Opinion
Docket No. 6007.
1947-09-10
MENDHAM CORPORATION, A CORPORATION OF NEW JERSEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Emanuel Wagner, Esq., for the petitioner. Albert Monacelli, Esq., for the respondent.
Foreclosure of mortgage resulting in elimination of mortgage debt and transfer of New Jersey property previously acquired by petitioner, subject to transferor's basis, in tax-free exchange, held to result in taxable gain to extent that proceeds of mortgage received by transferor-mortgagor exceeded adjusted basis for the property, notwithstanding that petitioner was not itself liable on the mortgage. Lutz & Schramm Co., 1 T.C. 682; R. O'Dell & Sons Co., 8 T.C. 1165, followed; Charles L. Nutter, 7 T.C. 480, distinguished. Emanuel Wagner, Esq., for the petitioner. Albert Monacelli, Esq., for the respondent.
Respondent determined deficiencies for the taxable year ended December 31, 1939, in income tax and declared value excess profits tax in the following amounts: Income tax, $10,772.98; and declared value excess profits tax, $6,217.98.
Petitioner having abandoned an issue raised in its pleading, the sole remaining question is whether the amount due on a mortgage, including accrued interest and taxes due on realty, constitute ‘property (other than money)‘ received by petitioner in computing the ‘amount realized‘ under Internal Revenue Code, section 111, where petitioner acquired the realty from its parent in a tax-free exchange, subject to the mortgage, and the mortgagee thereafter foreclosed the mortgage and bought in at the foreclosure sale.
Substantially all of the facts have been stipulated.
The stipulated facts are hereby found accordingly.
Petitioner, a New Jersey corporation, filed its tax returns for the year 1939 with the collector of internal revenue for the fifth district of New Jersey. It has kept its books and has prepared its returns on an accrual basis.
Upon its incorporation on June 1, 1932, it acquired from River Park Corporation (hereinafter sometimes referred to as River Park) improved real estate situate in Elizabeth, New Jersey, including certain improved realty hereinafter designated as the Isham property. In exchange for the real estate petitioner issued to River Park its entire capital stock, consisting of 10 shares of no par value common stock. This, it is agreed, was a tax-free transaction.
The Isham property consisted of two office buildings and property occupied by a gasoline station, all adjoining.
River Park had purchased the Isham property in 1927 at a cost of $231,502.16, allocating $140,000 to land and $91,502.16 to buildings; additional capital improvements in the sum of $138,233.26 were made from 1927 to 1931, which increased the amount allocated to buildings to $229,735.42.
In 1928 River Park borrowed $325,000 by placing a mortgage in that amount upon the Isham property. The money was used as follows:
+---------------------------------------------------+ ¦To pay off old mortgage on the property¦$140,000.00¦ +---------------------------------------+-----------¦ ¦Interest accrued thereon ¦10,706.70 ¦ +---------------------------------------+-----------¦ ¦Taxes ¦162.50 ¦ +---------------------------------------+-----------¦ ¦Expenses ¦4.00 ¦ +---------------------------------------+-----------¦ ¦Improvements on the property ¦25,200.00 ¦ +---------------------------------------+-----------¦ ¦Cash in bank ¦148,926.80 ¦ +---------------------------------------+-----------¦ ¦Total ¦325,000.00 ¦ +---------------------------------------------------+
Petitioner received the property from River Park subject to the mortgage, but did not become an obligor on the accompanying bond. Upon receipt of the property, petitioner set up the property on its books at its parent's cost— $140,000 allocated to land, $229,735.42 to buildings. It also set up a depreciation reserve of $28,783.33, representing what River Park had reserved on its books as depreciation on the property. Thereafter petitioner took depreciation on the property in each year, as follows, which amounts were allowed as deductions in its tax returns:
+----------------+ ¦1932 ¦$4,020.37 ¦ +-----+----------¦ ¦1933 ¦5,626.62 ¦ +-----+----------¦ ¦1934 ¦5,626.62 ¦ +-----+----------¦ ¦1935 ¦5,626.62 ¦ +-----+----------¦ ¦1936 ¦5,626.62 ¦ +-----+----------¦ ¦1937 ¦5,626.62 ¦ +-----+----------¦ ¦1938 ¦5,626.62 ¦ +-----+----------¦ ¦Total¦37,780.09 ¦ +----------------+
In connection with the Isham property petitioner accrued on its books and deducted in its income tax returns, but never paid, the following charges, all of which were payable in the years enumerated:
+-------------------------------------+ ¦Year ¦Interest on¦Taxes ¦Total ¦ +-----+-----------+---------+---------¦ ¦ ¦mortgage ¦ ¦ ¦ +-----+-----------+---------+---------¦ ¦1936 ¦$3,396.63 ¦ ¦$3,396.63¦ +-----+-----------+---------+---------¦ ¦1937 ¦19,500.00 ¦ ¦19,500.00¦ +-----+-----------+---------+---------¦ ¦1938 ¦19,500.00 ¦$2,723.13¦22,223.13¦ +-----+-----------+---------+---------¦ ¦Total¦42,396.63 ¦2,723.13 ¦45,119.76¦ +-------------------------------------+
The net operating loss on the Isham property as shown on petitioner's books totals $62,498.93, which total includes (1) $39,000 representing mortgage interest accrued in 1937 and 1938 by petitioner, but never paid, and (2) interest on past due taxes totaling $1,688.51, which respondent considers a financing expense of petitioner, rather than an operating expense of the property.
