Opinion
Docket Nos. 815 834.
1944-11-28
MAIN PROPERTIES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.SOUTHERN LOAN & INVESTMENT COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
George W. Rice, Esq., and Charles H. Draper, Esq., for the petitioners. Samuel G. Winstead, Jr., Esq., and Frank B. Schlosser, Esq., for the respondent.
1. Where a taxpayer on the cash basis purchased stock in a prior year and gave its note to the seller for the purchase price, and both purchaser and seller agreed that at any time prior to the payment of the note either party might rescind, and in later years prior to the taxable year the taxpayer received $1,900 liquidating dividends on the stock and then the stock became worthless and the taxpayer took a deduction on account thereof in its income tax return but received no tax benefit therefrom, and in the taxable year 1938 the taxpayer elected to rescind and returned the stock to the seller, who in turn returned the note to the taxpayer, held, the taxpayer realized no taxable gain on the transaction except the liquidating dividend which it received in years prior to the redelivery of the stock and did not pay over with the stock but reported for taxation.
2. Where a taxpayer on the cash basis for value received obligated itself to purchase certain corporation bonds held by an individual and to extend that individual or any of his companies a line of credit, and one of such companies obtained a loan from a bank by executing a promissory note, endorsed by the individual, secured by the bonds, and guaranteed by the taxpayer, and in the taxable year the taxpayer made the final payment for the bonds under its guaranty, and the bonds were then worthless and the final payment was used to liquidate the note, held, the taxpayer sustained a deductible loss in the taxable year in the amount of the final payment made for the then worthless bonds.
3. The fair market value of a building and leaseholds received in exchange for certain bonds in the taxable year 1939 is found from the evidence for the purpose of determining the amount of gain realized or loss sustained on the exchange.
4. Where a corporation's personal holding company income for the taxable year 1939 was less than 80 per centum of its gross income for that year, held, the corporation was not a personal holding company within the definition contained in section 501(a) of the Internal Revenue Code.
5. Where a taxpayer exchanged a building and leaseholds for some of its own bonds, which it canceled, and the evidence shows that the taxpayer was insolvent both before and after the exchange, held, the taxpayer realized no taxable gain on the exchange. Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 Fed.(2d) 95, followed; Lutz & Schramm Co., 1 T.C. 682, distinguished. George W. Rice, Esq., and Charles H. Draper, Esq., for the petitioners. Samuel G. Winstead, Jr., Esq., and Frank B. Schlosser, Esq., for the respondent.
These proceedings were consolidated. In Docket No. 815, the respondent determined deficiencies in income tax and declared value excess profits tax against Main Properties, Inc. (hereinafter sometimes referred to as ‘main‘) for the fiscal year ended November 30, 1939, in the amounts of $43,987.05 and $36,352.94, respectively. In Docket No. 834 the respondent determined deficiencies in income tax and declared value excess profits tax against the Southern Loan & Investment Co. (hereinafter sometimes referred to as ‘southern‘) for the calendar years 1938 and 1939 in amounts as follows:
+--+ ¦¦¦¦ +--+
Excess profits Year Income tax tax 1938 $17,870.30 $5,934.25 1939 18,888.32
By amended pleadings in Docket No. 834 the respondent affirmatively alleges that the deficiency of $18,888.32 determined for 1939 is understated and that the correct deficiency in income tax and penalty for that year is $161,120.76, determined as follows:
+-----------------------------------------------------------------------------+ ¦Deficiency in income tax ¦$1,331.81 ¦ +------------------------------------------------------------------+----------¦ ¦Deficiency in income or surtax under section 401 of the Revenue ¦ ¦ ¦Act ¦ ¦ +------------------------------------------------------------------+----------¦ ¦of 1938 and corresponding provisions of the Internal Revenue Code ¦128,131.16¦ +------------------------------------------------------------------+----------¦ ¦25% delinquency penalty ¦31,657.79 ¦ +------------------------------------------------------------------+----------¦ ¦Total additional income tax and penalty ¦161,120.76¦ +-----------------------------------------------------------------------------+
This affirmative allegation, which raises the issue as to whether Southern is liable for the personal holding company surtax and penalty for the year 1939, is treated by the parties as issue No. 4, and it will be so considered.
In an amended petition filed in Docket No. 834, Southern alleges that it overpaid its taxes for the year 1939 and requests that this Court determine the amount of the overpayment.
In a statement attached to the deficiency notice in Docket No. 815 the respondent made adjustments to the net income of Main for the fiscal year ended November 30, 1939, together with explanations thereof as follows:
+-----------------------------------------------------------------------+ ¦Net income as disclosed by return (loss) ¦ ¦$(140,121.67)¦ +---------------------------------------------+-----------+-------------¦ ¦Unallowable deductions and additional income:¦ ¦ ¦ +---------------------------------------------+-----------+-------------¦ ¦(a) Gain from sale of Chronicle Building ¦$427,817.98¦ ¦ +---------------------------------------------+-----------+-------------¦ ¦(b) Depreciation ¦2,229.10 ¦ ¦ +---------------------------------------------+-----------+-------------¦ ¦(c) Interest ¦13,015.75 ¦443,062.83 ¦ +---------------------------------------------+-----------+-------------¦ ¦Net income adjusted ¦ ¦$302,941.16 ¦ +-----------------------------------------------------------------------+
Explanation of Adjustments
(a) The transfer by you in the taxable year of the Chronicle Building leasehold having a basis of $212,182.02 in exchange for the surrender and cancellation of $640,000 principal amount of your own outstanding bonds is held to have been a transaction in which you realized a taxable gain of $427,817.98. It is held further that you were at all times during the taxable year solvent.
(b) and (c) These amounts represent adjustments which you have accepted * * * .
By an appropriate assignment of error Main contests adjustment (a). The issue thus raised is treated by the parties as issue No. 5, and it will be so considered.
In a statement attached to the deficiency notice in Docket No. 834 the respondent made several adjustments to the net income of Southern for the calendar years 1938 and 1939, some of which are contested by appropriate assignments of error and some of which are not contested. The issues thus raised by the contested adjustment are as follows:
Issue No. 1.— Did the respondent err in holding that the cancellation and delivery to Southern in 1938 of Southern's note for $20,000 payable to one J. E. Josey was a transaction from which Southern realized taxable income in the amount of $20,000?
Issue No. 2.— Is Southern entitled to a deduction of $75,000 from gross income of the year 1938 for a loss arising out of transactions entered into with one J. W. Colvin prior to that year?
Issue No. 3.— Did the exchange on June 1, 1939, by Southern of Main bonds costing $260,256.72 for the Chronicle Building and leaseholds result in taxable capital gain or deductible capital loss to Southern, and, if so, how much?
The respondent now concedes that the net income of Southern for the year 1938 should be reduced by $1,500 representing a recovery of a bad debt from Stallones & Bobo, Inc. The respondent also concedes that Southern, on Form 972, ‘Consent of Shareholder to Include Specific Amount in Gross Income Under Section 28 of the Revenue Act of 1938,‘ dated February 9, 1943, filed its consent to include as income for the taxable year 1939 the amount of $53,891.75 consent dividends from its wholly owned subsidiary, S.L.I. Corporation. Effect will be given to these concessions under Rule 50.
