Opinion
Docket No. 84886.
1962-03-16
HALSEY L. WILLIAMS AND JANE C. WILLIAMS, PETITIONERS, V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Halsey L. Williams, pro se. Eugene F. Reardon, Esq., for the respondent.
Halsey L. Williams, pro se. Eugene F. Reardon, Esq., for the respondent.
1. Value of certain inherited property determined as of date of decedent's death in order to establish basis for computing subsequent loss.
2. Held: Property received in a taxable exchange in 1941 takes on a basis equal to its fair market as of the time of the exchange. Cf. Philadelphia Park Amusement Co. v. United States, 126 F.Supp. 184 (Ct. Cl.). Value of such property determined.
The Commissioner determined a deficiency in petitioners' income tax for the year 1955 in the amount of $6,244.93 and for the year 1956 in the amount of $7,409.52. The question presented is whether petitioner Halsey L. Williams sustained a loss upon the sale of his interests in certain commercial property to the State of California in 1951, and the answer depends upon a determination of his basis in those interests. No question relating to petitioner's right to a carryover to the taxable years is presently in issue.
FINDINGS OF FACT.
The facts stipulated by the parties are incorporated herein by this reference.
Petitioners Halsey L. and Jane C. Williams, husband and wife residing in Riverside, California, filed joint income tax returns for the taxable years 1955 and 1956 with the collector or director of internal revenue, Los Angeles, California. Jane is a party herein solely because joint returns were filed. Halsey L. Williams will hereinafter be referred to as Halsey.
In 1922 Halsey's father owned certain unimproved land which was located in downtown Los Angeles at 1020-1038 West Seventh Street. Halsey's father leased the land to an individual named Stuart M. Salisbury on August 1, 1922. The lease was for a term of 15 years commencing on August 1, 1922, and providing among other things that the lessee should construct a building or buildings upon said premises costing not less than $50,000. The lease also provided:
IV. Ownership of New Building. All buildings constructed on said premises by the Lessee shall remain on said land and shall become the absolute property of the Lessor, without cost to him, upon any termination of this lease, whether by lapse of time or by forfeiture or otherwise. Nothing in this section, or in the section numbered XII and headed ‘Forfeiture by Default,‘ shall be construed as placing the title of the new buildings to be erected in the Lessee but said new buildings shall be part of the land the title to the same shall at all times be in the Lessor, subject to the leasehold interest of the Lessee in the same manner as the land itself.
The lessee was required to pay for all utilities, maintenance, and repairs, to pay all taxes, and to pay the lessor the sum of $25,000 as rental, payable $5,000 per year during each of the last 5 years of the lease, commencing August 1, 1932. The lessee was given the right to assign the lease in whole or in part.
On October 30, 1922, Stuart M. Salisbury assigned the lease to the Sun Realty Company for certain considerations. Sun Realty Company constructed a building on the land in 1924. The building consisted of a two-story stucco frame construction containing 10 stores and a 36-room hotel. The land also contained a parking area. At the time of its completion the building had a useful life of 40 years.
Halsey's father died on October 4, 1926. As of the date of his death, the land and building were valued at $500,000 for Federal estate tax and California State inheritance tax purposes. No allocation of the $500,000 was made between the land and building in either tax valuation.
After completion of the building the Sun Realty Company operated it as a hotel and rented the 10 ground floor areas as stores until September 6, 1932, when it ceased operating the building under the lease and voluntarily abandoned the premises. Under the terms of the lease this abandonment by the lessee-assignee terminated the lease.
Under the terms of the will of Halsey's father, title to the land (including any interest in the building) passed to a testamentary trust in which the Bank of California was named as trustee. Under the terms of the trust Halsey received a four-fifteenths interest in the land and the building, and his brothers and a sister received the remaining interest.