In 1939 the mortgagee instituted foreclosure proceedings upon the Isham property, and title to the property was conveyed to it by sheriff's deed, dated September 22, 1939, the mortgagee having bid in the property at $100.
The transaction was recorded in petitioner's books as follows:
+----------------------------------------------------------------+ ¦Mortgage Payable ¦$325,000.00¦ ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Reserve for Depreciation ¦66,563.42 ¦ ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Interest Accrued ¦42,396.63 ¦ ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Taxes Accrued ¦2,723.13 ¦ ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦ ¦ ¦ ¦$436,683.18¦ +-----------------------------+-----------+----------+-----------¦ ¦Rents Receivable ¦ ¦$2,693.12 ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Due from Prudential for Rents¦ ¦4,481.59 ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Land and Building “Isham” ¦ ¦369,735.42¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Due from Agents ¦ ¦79.91 ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦Surplus ¦ ¦59,693.24 ¦ ¦ +-----------------------------+-----------+----------+-----------¦ ¦ ¦ ¦ ¦436,683.18 ¦ +-----------------------------+-----------+----------+-----------¦ ¦ ¦ ¦ ¦ ¦ +----------------------------------------------------------------¦ ¦To reflect loss on Isham Building taken over by Mortgagee. ¦ +----------------------------------------------------------------+
Following the foreclosure of the mortgage, petitioner set up on its books the sum of $3,200 as a result of an oral agreement with the mortgagee whereby the mortgagee agreed not to sue for a deficiency and petitioner's grantor agreed to pay the mortgagee the sum of $3,200, said agreement having been made prior to the expiration of the three-month statutory period within which a suit for deficiency must be instituted. Suit for deficiency was never instituted. No part of said sum of $3,200 was ever paid either by petitioner or by petitioner's grantor.
In all its income tax returns from 1933 through 1939 petitioner carried the $325,000 mortgage on its balance sheet as a liability and carried the Isham property as an asset valued at $369,735.42. In its 1939 income tax return petitioner reported a surplus of $48,349.38. Both before and after the foreclosure upon the Isham property, petitioner was solvent. The Isham property had a value of $165,000 in September 1939.
In the statement attached to the notice of deficiency, respondent asserted:
It is held that the taxpayer corporation realized a taxable gain to the extent of $59,693.24 in the year 1939 upon the disposition, through foreclosure proceedings, of property known as ‘Isham Property.‘
OPINION.
OPPER, Judge:
Superficially it might appear that the present proceeding, involving an issue similar to the one presented by R. O'Dell & Sons Co., 8 T.C. 1165, is distinguishable from that case because of this petitioner's freedom from liability on the mortgage debt. The O'Dell case, however, was decided on the authority of Lutz & Schramm Co., 1 T.C. 682, which deals with the question, not from the standpoint of the elimination of an indebtedness, cf. United States v. Kirby Lumber Co., 284 U.S. 1, but as gain upon the final disposition of property.
Here, as in R. O'Dell & Sons Co., supra, petitioner's property was sold in foreclosure and as a result a mortgage indebtedness greater than petitioner's basis was eliminated under the New Jersey law. In several respects the difficulties here are fewer. Expiration of the limitation on any proceeding to collect the debt occurred here in the same year as the sale; and, in addition, the debt was discharged by affirmative agreement of the parties and not merely barred by operation of law. Although the record in the O'Dell case was not definitive, it was assumed there, for failure of proof to the contrary, that the taxpayer had, as in Lutz & Schramm, supra, itself placed the mortgage on the property and received its proceeds to do with as it pleased, free from restriction. The resulting indebtedness prevented the original borrowing from creating gain, but the transaction was completed when the mortgage was discharged in exchange for a conveyance of the property, the final disposition of which thus established as taxable income the difference between the basis for the property and the amount acquired from the earlier borrowing. Unlike Charles L. Nutter, 7 T.C. 480, which presented only a situation ‘akin to a reduction of sale price,‘ O'Dell and Lutz & Schramm involved not purchase money mortgages, but subsequent borrowings resulting in an ultimate cash benefit to the mortgagor upon completion of the whole operation. Cf. 4 The Tax Barometer, Par. 331 (June 14, 1947).