FINDINGS OF FACT.
Many of the facts have been stipulated. The stipulation is incorporated herein by reference.
In general.— Petitioners are corporations organized under the laws of the State of Texas, with their principal places of business in Houston, Texas. Main was dissolved by the Secretary of State of Texas on February 10, 1942. Both corporations will continue in existence for three years after their respective dissolutions for the purpose of settling their affairs. The income and excess profits tax returns of petitioners for the periods here involved were filed with the collector for the first district of Texas. Southern did not file for the year 1939 any return on Form 1120H as a personal holding company. Throughout 1939 the capital stock of Main was owned by the Realty Management Co., and the capital stock of Southern was owned by John T. Jones.
Main kept its books and filed its Federal income tax returns on the accrual basis of accounting. Southern kept its books and filed its income tax returns on the cash receipts and disbursements basis.
Southern filed a timely income and excess profits tax return for the table year 1939 showing taxable net income of $8,329.44 and income tax of $156.18, which it paid when due in 1940. Southern filed an amended income and excess profits tax return for the taxable year 1939 showing amended taxable net income of $53,329.44 and amended income tax of $2,653.14, and paid additional income tax of $2,496.96 in 1941. On November 28, 1‘42, respondent mailed the deficiency notice to Southern, claiming an amended net income of $144,974.50 and amended income tax of $21,541.46, or deficiency in income tax of $18,888.32. On February 26, 1943, Southern filed with the Tax Court a petition for redetermination of the above deficiency.
Issue No. 1.— One of the adjustments to net income of Southern for the year 1938 was an addition thereto of $20,000, which the respondent called ‘(d) Gain through cancellation of indebtedness‘ and explained as follows:
(d) It is held that the cancellation and delivery to you of your note for $20,000 payable to J. E. Josey was a transaction from which you realized taxable income to the amount of such note.
On September 4, 1929, Southern gave its demand note for $20,000 to one J. E. Josey of Houston, Texas, and received therefor 1,000 shares of the capital stock of the National Standard Fire Insurance Co. of Houston, Texas, hereinafter sometimes referred to as ‘National.‘ At the time of the purchase there was an oral agreement between the parties that at any time before the note was paid Southern could redeliver the stock to Josey, who would thereupon cancel the note, or Josey could turn the note back to Southern and recapture the stock. On its income tax return for the taxable year ended December 31, 1933, Southern reported liquidating dividends of $900 on the stock, and charged off $17,190 as a loss from the worthless stock of National. In the taxable year ended December 31, 1933, Southern was included in a consolidated income tax return filed by its parent company, Jesse H. Jones Co., which return showed a net loss of $3,373,771.68. Of this loss, $2,259,354.08 represented a deduction for worthless stocks, including the loss of $17,190 referred to above and $262,622.20 for bad debts, and the balance for a loss from ordinary operations. On June 21, 1935, Southern received a $1,000 liquidating dividend on the 1,000 shares of National stock. The $20,000 note given by Southern to Josey for the 1,000 shares of National stock was an interest-bearing note and interest was paid thereon until March 4, 1936, after which date Southern did not pay any interest on the note. On or about March 1, 1936, Southern asked Josey to surrender the note in exchange for the stock, but Josey was unable to do so at that time for the reason that the note was pledged by him as collateral with a bank. As soon as the financial affairs of Josey permitted, he got the bank to release the note as collateral and thereupon, on February 1, 1938, Southern notified Josey of its intention to exercise the option contained in the original agreement between the parties, whereupon Southern delivered and transferred to Josey the 1,000 shares of National stock originally purchased from him on September 4, 1929, and on the same date, and as a part of the same transaction, Josey canceled and delivered back to Southern the $20,000 note originally given by Southern as purchase price of the stock. The 1,000 shares of the capital stock of National were worthless at the time Southern received its $20,000 note back from the seller of the stock. Southern, on its income tax return for the taxable year ended December 31, 1938, returned as income the amount of $1,900 representing the liquidating dividends which it had received and which had been credited to cost of the 1,000 shares of National stock in 1933 and 1035. Respondent in his deficiency notice determined that an additional amount of $20,000 should be returned as income from the cancellation of the Josey note originally given by Southern as purchase price of the 1,000 shares of the National stock.
For the taxable years 1934 to 1936, inclusive, Southern's Federal income tax returns show net losses as follows:
+-------------------+ ¦1934¦$2,646,215.40 ¦ +----+--------------¦ ¦1935¦21,853.61 ¦ +----+--------------¦ ¦1936¦24,500.44 ¦ +-------------------+
For the taxable year 1937 Southern's Federal income tax return showed net income $4,029.19, with respect to which a tax was paid in the amount of $683.43. For the taxable years 1931, 1932, and 1933 Southern was included in the consolidated returns of its parent, Jesse H. Jones Co. Such consolidated returns for 1931 showed no net income, and for 1932 they showed a net loss of $1,396,600.08. No substantial adjustments were made by respondent for the years 1931 to 1936, inclusive.
Southern realized no taxable gain on the redelivery to Josey in 1938 of the 1,000 shares of National stock in exchange for its $20,000 note, except the $1,900 representing liquidating dividends, which it duly reported as income.
Issue No. 2.— Another of the adjustments to net income of Southern for the year 1938 was an addition thereto of $75,000 which the respondent called ‘(e) Capital loss‘ and explained as follows:
(e) The amount of $75,000 claimed by you as a bad debt and deducted from gross income in your return is disallowed since it represents a payment made by you within the taxable year upon your own obligation voluntarily assumed.
In 1928, 1929, 1930, and 1931 Southern owned the capital stock of the Fort Worth Properties Corporation. In 1928 the Fort Worth Properties Corporation owned certain land in Fort Worth, Texas, upon which Southern was constructing what was later known as the Fort Worth Electric Building and Theatre.
On October 12, 1928, a written contract was entered into between J. W. Colvin of Houston, Texas, as first party, and Jesse H. Jones of Houston, as second party. Jones was acting on behalf of Southern ‘and/or those affiliated companies owning and building the Electric Building in Fort Worth, Texas * * * .‘ This contract was later modified by written agreements dated February 9 and July 3, 1929. Pursuant to these three agreements: (1) A new corporation, named Fort Worth Electric Building Co., hereinafter sometimes referred to as the Electric Co., was organized under the laws of the State of Texas; (2) Fort Worth Properties Corporation paid in the entire capital stock of the Electric Co.; (3) Southern during 1929 sold the Fort Worth Electric Building and Theatre to the Electric Co. for $1,500,000 first mortgage bonds of the Electric Co., on which Southern realized $1,380,000 cash during 1929, after paying $120,000 commission to an investment broker; (4) Fort Worth Properties Corporation sold part of the land on which the Fort Worth Electric Building and Theatre was built to the Electric Co. for $500,000 par value series A bonds and $100,000 par value series B bonds of the Electric Co., and it leased the remainder of the land on which the Fort Worth Electric Building and Theatre was built to the Electric Co. for $30,000 per annum; and (5) Colvin for a cash consideration of $200,000 paid to Fort Worth Properties Corporation, received, together with other considerations, the entire capital stock of the Electric Co., $150,000 par value series A bonds, and $100,000 par value series B bonds of the Electric Co., and an option to acquire for $600,000 the fee to that part of the land under the Fort Worth Electric Building and Theatre which was leased by the Electric Co.