On February 20, 1931, the trust paid a storm drain assessment to the City of Los Angeles in an amount of $1,348.35 on the land and the building. Also while the property was held in trust, the trust paid attorney's fees in the amount of $250,30 in connection with proceedings on a setback ordinance directly related to the property. When the building was obtained from the lessees as described above, the trust paid attorney's fees in an amount of $100 in connection with the repossession of the building and improvements. On December 14, 1934, the trust paid attorney's fees in an amount of $200 in connection with a quiet title suit on the property.
The land and building were held in the trust until September 8, 1937, when under its provisions the trust terminated and the corpus was distributed to the beneficiaries. During the time the trust held the property the trust never claimed any depreciation on the building in any income tax returns filed by it.
Upon termination of the trust the beneficiaries continued to operate the building as a hotel, to rent out the ground floor stores, and to lease the parking lot area.
Halsey's brother Burdick F. Williams also inherited a four-fifteenths interest in the hotel property (land and building) from their father. Halsey's and Brudick's mother died on September 1, 1930. Included in the mother's estate was a private residence located at 15 Glen Alpine Road, Piedmont, California, the household furnishings therein, and certain silverware and other silver pieces located in said residence. Halsey and Burdick each inherited an undivided one-half interest in the Piedmont residence, the household furnishings therein, and the aforementioned silverware and other silver pieces.
In both the Federal estate tax return and the California State inheritance tax return, the Piedmont residence was valued in a total amount of $115,000 as of the date of the mother's death. The household furnishings in the Piedmont residence were valued in a total amount of $7,500 in the same returns.
On April 1, 1941, Halsey exchanged his undivided one-half interest in the Piedmont residence, the household furniture and fixtures therein, and the silverware and other silver pieces for Burdick's four-fifteenths interest in the Los Angeles hotel property (land and building). This exchange gave Burdick sole title to the Piedmont residence, the household furnishings and fixtures therein, the silverware, and the other silver pieces. After the exchange Halsey owned an undivided eight-fifteenths interest in the Los Angeles hotel property.
The exchange was arranged by Burdick so that he could obtain cash with which to make an investment in certain other property. Prior to the exchange Burdick had received an offer for the Piedmont residence which he believed Halsey would consider unsatisfactory. He, therefore, suggested the exchange so that he would be in a position to make the sale. Within 40 days of the exchange Burdick sold the Piedmont residence, including some of the household furnishings, to the party who had made the preexchange offer for a total price of $58,500. Burdick considered the sale of the Piedmont residence for this price somewhat of a ‘sacrifice sale’ at the time. The only prior purchase offer which had been made for the Piedmont residence had been in 1931 in the amount of $110,000.
Neither Halsey nor Burdick reported any profit or loss for Federal income tax purposes on their April 1, 1941, exchange of property interests.
On or about November 22, 1950, the State of California initiated condemnation proceedings to acquire the Los Angeles hotel property (land and building) for the purpose of building a ‘freeway’ through such property. Halsey and the other owners of the property opposed the condemnation and contended that the price offered by the State for the land and building did not constitute adequate compensation. Court proceedings were commenced to determine the amount of compensation to be paid by the State and were terminated on September 26, 1951, when a final judgment was entered in the Superior Court of the State of California for the County of Los Angeles under which title to the property passed to the State of California on September 25, 1951, and the compensation to be paid for the property was determined to be a total amount of $231,000 of which $161,250 was allocated to the land and $69,750 was allocated to the building.
In October 1951 the State of California paid Halsey eight-fifteenths of $231,000 or $123,200 for his interest in the land and building.
During 1951 Halsey and the other owners of the property incurred expenses in connection with the condemnation litigation in a total amount of $21,332.63, of which Halsey paid his aliquot eight-fifteenths share amounting to $11,377.40.
Halsey claimed no depreciation on the Los Angeles hotel property building in any of his income tax returns prior to and including the year 1939. On his 1940 income tax return, signed by L. F. Lamont, attorney in fact,.$868.13 was claimed as depreciation on the building which was reported to have been acquired on September 6, 1932, at a cost of $34,725.