Whether this proceeding presents a comparable situation depends upon the effect of the circumstance that it was not petitioner, but its transferor in a nontaxable exchange, which made the original borrowing, and hence the opening move toward that final profit. Had the sale to petitioner been an ordinary one, the gain to its predecessor, including the receipt from the mortgage loan, would have been computed at the time, and the necessity of considering its effect upon petitioner would not have arisen. But, because the whole operation was within the corporate family, no tax consequence attached and petitioner took the property accompanied by its transferor's basis. Sec. 113(a)(8). Nevertheless, it is petitioner's disposition of the property, and its elimination of the mortgage debt, which concludes the operation instituted by its predecessor and furnishes the occasion for a survey of the results of the entire transaction. Unless the transferee's situation be thought of as including the consequences of the original borrowing, that phase of the calculation will never be taken into account, and this omission will be the direct consequence of the tax-postponing provisions of section 112. Since the underlying philosophy of the statutory treatment of basis after tax-free exchanges is to preserve the continuity of dealings in property
for the very purpose of avoiding such a result, H. Rept. 179 (68th Cong., 1st sess.), pp. 16-17, we think it would be inconsistent with those provisions to disregard the ultimate profit from the entire operation in fixing petitioner's gain on the sale.
‘ * * * the exchange and basis provisions have two important results: (a) to postpone the determination and recognition of gain or loss, in the cases of the designated exchanges, from the time the exchange is made, until the time when the securities or property are disposed of; and (b) to impose upon the transferee a possible tax upon any appreciation which may have accrued in the hands of the transferor, prior to the transfer.‘ Magill, Taxable Income (Rev. Ed.), 168-169.
2.
This view is supported by various considerations. It is only the reduction of basis for depreciation deductions previously allowed which leads to the attribution to petitioner of any profit on the sale. This, as we pointed out in R. O'Dell & Sons Co., supra, is necessary to a proper consideration of the gain in such a case as this, under the principle of Crane v. Commissioner, 331 U.S. 1. But the depreciation was essentially that deducted by and beneficial to the predecessor. Had not petitioner, as compelled by section 113, debited itself with its transferor's accumulated depreciation, there would have been no excess of proceeds over basis on any theory.
Hence, to sustain petitioner by eliminating the gain to the combined owners resulting from the original borrowing would have the same effect as disregarding the predecessor's depreciation— an action expressly condemned by section 113.
Furthermore, although the occasion for its application is different, this situation seems to fall solidly within the doctrine of such cases as Commissioner v. Sansome (C.C.A., 2d Cir.), 60 Fed.(2d) 931; certiorari denied, 287 U.S. 667; and Commissioner v. Munter, 331 U.S. 210. We may say here in paraphrase of the former case: ‘A corporate reorganization which results in no gain or loss‘ under section 112 ‘does not toll‘ the property's ‘life as (a) continued venture.‘ It seems to us to follow that petitioner must be treated here exactly as though it had itself placed the mortgage on the property and benefited by the cash so acquired.
Thus regarded, petitioner's situation is not to be distinguished from that dealt with in Lutz & Schramm Co., supra, and R. O'Dell & Sons Co., supra, and the result here must be the same.
As appears in our findings, petitioner's transferor concluded the original borrowing with $148,926.80 ‘cash in bank.‘
What we have said, however, applies only to so much of petitioner's gain as arises from the computation of sale price and adjusted basis. Cf. Virginian Hotel Corporation of Lynchburg v. Helvering, 319 U.S. 523. To the extent that the deficiency includes interest and taxes which petitioner was never required to pay, respondent's determination must be disapproved on the principle of Helvering v. American Dental Co., 318 U.S. 322.
Reviewed by the Court.
Decision will be entered under Rule 50.
ARUNDELL, VAN FOSSAN, TYSON, HILL, DISNEY, and HARRON, JJ., dissent.
+-----------------------------------------------------+ ¦Amount received from mortgage¦ ¦$325,000.00¦ +-----------------------------+-----------+-----------¦ +-----------------------------+-----------+-----------¦ ¦Original cost of property ¦$369,735.42¦ ¦ +-----------------------------+-----------+-----------¦ ¦Petitioner's depreciation ¦37,780.09 ¦ ¦ +-----------------------------+-----------+-----------¦ ¦ ¦ ¦331,955.33 ¦ +-----------------------------------------------------+