Thereafter Colvin became dissatisfied with what he had received and a controversy arose between Southern and Colvin, with the result that on February 28, 1931, Southern, Fort Worth Properties Corporation, and Colvin entered into a written agreement, hereinafter sometimes referred to as the three-party agreement, supplemented by two written agreements of the same date between Southern and Colvin, hereinafter sometimes referred to as Exhibit A and Exhibit B, respectively. Pursuant to these agreements: (1) Fort Worth Properties Corporation, which owned $350,000 par value series A bonds of the Electric Co., transferred $200,000 par value thereof to Colvin, who transferred to Fort Worth Properties Corporation all the capital stock of the Electric Co., $100,000 series B bonds of the latter company, and one-half interest in a theatre lease and certain equipment; and (2) Fort Worth Properties Corporation canceled $150,000 par value series A bonds and the $100,000 par value series B bonds of the Electric Co. which it received back from Colvin.
Paragraphs eighth and ninth of the three-party agreement were as follows:
Eighth
Southern, for value received, agrees to execute to and with Colvin agreements for the purchase of Series A bonds and to establish and maintain a line of credit for Colvin, his heirs or estate,— such agreements to be executed in the form of those hereto attached marked ‘Exhibit A‘ and ‘Exhibit B‘, respectively.
Ninth
Colvin and Jesse H. Jones, acting for himself and companies or corporations owned or controlled by him, executed a certain agreement dated October 12, 1928, and a supplement or amendment thereto dated February 9, 1929, and a further supplement or amendment dated on or about July 3, 1929,— all having reference or being related to dealing with the properties of Electric Company, reference being here made for al l purposes to said original contract of October 12, 1928, and any and all amendments or supplements thereto irrespective of whether same are hereinabove mentioned or identified.
Part of the consideration for the execution of this instrument is the cancellation and full release of said contract of October 12, 1928, and any and all amendments or supplements thereto; hence, Colvin hereby agrees that said original contract, and the amendments or supplements thereto are hereby fully discharged, canceled, rescinded and set aside and all parties thereto are fully, finally and unconditionally released and discharged from any and all liability thereunder, and Colvin hereby waives and releases all claims for losses or damages and all causes of action, if any, of any and every kind or character which he has, had or may have against Jesse H. Jones and/or any of those corporations for which Jesse H. Jones was acting in making said original contract of October 12, 1928, and all amendments or supplements thereto.
Exhibit A referred to in the three-party agreement was an agreement reciting that Colvin was the owner of $350,000 of series A bonds of the Electric Co. and that Southern agreed to purchase such bonds, $15,000 par value on or before March 2, 1932, an additional $15,000 every year thereafter until and including March 2, 19.5, and the balance on or before March 2, 1946. It was also provided that these purchases could be made in advance of Southern's obligation to purchase.
Exhibit B referred to in the three-party agreement was an agreement wherein Southern agreed to establish and maintain for a period of five years an unconditional line of credit for ‘Colvin, his heirs or Estate, and/or any companies or corporations owned or controlled by him‘ up to $150,000, on condition that any loan made be secured by a pledge of series A bonds of the Electric Co. in a par value amount of one and one-third times the amount of any loan made.
In April 1931 Colvin transferred to Fort Worth Properties Corporation $100,000 par value series A bonds of the Electric Co. in consideration of his release from liability for his one-half of losses on the theatre lease. This transfer left Colvin with $250,000 series A bonds.
On June 10, 1931, Texas Investors, Inc., a corporation controlled by Colvin, obtained from the National Bank of Commerce of Houston, Texas, hereinafter sometimes referred to as the bank, the sum of $150,000, executing a note endorsed by Colvin, guaranteed by Southern, and secured by Colvin's series A bonds in the face amount of $200,000.
The series A bonds of the Electric Co., if not worthless on February 28, 1931, were worthless in 1934 or prior thereto. On June 5, 1934, all of the properties of the Electric Co. were sold at public auction, pursuant to foreclosure decree to the first mortgage bondholders' committee for $300,000, and immediately thereafter the first mortgage bondholders transferred the assets to a new corporation, Electric Properties, Inc., for all the capital stock of the new corporation. Since the first mortgage bonds amounted to $1,500,000, there were no assets to be applied against the series A bonds. Likewise, Fort Worth Properties Corporation was insolvent in 1934 or prior thereto. 4 Southern, during the years 1932, 1933, and 1934 and prior to November 25, 1935, purchased the $15,000 par value series A bonds per year it had agreed to purchase in accordance with Exhibit A referred to above, and $7,500 of the amount paid was applied on the $150,000 note referred to above, leaving a balance due on November 25, 1935, of $142,500 and leaving $190,000 face amount of series A bonds in the possession of the bank.
On May 11, 1932, Metropolitan Properties Corporation, a corporation controlled by Colvin, had entered into an agreement with Southern in regard to Southern's liability to Metropolitan Properties Corporation under an operating agreement entered into prior to 1932, and thereafter on November 25, 1935, a final settlement of such liability was agreed upon. As a part of the consideration for this final settlement contract and on the same date, four agreements in the form of four letters were entered into.
The body of the first letter, dated November 25, 1935, from Southern to Texas Investors, Inc., was as follows:
This is to evidence our agreement that the undersigned has this day purchased from you for $145,775.00 all of the Second Mortgage Series A Bonds of Fort Worth Electric Building Company pledged as collateral secure your note at The National Bank of Commerce of Houston maturing December 1, 1935, for the principal sum of $142,500.
Of the consideration aforesaid $13,275.00 has this day been paid to you by the undersigned and $10,000 applied by you on your note at said Bank, the balance on your note having been renewed for ninety (90) days from the date hereof.
You agree upon the interest being paid in advance upon said bank note by Southern Loan & Investment Company to renew the same from time to time for the convenience of Southern Loan & Investment Company over a period of the next eighteen months on or before the expiration of which time full payment for the purchase price of said bonds will be made to you by the undersigned and paid by you to the Bank in liquidation of your note.
The body of the second letter, dated November 25, 1935, from Southern to the bank was as follows:
The undersigned at present is a guarantor of an obligation held by you in the amount of $142,500.00 executed by Texas Investors, Inc. and endorsed by J. W. Colvin of Houston, Texas.
This will authorize you to release J. W. Colvin and Texas Investors, Inc. from any personal liability on said note or any renewal or extension thereof without effecting in any way the liability of the undersigned on its present guarantee to you.
