 277; Nibley-Mimnaugh Lumber Co., supra; Perry v. Commissioner, 152 F.2d 183.
In determining what obligations are the ‘equivalent of cash‘ the requirement has always been that the obligation, like money, be freely and easily negotiable so that it readily passes from hand to hand in commerce. See Dudley T. Humphrey, supra, wherein we held that nonnegotiable promissory notes are not the equivalent of cash and cf. S. L. Meyer, Executor, 23 B.T.A. 1201; Harold W. Johnston, 14 T.C. 560; C. W. Titus, supra; Perry v. Commissioner, supra. This principle was recently reiterated in the Johnston case wherein we held that a cash basis taxpayer realizes no income when he receives upon the sale of property a promise to pay contained in a contract of sale that ‘merely requires future payments and no notes, mortgages, or other evidence of indebtedness such as commonly change hands in commerce, which could be recognized as the equivalent of cash to some extent, are given and accepted as part of the purchase price.‘
In the case before us the promise to pay was merely contractual; it was not embodied in a note or other evidence of indebtedness possessing the element of negotiability and freely transferable. It is true that the contract possessed many elements of a mortgage, Corpus Juris, vol. 66, sec. 1080, p. 128; Tiffany, Real Property, 3d ed., vol. 1, sec. 308, p. 535; Corpus Juris Secundum, vol. 59, sec. 9-11, pp. 33-42; Qualls v. Union Cont. Life Ins. Co., 7 So.2d 558, but this characteristic does not lend to the contract the necessary element of negotiability. Cf. Bernard Realty Co. v. United States, 188 F.2d 861.
We conclude, therefore, that the contractual obligation was not the ‘equivalent of cash,‘ and the only ‘amount realized‘ by petitioner on the sale of the property in 1945 was the sum of cash received. Since this sum was not in excess of petitioner's basis for that property no gain was realized on the sale in 1945.
Reviewed by the Court.
Decision will be entered under Rule 50. TURNER, J., dissenting: I am unable to reconcile the conclusions reached in this case with the contrary ruling which has long been settled law in cases where a vendor of real estate, in addition to the simple individual liability to pay, receives as further security a mortgage on the property sold. While there are form and technical differences in the two types of transactions, they are for practical purposes substantially similar. In each instance, the vendee is regarded as the owner of the real estate, and in each instance, the land may be sold, devised, or encumbered by him, and on his death, descends to his heirs subject only to the mortgage or land contract. In the case of land contracts, see on this point Bowen v. Lansing, 219 Mich. 117, 88 N.W. 384. The purpose of both the land contract and the mortgage is to secure payment of the balance remaining of the simple or personal obligation to pay. For a land contract case, see Walker v. Casgrain, 101 Mich. 604, 60 N.W. 291. It is true that in the land contract cases there is not transfer of legal title until full payment is made, but the vendor holds legal title in trust for the purchaser pending such full payment. Hooper v. Van Husen, 105 Mich. 592, 63 N.W. 522; City of Marquette v. Michigan Iron & Land Co., 132 Mich. 130, 92 N.W. 934. For other cases which seem to establish the similarity in over-all effect between mortgages and land contracts, see Harold R. Smith, 39 B.T.A. 892; Title & Trust Co., 33 B.T.A. 25; Barnard v. Huff, 252 Mich. 258, 233 N.W. 213; Chicago Boulevard Land Co. v. Apartment Garages, 245 Mich. 448, 222 N.W. 697; and Conners v. Winans, 122 Misc. 824, 204 N.Y.S. 142. And finally, both mortgages and land contracts are regularly sold, traded and assigned. Probably the most noticeable difference between the two is geographic. In Michigan, for instance, the use of the land contract, rather than the mortgage, appears to be the method commonly followed in making real estate sales. We should where possible avoid one rule of law for one part of the country and a different rule for other sections.
Harold W. Johnston, supra, relied on by the Court herein, is in my opinion an entirely different case. There the property sold was corporate stock and the selling price had not even been and could not be fixed and determined in 1942, the taxable year. Furthermore, the discussion therein as to property received would, it seems to me, bring this case more nearly in line with the land mortgage cases than otherwise.