On his 1941 return, signed by the same Lamont, $231.50 was claimed as depreciation on Halsey's original four-fifteenths interest in the building and $172.05 was claimed as depreciation on the four-fifteenths interest in the building acquired on April 1, 1941, from Burdick at a reported cost of $7,206.50. On Halsey's 1950 income tax return, as amended, he claimed $231.50 as depreciation on his original four-fifteenths interest in the building (shown to have been acquired on September 6, 1932, at a cost of four-fifteenths of $34,725, or $9,260, and to have an estimated life of 40 years), and he claimed $229.40 as depreciation on the four-fifteenths interest in the building acquired from Burdick (shown to have been acquired on April 1, 1941, at a cost of $7,206.50 and to have an estimated life of 31 5/12 years). On his 1951 return, as amended, Halsey determined the adjusted basis of his interests in the building on the same cost and depreciation scale that he used in his 1950 return.
From subsequent returns filed by Halsey, it appears that what was assumed to be the entire allowable depreciation on the building in 1940 was mistakenly claimed on Halsey's return for that year rather than only four-fifteenths of such amount which Halsey claimed in later years.
Halsey's brother Chester N. Williams also inherited a four-fifteenths interest in the Los Angeles hotel property which he retained until the entire property was acquired by the State of California in 1951. On his 1950 income tax return, Chester claimed a depreciation deduction on his interest in the building based on the assumption that the building was worth $200,000 and the land was worth $300,000 at the time of his father's death in 1926.
Halsey claims that the total amount of his loss arising out of the 1951 condemnation was $146,769.94. In addition, Halsey claimed a net operating loss from mining operations in an amount of $14,229.29 on his amended return for the year 1951. Therefore, the total net operating loss claimed by Halsey for 1951 is an amount of $160,999.23.
Halsey filed individual income tax returns for the years 1950 and 1951. Halsey and Jane were married in 1952 and filed joint income tax returns for the years 1952 through 1956. No net operating loss deductions were claimed in the original returns filed for the years 1950, 1952, 1953, and 1954. The net operating loss that Halsey contends was incurred in 1951 upon the disposition of the Los Angeles hotel property to the State of California was claimed by Halsey as a loss carryback in an amended return filed for the year 1950 and as a loss carryover in amended returns for the years 1952 and 1954 and in the original returns filed for the years 1955 and 1956. Petitioners reported no taxable income in their original return for the year 1953.
In the aforementioned amended returns for the years 1950, 1951, 1952, and 1954, and in the original returns for the years 1953, 1955, and 1956, the following net operating loss deductions were claimed:
+----------------------------------+ ¦ ¦Total available¦Net operating¦ +----+---------------+-------------¦ ¦Year¦net operating ¦loss applied ¦ +----+---------------+-------------¦ ¦ ¦loss claimed ¦in return ¦ +----+---------------+-------------¦ ¦ ¦per return ¦ ¦ +----+---------------+-------------¦ ¦1950¦$129,971.36 ¦$14,728.04 ¦ +----+---------------+-------------¦ ¦1951¦160,999.23 ¦31,027.87 ¦ +----+---------------+-------------¦ ¦1952¦115,243.32 ¦7,537.02 ¦ +----+---------------+-------------¦ ¦1953¦107,706.30 ¦None ¦ +----+---------------+-------------¦ ¦1954¦107,706.30 ¦22,690.23 ¦ +----+---------------+-------------¦ ¦1955¦85,016.07 ¦26,221.97 ¦ +----+---------------+-------------¦ ¦1956¦58,794.10 ¦29,653.61 ¦ +----------------------------------+
The Commissioner disallowed the net operating loss deductions claimed in the years 1955 and 1956. The deficiency notice sent to petitioners explained this adjustment as follows:
It is held that you sustained no loss in the year 1951; also, the loss as claimed for the year 1951 does not constitute a net operating loss for the year 1951 or a net operating loss carry-over to the years 1955 and 1956 under the applicable provisions of the Internal Revenue Code of 1939 or the Internal Revenue Code of 1954.
At the trial and on brief the Commissioner conceded that if Halsey did incur a condemnation loss in 1951, it would be properly includible in computing a net operating loss and would be subject to carryover under the applicable statutes.