The body of the third letter, dated November 25, 1935, from Jesse H. Jones & Co. to the bank was as follows:
Southern Loan & Investment Company has this day authorized you to release from personal liability J. W. Colvin and Texas Investors, Inc. on a certain note in the amount of $142,500 held by you and executed by Texas Investors, Inc. and endorsed by J. W. Colvin.
This is to advise you that we concur in the request made upon you by Southern Loan & Investment Company and hereby agree that our guarantees made to you in regard to direct or indirect liabilities of Southern Loan Investment Company shall not be affected or the collateral securing the same shall not be affected in any respect by your action in complying with the request of Southern Loan & Investment Company.
The body of the fourth letter, dated November 25, 1935, from the bank to Colvin and Texas Investors, Inc., was as follows:
Because of the $10,000 payment on the principal of the note of Texas Investors, Inc. held by us in the amount of $142,500, we are accepting renewal note of Texas Investors, Inc. due in 90 days for the balance, without Mr. Colvin's personal guarantee.
We agree to accept the collateral of and promises made by Southern Loan & Investment Company in lieu of the personal liability of either of you and in the event said note, or any renewal or extension thereof, is not paid in full we will not hold you or either of you personally responsible.
On August 1, 1936, Jesse H. Jones & Co. executed and delivered to the bank a guaranty of the note in question. On November 25, 1935, the note at the bank was reduced to $132,500 as a result of the $10,000 payment. In 1936 Southern paid $17,500 to the bank, reducing the note to $115,000. In 1937 Southern paid $40,000 to the bank, reducing the note to $75,000. On December 27, 1938, Southern paid $75,000 to the bank, thus paying in full the note to the bank, and the bank delivered to Southern $190,000 face amount of the series A bonds which had been received by the bank the taxable year ended December 31, 1938, Southern charged off the above $75,000 payment made to the bank in 1938 as a bad debt, and respondent, in his deficiency notice, disallowed it as a deduction.
Issue No. 3.— One of the adjustments to the net income of Southern for the year 1939 was an addition thereto of $139,743.28 which the respondent called ‘(a) Gain on exchange‘ and explained as follows:
(a) It is held that you realized a taxable gain in the amount of $139,743.28 from the exchange of bonds of Main Properties, Inc. costing you $260,256.72 for the Chronicle Building leasehold having a fair market value of $400,000.00.
Prior to June 1, 1939, Southern had acquired bonds of Main in the face amount of $640,000 at a cost to Southern of $260,256.72. On June 1, 1939, Southern exchanged these bonds for a certain building and two leaseholds (one being a sublease) in Houston, Texas, known as the Chronicle Building leasehold, on which is situated a 10-story office building known as the Chronicle Building. Southern, in its amended petition, alleges that the building and leaseholds had a fair market value as of June 1, 1939, of ‘not more than‘ $213,107.33, and claims that it sustained a deductible capital loss of $47,149.39, being the difference between the cost of the bonds and the alleged fair market value of the building and leaseholds. Net capital gain of Southern from other sales during 1939 was $45,149.39.
On May 20, 1926, a contract was entered into between Houston Chronicle Realty Co., as lessor, and Houston Chronicle Building Co., hereinafter sometimes referred to as Building Co., as lessee, wherein the lessor let and leased for a period of 99 years from May 1, 1926, unto the lessee an irregular shaped lot in the city of Houston containing in all 10,579 square feet of land. On the same day, May 20, 1926, the Building Co. assigned its interest in the above contract to United Properties Corporation. The 99-year lease provided that the lessee should pay as rent to the lessor the amount of $65,000 per year, plus all taxes on the ground and improvements, and insurance on the building, so that the lessor would receive a net annual rental of $65,000. If the lessee or any of its assigns should fail to perform any of the obligations imposed by the contract, then, under article VIII of the contract (the 99-year lease), ‘all improvements, of every kind of character, then occupying the demised premises, shall be and become the property of the Lessor, and the Lessee shall have no claim for, or upon, or against the same, of any kind or character whatsoever * * * .‘
On July 1, 1927, United Properties Corporation executed a 15-year sublease of the Chronicle Building to the Building Co., under the terms of which the Building Co. obligated itself to pay the annual ground rent of $65,000 plus taxes and insurance to the Houston Chronicle Realty Co. and addition to pay $40,000 per annum to United Properties Corporation. On December 29, 1932, without otherwise modifying the sublease, the rental under such sublease payable by the Building Co. was reduced to $15,000 per annum. In 1934 the bondholders of United Properties Corporation foreclosed on the properties of that company and as a result thereof the 99-year lease and the sublease and the Chronicle Building were transferred to Main. On April 27, 1934, after the properties in question had been transferred to Main, the term of the sublease was extended 6 1/2 years, or until December 31, 1948, without otherwise modifying the sublease. The performance of the sublease by the Building Co. was guaranteed to Main by the Houston Chronicle Publishing Co. This latter company rented from the Building Co. several of the floors of the Chronicle Building. The July 1, 1927, contract (the sublease) between United Properties Corporation and the Building Co. contained the following provisions of article VIII thereof:
* * * Provided, however, any equipment, fixtures and machinery of every kind and character placed therein and/or used by the Houston Chronicle Publishing Company or any other sub-tenant of any part of the premises, may be removed at the end of the term hereof, but any injury done to the premises by said removal shall be promptly repaired by the person so removing said property.
It was this Chronicle Building and 99-year lease and sublease which Southern acquired from Main on June 1, 1939.
During the period from June 1937 to August 1938, the Houston Chronicle Publishing Co. made certain expenditures on the 10-story Chronicle Building which aggregated a cost of $120,908.82. The items totaling $120,908.82 were capitalized on the books of the Houston Chronicle Publishing Co.
The Chronicle Building was constructed in 1909 and cost $525,000, plus $33,533.36 cost of remodeling the mailing room in 1926.
The fair market value on June 1, 1939, of the Chronicle Building and two leaseholds was $260,256.72.
Issue No. 4.— Southern is in the business of erecting, maintaining, and managing real properties. Its gross income for the taxable year 1939 was as follows (item numbers are those shown under the heading of ‘Gross Income‘ on petitioner's corporation income and excess profits tax return, Form 1120A, for the calendar year 1939):
+---------------------------------------------------------------------+ ¦Item No.¦Gross income from— ¦Amount ¦ +--------+------------------------------------------------+-----------¦ ¦7 ¦Interest ¦$16,792.94 ¦ +--------+------------------------------------------------+-----------¦ ¦9 ¦Rents ¦203,975.99 ¦ +--------+------------------------------------------------+-----------¦ ¦10 ¦Light and power sales ¦100,756.32 ¦ +--------+------------------------------------------------+-----------¦ ¦11(a) ¦Capital gain (or loss) ¦45,149.39 ¦ +--------+------------------------------------------------+-----------¦ ¦11(b) ¦Gain (or loss) from sale or exchange of property¦ ¦ +--------+------------------------------------------------+-----------¦ ¦ ¦other than capital assets ¦(51,533.03)¦ +--------+------------------------------------------------+-----------¦ ¦12 ¦Dividends ¦70,856.75 ¦ +--------+------------------------------------------------+-----------¦ ¦Total ¦ ¦385,998.36 ¦ +---------------------------------------------------------------------+
Southern's ‘personal holding company income,‘ as that term is used in section 503 of the Internal Revenue Code for the taxable year 1939, consisted of the following portion of the gross income:
+------------------------------------------------+ ¦Item No. ¦Gross income from— ¦Amount ¦ +---------+---------------------------+----------¦ ¦7 ¦Interest ¦$16,792.94¦ +---------+---------------------------+----------¦ ¦11(a) ¦Capital gain (or loss) ¦45,149.39 ¦ +---------+---------------------------+----------¦ ¦12 ¦Dividends ¦70,856.75 ¦ +-------------------------------------+----------¦ ¦Total personal holding company income¦132,799.08¦ +------------------------------------------------+
Southern's ‘personal holding company income‘ for the taxable year 1939 did not constitute 80 percent of Southern's gross income for that year. Southern was not a personal holding company for the taxable year 1939.
Issue No. 5.— On June 1, 1939, Main transferred to Southern the Chronicle Building and leaseholds in exchange for $640,000 face value of Main's own bonds. At the time of such exchange Main had an adjusted basis of $212,182.02 in the building and leaseholds. The respondent determined that Main derived a gain from the exchange in the amount of the difference between $640,000 and $212,182.02, or $427,817.98.
In 1939, prior to the exchange in question, Main owned the following properties located in the city of Houston, Texas:
Lamar Hotel Annex and leasehold
Loew's State Theatre Building and leasehold
National Standard Building and leasehold
Kirby Building, and the land thereunder
Chronicle Building and leaseholds
Prior to the exchange in question in 1939, all of the above properties were subject to first mortgage bonds issued by Main in the amount of $2,935,050.
Main's balance sheets as of the beginning and end of the fiscal year ended November 30, 1939, were as follows (the land, buildings and equipment account includes the properties referred to in the immediately preceding paragraph. The values marked with an asterisk are undisputed):
+--------------------------------------------------------------------+ ¦ ¦Nov. 30, 1938¦Nov. 30, 1939¦ +----------------------------------------+-------------+-------------¦ ¦Assets and deficit: ¦ ¦ ¦ +----------------------------------------+-------------+-------------¦ ¦Cash ¦*$85,997.73 ¦*$67,104.45 ¦ +----------------------------------------+-------------+-------------¦ ¦Notes and accounts receivable ¦*4,350.23 ¦*4,565.53 ¦ +----------------------------------------+-------------+-------------¦ ¦Supplies ¦*66.02 ¦*71.69 ¦ +----------------------------------------+-------------+-------------¦ ¦Prepaid expenses, furniture and fixtures¦*5,496.94 ¦*8,140.14 ¦ +----------------------------------------+-------------+-------------¦ ¦ ¦95,910.92 ¦79,881.81 ¦ +----------------------------------------+-------------+-------------¦ ¦Land, buildings and equipment ¦3,017,258.28 ¦2,377,258.28 ¦ +----------------------------------------+-------------+-------------¦ ¦Less reserve for depreciation ¦418,259.52 ¦499,177.28 ¦ +----------------------------------------+-------------+-------------¦ ¦ ¦2,598,998.76 ¦1,878,081.00 ¦ +----------------------------------------+-------------+-------------¦ ¦Deficit ¦345,656.87 ¦485,778.54 ¦ +----------------------------------------+-------------+-------------¦ ¦ ¦3,040,566.55 ¦2,443,741.35 ¦ +----------------------------------------+-------------+-------------¦ ¦Liabilities and common stock: ¦ ¦ ¦ +----------------------------------------+-------------+-------------¦ ¦Accounts payable ¦4,859.21 ¦4,121.76 ¦ +----------------------------------------+-------------+-------------¦ ¦Bonds, notes and mortgages ¦2,935,050.00 ¦2,295,050.00 ¦ +----------------------------------------+-------------+-------------¦ ¦Interest, taxes, expenses ¦80,657.34 ¦124,569.59 ¦ +----------------------------------------+-------------+-------------¦ ¦Common stock ¦20,000.00 ¦20,000.00 ¦ +----------------------------------------+-------------+-------------¦ ¦ ¦3,040,566.55 ¦2,443,741.35 ¦ +--------------------------------------------------------------------+
The respondent has determined that the land, buildings, and equipment owned by Main in 1939, prior to the transfer of the Chronicle Building and leaseholds to Southern, had a fair market value of $3,250,000; that such land, buildings, and equipment had a fair market value of $2,850,000 at the end of the fiscal year; and that the total value of Main's assets as of the beginning and end of the fiscal year ended November 30, 1939, were as follows:
+---------------------------------------------------------+ ¦ ¦Nov. 30, 1938¦Nov. 30, 1939¦ +-----------------------------+-------------+-------------¦ ¦Land, buildings and equipment¦$3,250,000.00¦$2,850,000.00¦ +-----------------------------+-------------+-------------¦ ¦All other assets ¦95,910.92 ¦79,881.81 ¦ +-----------------------------+-------------+-------------¦ ¦Total ¦3,345,910.92 ¦2,929,881.81 ¦ +---------------------------------------------------------+
On the basis of the above determined values, the respondent further determined that Main was solvent both before and after the exchange in question.
The buildings known as Lamar Hotel Annex and Loew's State Theatre are located at the southeast corner of Travis and McKinney in Houston, on land covered by a 99-year lease entered into on April 1, 1926. Under this lease the lessee agreed to pay $35,000 per year for the first 25 years and $50,000 per year for the balance of the term, and, as additional rental for the full term of 99 years, ‘all taxes, assessments, levies and governmental charges of every kind and character whatsoever * * * .‘ Article VIII of the lease provided in part:
At the expiration and termination of this lease, whether from lapse of time, or from breach of any term, covenant or condition herein imposed upon the LESSEE, all improvements of every kind and character then occupying the demised premises, shall be and become the property of the LESSOR * * * .
Article XVI of the lease provided that within five years from the date of the lease the lessee would construct and equip upon the leased land a building or buildings to cost not less than $500,000. During 1928 and 1929 Lama Hotel Annex (an 8-story building) was constructed at a cost of $531,596.57. The theatre seats approximately 2,500 people.
The National Standard Building is an 8-story store and office building, located at the southwest corner of Main and McKinney in Houston on land covered by a 99-year lease entered into on April 1, 1926. Under this lease the lessee agreed to pay ‘40,000 per year for the first 25 years and $50,000 per year for the balance of the term, and, as an additional rental for the full term of 99 years, ‘all taxes, assessments, levies and governmental charges of every kind and character whatsoever * * * .‘ Articles VIII and XVI contained provisions identical with articles VIII and XVI of the lease mentioned in the immediately preceding paragraph. During 1928 and 1929 the National Standard Building was constructed at a cost of $667,289.23.
Prior to 1938 Main succeeded to the obligations and interests of the lessees under the last two leases mentioned above in a manner more fully described below.