The fair market value of the Los Angeles hotel property (land and building) on the date of death of Halsey's father was $500,000. The land had a fair market value on such date in the amount of $432,500, and the building had a fair market value on such date in the amount of $67,500.
The fair market value of the Los Angeles hotel property (land and building) on April 1, 1941, was $220,000. The land had a fair market value on such date in the amount of $160,000, and the building had a fair market value on such date in the amount of $60,000.
OPINION.
RAUM, Judge:
We are asked to determine Halsey's basis in two separately acquired four-fifteenths interests in certain Los Angeles commercial property which was sold pursuant to condemnation proceedings to the State of California in 1951. If as petitioners contend Halsey incurred a loss on this sale, the Commissioner concedes that such loss is includible in computing a net operating loss for 1951 and the amount, if any, of the carryover of that net operating loss to the taxable years in issue may be computed under Rule 50. Since the amount received by Halsey in the condemnation proceedings is not in dispute,
the only issue before us is the determination of the basis of each of the four-fifteenths interests sold by him in the condemnation proceedings. It will be convenient to deal with each of these interests separately.
Nor is there any dispute that the amount received by Halsey must be reduced by his $11,377.40 aliquot share of the litigation expenses.
1. Interest acquired by inheritance.— Halsey acquired his original four-fifteenths interest in the Los Angeles hotel property by inheritance from his father, who died on October 4, 1926. It is agreed by the parties that Halsey's basis in this interest and the allocation thereof between the land and building is dependent upon the fair market value of the Los Angeles hotel property and its component parts on the date of the father's death. It is stipulated that the entire property was valued in the amount of $500,000 for Federal estate tax and California inheritance tax purposes, and the parties accept that figure as controlling here. Cf. Regs. 111, sec. 29.113(a)(5)-1(c). The principal matter in controversy in regard to Halsey's basis in his inherited four-fifteenths interest is the allocation of the foregoing amount between the land and building, so that proper adjustments for depreciation may be made against that portion allocated to the building.
Other adjustments to land and building, based upon certain facts stipulated by the parties, are not in dispute herein, and will be given effect in the decision to be entered under Rule 50. See infra.
We have found as a fact that on the date of Halsey's father's death the land and building had fair market values of $432,500 and $67,500, respectively. Our finding is based to a considerable extent upon the testimony of an expert witness who impressed us as being highly reliable, who was familiar with the area over a long period of years, and who had valued this very property in 1926. The Commissioner presented no expert evidence on the 1926 allocation, and offered no rebuttal to petitioners' evidence other than some unpersuasive testimony by one of Halsey's brothers, Chester N. Williams, who had also inherited a four-fifteenths interest in the same property, and who testified that he ‘thought the building might be worth 2/5ths of the total price * * * of $500,000’ in computing his own depreciation deductions.
He also testified that he had ‘no idea what it (the land) was worth.’
In separate litigation involving Chester, the $200,000 figure used by him was accepted by this Court. Chester N. Williams, T.C. Memo. 1960-275. However,since the facts in that case appear to have been fully stipulated the Court did not have the benefit of the expert testimony presented to us in the present case, and it plainly indicated that it was with skepticism that it accepted the $200,000 valuation in the circumstances presented by the record before it.
Our finding that the land had a fair market value of $432,500 in 1926 and that the building had a fair market value of $67,500 in 1926 disposes of everything in controversy between the parties as to Halsey's basis in the four-fifteenths interest inherited from his father. The adjustments for depreciation of the building may be made in the computation under Rule 50.
Also, the Commissioner concedes that Halsey's allocable share of certain stipulated additions to basis must be taken into consideration in determining the amount of his adjusted basis in his inherited four-fifteenths interest in the land and building. Thus, $1,348.35 paid as a storm assessment to the City of Los Angeles on February 20, 1931, and $250.30 paid as attorney's fees in connection with proceedings on a setback ordinance related to the land must be added to the total basis of the land. Similarly, $100 expended by the trust which held title to the building in 1933 and $200 expended by the trust in 1934 must be added to the total basis of the building. These adjustments will also be taken into account in the Rule 50 computation.