The building known as the Kirby Building is a 10-story office building and is located between Walker and McKinney on the east side of Main Street in Houston. The land under this building was owned in fee by Main during the fiscal year ended November 30, 1939. The building was constructed in 1927 at a cost of $496,977.62.
Main was organized in the spring of 1934. It acquired the above mentioned five buildings and leaseholds from a bondholders' committee which had acquired them at a foreclosure sale. Prior to the foreclosure sale the properties were owned by United Properties Corporation, which had constructed all of the buildings except the Chronicle Building and had placed a bond issue thereon of #3,000,000. In 1932 the United Properties Corporation defaulted on the bond issue and the bondholders' committee was organized. A plan of reorganization was worked out between Main and the committee whereby the committee, after acquiring the properties at a foreclosure sale, transferred them to Main, which issued income bonds in the same principal amounts as bonds held by the committee, plus some accumulation of interest, which bonds were sinking fund bonds to mature 15 years after January 1, 1934, and bore 5 percent interest during the first 5-year period only if earned, and after the first 5-year period a fixed 3 percent interest and an additional 2 percent only if earned. The additional 2 percent, if not earned currently, was to accumulate and be payable in any event out of future earnings or at maturity. Towards the end of 1938 it became evident that Main could not meet, beginning July 1, 1939, the fixed interest of 3 percent. At that time the bonds were selling in Chicago at about 30 cents on the dollar. Main desired to avoid default if possible. Main's officers thought that if Main retired about $640,000 of its bonds it might be able to meet the fixed 3 percent interest on the balance. As a result Main transferred the Chronicle Building and leaseholds to Southern for $640,000 face value of the bonds, which were canceled. This is the same transaction involved under issue 3.
The disposal of the Chronicle Building and leaseholds for the bonds did not have the desired effect of substantially improving Main's financial position. New air conditioned buildings were erected in Houston, which tended to make Main's buildings less desirable. It then became necessary for Main to assess its stockholders to avoid a default on the bonds, but this also failed. A new company was then organized, under the name of Block 139, Inc., for the purpose of purchasing the remaining properties of Main for such amount of money in cash as to pay the bondholders 40 cents on the dollar and all expenses in connection with the liquidation. That offer was submitted to the bondholders in March 1941, and it was accepted by them in November 1941. In January 1942 the transaction was closed and Block 139, Inc., acquired all the remaining properties of Main for approximately $1,250,000.
The net income (or loss) of the properties owned by Main from the time of its incorporation to the end of the taxable year, before deducting general administrative expenses, interest paid, and depreciation, was as follows:
+---------------------------------------------------------------------------+ ¦ ¦Lamar ¦Loew's ¦National ¦ ¦ ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦Year ¦Annex ¦Theatre ¦Standard ¦Kirby ¦Chronicle ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦April to 12-31-34 ¦$9,540.93¦$27,104.33¦($27,797.63)¦$27,144.47¦$10,343.22¦ +-------------------+---------+----------+------------+----------+----------¦ ¦Calendar 1935 ¦13,343.26¦37,135.10 ¦(34,265.19) ¦44,097.50 ¦14,250.00 ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦1-1-36 to 11-30-36 ¦12,096.81¦33,561.23 ¦(29,933.74) ¦57,297.06 ¦13,062.50 ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦12-1-36 to 11-30-37¦13,117.65¦37,728.00 ¦(34,460.29) ¦41,391.96 ¦14,250.00 ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦12-1-37 to 11-30-38¦13,027.88¦37,845.18 ¦(29,748.36) ¦45,374.49 ¦14,250.00 ¦ +-------------------+---------+----------+------------+----------+----------¦ ¦12-1-38 to 11-30-39¦9,986.79 ¦36,950.60 ¦(23,687.18) ¦47,391.52 ¦7,125.00 ¦ +---------------------------------------------------------------------------+
After deducting the general administrative expenses, interest paid, depreciation, Main sustained net losses from the operation of said properties for the above mentioned periods, which resulted in a growing operating deficit as follows:
+------------------------------------------------------+ ¦Year¦Net losses¦Deficit ¦Year¦Net losses¦Deficit ¦ +----+----------+----------+----+----------+-----------¦ ¦1934¦$48,561.42¦$48,561.42¦1937¦$85,175.70¦$255,158.80¦ +----+----------+----------+----+----------+-----------¦ ¦1935¦71,402.77 ¦119,168.58¦1938¦90,498.07 ¦345,656.87 ¦ +----+----------+----------+----+----------+-----------¦ ¦1936¦52,746.22 ¦170,255.32¦1939¦140,121.67¦485,778.54 ¦ +------------------------------------------------------+
The fair market value of Main's land, buildings, and equipment, both before and after the exchange of the Chronicle Building and leaseholds on June 1, 1939, was not more than the depreciated book values of $2,598,998.76 and $1,878,081, respectively.
Main was insolvent both before and after the transfer of the Chronicle Building and leaseholds to Southern on June 1, 1939.
OPINION.
BLACK, Judge:
Issue No. 1.— The issues presented and the evidentiary facts, all of which were stipulated, have been previously stated and need not be repeated. It is our opinion that the respondent erred in holding that the cancellation and redelivery by Josey to Southern in 1938 of Southern's note for $20,000 payable to Josey was a transaction from which Southern realized $20,000 of taxable income. We do not think Southern realized any taxable income on that transaction. The $1,900 of liquidating dividends which Southern reported as income in 1938 and which has been accepted by the respondent as being correct is not in issue.
This is not a case where a taxpayer, as the respondent contends, realizes income through the cancellation of indebtedness as provided for in article 22(a)-14 of Regulations 101.
Until the note was paid, either Southern or Josey had the right under their oral agreement to demand what was actually done in 1938.
ART. 22(a)-14. Cancellation of indebtedness.— (a) In General.— The cancellation of indebtedness, in whole or in part, may result in the realization of income. If, for example, an individual performs services for a creditor, who in consideration thereof cancels the debt, income in the amount of the debt is realized by the debtor as compensation for his services. A taxpayer realizes income by the payment or purchase of his obligations at less than their face value. (See article 22(a)-18.) In general, if a shareholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution to the capital of the corporation to the extent of the principal of the debt.
The situation here is somewhat analogous to the situation in those cases like Hirsch v. Commissioner, 115 Fed.(2d) 656, and Helvering v. A. L. Killian Co., 128 Fed.(2d) 433, where property was purchased partly on credit and in a later year, due to the property having greatly depreciated in value, the creditor settled for less than the amount originally agreed upon. The courts hold that substance rather than form is to be given controlling weight and that such a settlement is in essence a reduction of the purchase price. Of course, in the instant proceeding, Southern returned the 1,000 shares of National stock to Josey, so we could hardly say that the cancellation and return of the $20,000 note to Southern was a reduction of the purchase price, as Southern no longer owned the stock. We do think, however, that the return of the stock by Southern and the return of the note by Josey in 1938 were in substance a rescission of the 1929 purchase by Southern, resulting in neither gain nor loss, except for the $1,900 which is not in question. Just why Southern did not return to Josey the $1,900 which it received as a liquidating dividend on the stock, the stipulated facts do no show. But, inasmuch as there is no issue concerning this $1,900, we need not discuss it further.
Neither the petitioner here nor its parent company, the Jesse H. Jones Co., received any tax benefit from the charge-off by Southern in 1933 of $17,190 as a loss from the worthless stock of National. If the Commissioner had disallowed this loss in its entirety it would not have affected the tax liability of either Southern or its parent company, Jesse H. Jones Co.
We think the tax accounting question here is somewhat similar in principle to the tax accounting question in Dobson v. Commissioner, 320 U.S. 489. The taxpayer in that case in 1929 purchased 300 shares of certain stock. He sold 100 shares in 1930, sustaining a deductible loss of $41,600.80, which was claimed on his return for that year and allowed. In 1931 he sold another 100 shares, sustaining a deductible loss of $28,163.78, which was claimed on his return and allowed. He retained the remaining 100 shares. In 1936 he learned that the purchase in 1929 had been induced by fraudulent representations. He filed suit against the seller and asked rescission of the entire transaction. In 1939 the suit was settled on a basis which gave him a net recovery of $45,150.63, of which $23,296.45 was allocable to the stock sold in 1930 and $6,454.18 allocable to that sold in 1931. He did not report any part of the recovery as income in 1939. Any adjustment of his 1930 and 1931 tax liability was barred by the statute of limitations. He had not, however, received any tax benefits from the charge-offs in 1930 and 1931. The Commissioner contended that the amount of the recovery attributable to the shares sold was income in 1939. The recovery upon the shares sold was not, however, sufficient to make good the taxpayer's original investment in them. It was held that the taxpayer there realized no taxable gain from the recovery.
The respondent's determination on this issue is reversed.
Issue No. 2.— In assigning error as to this issue, petitioner alleges that respondent ‘erroneously disallowed a payment made by petitioner to the National Bank of Commerce of Houston‘ in the amount of $75,000. Although the amount was deducted by petitioner in its return as a bad debt, the parties have briefed the issue from the standpoint of a statutory loss rather than a bad debt. Section 23 of the Revenue Act of 1938 provides that in computing net income there shall be allowed as deductions:
(f) LOSSES BY CORPORATIONS.— In the case of a corporation, losses sustained during the taxable year and not compensated for by insurance or otherwise.
On the basis of the facts set out in our findings, all of which were stipulated, did Southern sustain a deductible loss of $75,000 during he taxable year 1938? We think it did.
The payment of $75,000 by Southern to the bank in the taxable year 1938 had its origin in the October 12, 1928, contract between Colvin and Jones, who was acting on behalf of Southern and certain affiliated companies. That contract and any and all amendments or supplements thereto were rescinded and set aside by the three-party agreement of February 28, 1931, and the two supplemental agreements (Exhibits A and B) attached thereto. The details of these written instruments are set out in our findings of fact and need not be repeated here.
The taxable year here involved is the calendar year 1938. Southern is not claiming as a loss in 1938 any of the payments made prior to 1938. Since it reports on the cash receipts and disbursements basis, we are of the opinion that Southern, in making the final payment of $75,000 in 1938 on its guaranty, sustained a deductible loss of that amount in the taxable year, and we so hold. Eckert v. Burnet, 283 U.S. 140; Helvering v. Price, 309 U.S. 409. See also I.T. 3252, C.B. 1939-1 (Part 1), p. 182.
Issue No. 3.— Did the exchange by Southern on June 1, 1939, of $640,000 par value of Main bonds for the Chronicle Building and leaseholds result in a capital gain or loss to Southern, and if so, how much? The respondent determined that the exchange resulted in a taxable gain of $139,743.28 on the ground that Southern's cost basis of the bonds was $260,256.72 and that the fair market value of the building and leaseholds was $400,000. The parties have stipulated that Southern's cos basis of the bonds was $260,256.72, but petitioner contends that the fair market value of the Chronicle Building and leaseholds was ‘not more than‘ $213,107.33. Petitioner actually contends that the fair market value of the Chronicle Building and leaseholds was much less than $213,107.33, but, due to section 117(d) of the Internal Revenue Code
and the stipulated fact that the net capital gain of Southern from other sales during 1939 was $45,149.39, the maximum deductible capital loss to Southern could not exceed $47,149.39, which is the difference between the cost of the bonds and the above mentioned amount of $213,107.33.
SEC. 117. CAPITAL GAINS AND LOSSES.(d) LIMITATION ON CAPITAL LOSSES.—(1) CORPORATIONS.— In the case of a corporation, losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. * * *
What was the fair market value of the Chronicle Building and leaseholds on June 1, 1939? The respondent determined and still contends it was $400,000. Petitioner contends it was $110,000, but in any event not more than $213,107.33. We have found as a fact that the fair market value of the Chronicle Building and leaseholds on June 1, 1939, was $260,256.72.
The evidence on this question consists of the testimony of five witnesses for the petitioner and one for the respondent, all supplemented by certain documentary evidence and some stipulated facts. We do not consider it necessary to review in detail all of this evidence. In arriving at our valuation of the Chronicle Building and leaseholds on June 1, 1939, we have given careful consideration to all of this evidence. We have concluded that there is no reason for disturbing the valuation which Southern evidently put upon the property at the time of the exchange. It owned bonds of Main which had cost it $260,257.72, and in an arm's length transaction it exchanged these bonds with Main for the Chronicle Building and leaseholds. It is fair to assume that in making the exchange it regarded itself as getting its money's worth, and we think the evidence justifies a valuation finding which shows that it did get its money's worth. It received property of a value equal to the cost of the bonds which it exchanged. In a recomputation under Rule 50, $260,257.72 will be used as the fair market value of the Chronicle Building and leaseholds at the time of the exchange. This means that Southern had neither gain nor loss on the transaction.
Issue No. 4.— Is Southern liable for the personal holding company surtax and penalty for the taxable year 1939? This depends on whether Southern is a ‘personal holding company‘ as that term is defined in sections 501 and 502 of the Internal Revenue Code, the material provisions of which are in the margin.
SEC. 501. DEFINITION OF PERSONAL HOLDING COMPANY.(a) GENERAL RULE.— For the purposes of this subchapter and chapter 1, the term ‘personal holding company‘ means any corporation if—(1) GROSS INCOME REQUIREMENT.— At least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 502; * * *SEC. 502. PERSONAL HOLDING COMPANY INCOME.For the purposes of this subchapter the term ‘personal holding company income‘ means the portion of the gross income which consists of:(a) Dividends, interest (other than interest constituting rent as defined in subsection (g), royalties (other than mineral, oil, or gas royalties), annuities.(b) STOCK AND SECURITIES TRANSACTIONS.— Except in the case of regular dealers in stock or securities, gains from the sale or exchange of stock or securities.(g) RENTS.— Rents, unless constituting 50 per centum or more of the gross income. * * *
As shown in our findings, petitioner's gross income for the year 1939 was $385,998.36 and its personal holding company income for the same year was only $132,799.08. Since this latter amount is less than 80 percent of petitioner's gross income, it follows that petitioner is not a personal holding company for the year 1939 and is not liable for the personal holding company surtax and penalty for that year. It thus becomes unnecessary to decide several other questions briefed by the parties under this issue which would have been material if we had held that petitioner was a personal holding company for the year 1939.