The Commissioner argues on brief, and petitioners do not disagree, that the depreciation adjustments should be made from the date of the termination of the lease in 1932 rather than from the date of the father's death 1926. Accordingly, since there is no issue between the parties in this regard, it becomes unnecessary for us to consider whether cases like Schubert v. Commissioner, 286 F.2d 573 (C.A. 4), affirming 33 T.C. 1048, certiorari denied 366 U.S. 960, are applicable here.
2. Interest acquired by exchange.— Halsey acquired a second four-fifteenths interest in the Los Angeles hotel property on April 1, 1941, by an exchange of property interests with his brother Burdick F. Williams. Halsey traded a one-half interest in a residence in Piedmont, California, its furnishings, some silverware and silver pieces, inherited from his mother, for Burdick's four-fifteenths interest in the hotel property. Neither Halsey nor Burdick reported any gain or loss on the exchange in their Federal income tax returns for 1941. However, neither of the parties herein argues that the exchange was nontaxable. The only matter presently in dispute is Halsey's basis in the four-fifteenths interest he acquired by the exchange. Petitioners argue that this basis is equal to the fair market value of the interest Halsey received, that is, of a four-fifteenths interest in the hotel property on April 1, 1941. The Commissioner's position is that the basis is equivalent to the fair market value of the interest given up, that is of Halsey's one-half interest in the Piedmont residence and related personal property. Both parties cite and rely upon Philadelphia Park Amusement Co. v. United States, 126 F.Supp. 184 (Ct. Cl.). In the circumstances of this case, where the property interests exchanged both had been ascertainable fair market value as of the date of the exchange, we think petitioners' statement of the applicable principle of law correct. In the Philadelphia Park case, 126 F.Supp. 188-189, the reason for selecting the fair market value of the property interest received as the basis of such property was explained as follows:
When property is exchanged for property in a taxable exchange the taxpayer is taxed on the difference between the adjusted basis of the property given in exchange and the fair market value of the property received in exchange. For purposes of determining gain or loss the fair market value of the property received is treated as cash and taxed accordingly. To maintain harmony with the fundamental purpose of these sections, it is necessary to consider the fair market value of the property received as the cost basis to the taxpayer. The failure to do so would result in allowing the taxpayer a stepped-up basis, without paying a tax therefor, if the fair market value of the property received is less than the fair market value of the property given, and the taxpayer would be subjected to a double tax if the fair market value of the property received is more than the fair market value of the property given. By holding that the fair market value of the property received in a taxable exchange is the cost basis, the above discrepancy is avoided and the basis of the property received will equal the adjusted basis of the property given plus any gain recognized, or that should have been recognized, or minus any loss recognized, or that should have been recognized.
We are in accord with this view. Cf. Rev. Rul. 55-757, 1955-2 C.B. 557.
It is true that in the Philadelphia Park case itself, there is some indication that the interest there received by the taxpayer, a 10-year extension of a railway franchise, may not have had an ascertainable fair market value, so it was specifically provided in that case that the fair market value of the interest given up, the ownership of a bridge, might be presumed to be the value of the extended franchise in the arm's-length transaction there under consideration. Here, there is no such problem. Here, the hotel property interest acquired may be valued as readily as the interest in the Piedmont residence and personalty which was relinquished. Petitioners have presented testimony of two expert witnesses in regard to the value of the hotel property on April 1, 1941. On the basis of such testimony and the other evidence of record, we have made findings that the subject property had a total fair market value of $220,000 on the date of the exchange, consisting of the building worth $60,000 and the land worth $160,000. Thus, a four-fifteenths interest in this property on the exchange date had a fair market value of approximately $58,666.67. This basis must, of course, be adjusted for depreciation of the building from April 1, 1941, until the condemnation sale in 1951. We do not understand that there is any dispute between the parties with respect to such adjustment, and it may be made in the Rule 50 computation.
Decision will be entered under Rule 50.