Issue No. 5.— The question here is whether Main realized any taxable gain on the exchange of the Chronicle Building and leaseholds on June 1, 1939, for $640,000 of its own bonds, which it canceled. The parties have stipulated that Main's adjusted basis of the property was $212,182.02 at the time of the exchange.
The respondent contends that Main was solvent both before and after the exchange and that, in line with United States v. Kirby Lumber Co., 284 U.S. 1, and similar cases, Main realized a taxable gain of $427,817.98, which represents the difference between the adjusted basis of the property exchanged and the face value of the bonds which were received and canceled.
Petitioner contends that it was insolvent both before and after the exchange and that in line with Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 Fed.(2d) 95, and similar cases, it realized no taxable gain on the exchange.
The parties agree that the liabilities of Main before and after the exchange were $3,020,566.55 and $2,423,741.35, respectively. They also agree that the values of Main's current assets before and after the exchange were $95,910.92 and $79,881.81, respectively. They disagree on the value of the land, buildings, and equipment. The respondent determined and contends that the values of such assets before and after the exchange were $3,250,000 and $2,850,000, respectively, whereas Main contends that the values of such assets before and after the exchange were considerably less than their depreciated book values of $2,598.998.76 and $1,878,081, respectively. The parties agree that the value of the separate properties on June 1, 1939, may be taken as the value of such properties both before and after the exchange. As stated above, the respondent determined these values to be $3,250,000, itemized as follows:
+-----------------------------------------------------+ ¦Lamar Hotel Annex and leasehold ¦$375,000 ¦ +-------------------------------------------+---------¦ ¦Loew's State Theatre Building and leasehold¦650,000 ¦ +-------------------------------------------+---------¦ ¦National Standard Building and leasehold ¦750,000 ¦ +-------------------------------------------+---------¦ ¦Kirby Building and the land thereunder ¦1,075,000¦ +-------------------------------------------+---------¦ ¦Total value after exchange ¦2,850,000¦ +-------------------------------------------+---------¦ ¦Chronicle Building and leaseholds ¦400,000 ¦ +-------------------------------------------+---------¦ ¦Total value before exchange ¦3,250,000¦ +-----------------------------------------------------+
Under issue No. 3 we found the fair market value of the Chronicle Building and leaseholds on June 1, 1939, to be $260,256.72. Under the present issue it will therefore only be necessary for us to determine from the evidence the fair market value on June 1, 1939, of the four remaining properties.
Four of petitioner's witnesses testified to values of these four remaining properties as of June 1, 1939, as follows:
+---------------------------------------------------------+ ¦ ¦ ¦Loew's ¦National¦ ¦ ¦ +----------+--------+--------+--------+--------+----------¦ ¦ ¦Lamar ¦Theatre ¦Standard¦Kirby ¦Total ¦ +----------+--------+--------+--------+--------+----------¦ ¦Hester ¦$100,000¦$370,000¦None ¦$700,000¦$1,170,000¦ +----------+--------+--------+--------+--------+----------¦ ¦Butler ¦135,000 ¦375,000 ¦None ¦700,000 ¦1,210,000 ¦ +----------+--------+--------+--------+--------+----------¦ ¦Moore ¦130,000 ¦375,000 ¦None ¦700,000 ¦1,205,000 ¦ +----------+--------------------------+--------+----------¦ ¦Burchfield¦($550,000 for all three) ¦650,000 ¦1,200,000 ¦ +---------------------------------------------------------+
Houx, a witness for petitioner, and Rowe, a witness for respondent, testified to depreciated reproduction cost new values as of June 1, 1939, for the buildings only, exclusive of land and leaseholds, as follows:
+---------------------------------------------------+ ¦ ¦ ¦Loew's ¦National¦ ¦ ¦ +----+--------+--------+--------+--------+----------¦ ¦ ¦Lamar ¦Theatre ¦Standard¦Kirby ¦Total ¦ +----+--------+--------+--------+--------+----------¦ ¦Houx¦$207,143¦$439,107¦$488,176¦$380,311¦$1,514,737¦ +----+--------+--------+--------+--------+----------¦ ¦Rowe¦292,700 ¦612,000 ¦744,000 ¦570,000 ¦2,218,700 ¦ +---------------------------------------------------+
Houx expressed no opinion as to the value of the land under the Kirby Building. Rowe thought the land alone was worth $514,800, which would bring his total values of the four properties up to $2,733,500. Burchfield's $650,000 valuation of the Kirby property was divided $400,000 for the land and $250,000 for the building.
We do not deem it necessary to fix a specific value for each of the above properties. We are convinced from all of the evidence that the fair market value of the land, buildings, and equipment before and after the exchange was not more than the depreciated book values of $2,598,998.76 and $1,878,081, respectively. On the basis of these values, petitioner was insolvent both before and after the exchange. Nothing, therefore, would be gained in taking up each property separately as we did in valuing the Chronicle Building and leaseholds under issue No. 3. The testimony of the several witnesses relative to the four properties now under consideration was of the same general nature as that given relative to the Chronicle Building and leaseholds, and we do not deem it necessary to review it in detail.
The Commissioner strongly urges Lutz & Schramm Co., 1 T.C. 682, in support of his determination that Main received a profit of $427,817.98 when it transferred to Southern the Chronicle Building and leaseholds, which had a cost basis to Main of $212,182.02, for bonds of Main having a face value of $640,000. We think Lutz & Schramm Co. is distinguishable on its facts. In that case during the course of our opinion we pointed out: ‘This petitioner was not insolvent and the question is not whether it realized income from the discharge or forgiveness of indebtedness, cf. United States v. Kirby Lumber Co., 284 U.S. 1; Lakeland Grocery Co., 36 B.T.A. 289; but is rather whether it realized gain from the disposition of a piece of real property.‘
In the instant case we have found that petitioner was insolvent both before and after its transfer of the Chronicle Building and leasehold for $640,000 face value of its own bonds.
As was said in Dallas Transfer & Terminal Warehouse Co. v. Commissioner, supra:
* * * In effect the transaction was similar to what occurs in an insolvency or bankruptcy proceeding when, upon a debtor surrendering, for the benefit of his creditors, property insufficient in value to pay his debts, he is discharged from liability for his debts. This does not result in the debtor acquiring something of exchangeable value in addition to what he had before. There is a reduction or extinguishment of liabilities without any increase of assets. There is an absence of such a gain or profit as is required to come within the accepted definition of income. [Citing cases.]
We think the instant case under issue 5 falls within the ambit of such cases as Dallas Transfer & Terminal Warehouse Co. v. Commissioner, supra, rather than within the ambit of Lutz & Schramm Co., supra, and we so hold.
Decisions will be entered under Rule 50.