Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Nov 28, 1952
19 T.C. 360 (U.S.T.C. 1952)

Docket No. 36894.



Gordon Davis, Esq., and Olin W. Zeanah, Esq., for the petitioners. S. Earl Heilman, Esq., for the respondent.

Gordon Davis, Esq., and Olin W. Zeanah, Esq., for the petitioners. S. Earl Heilman, Esq., for the respondent.

1. Rentals paid to lessor after he had agreed to sell the leased property to petitioner and apply the rentals to the purchase price did not constitute rental income to petitioner.

2. Transfer of the assets of the old partnership in which the petitioner was a member to a new partnership was not accomplished by means of a sale by the old partnership, and the old partnership did not realize taxable gain as a result of the transfer.

For the taxable years ended December 31, 1944 and 1945, the respondent has determined deficiencies in income tax liability of the petitioners in the amounts of $883.64 and $8,268.39, respectively, and negligence penalties in the amounts of $44.18 and $413.42, respectively. The petitioners assign error to the respondent's determination that rentals paid in 1944 and 1945 by a partnership of which the petitioner H. Eugene Boyd was a member constituted rental income to him; and that in 1945 the partnership sold its assets and realized a gain, part of which the petitioner should have reported as his distributive share. The petitioner also assign error to the determination of negligence penalties for each of the years 1944 and 1945. Other assignments of error raised in the petition have been abandoned.


The petitioners, husband and wife, reside in Northport, Alabama. They filed the joint income tax returns for the taxable years in question with the collector of internal revenue for the district of Alabama. The petitioner, H. Eugene Boyd, computed and reported his income on the cash basis of accounting.

On May 11, 1943, the petitioner, H. Eugene Boyd, hereinafter sometimes referred to as the petitioner, and one Dr. E. L. Harper executed a lease as lessees with one Albert Holman as lessor. Albert Holman leased to the lessees a lumber yard, lumber mill, and equipment to be used in their lumber operations in Northport. The lease term was May 15, 1943 through 1944, and if neither the lessees nor the lessor, Holman, exercised the option to terminate on or after December 31, 1944, the lease was to continue for a term of 5 years after 1944, subject to the right of either party to terminate the lease on 6 months' notice.

The rental was one dollar for every one thousand feet of lumber processed in the plant or yard from the effective date of the lease, and beginning in July 1943 there was a minimum rent of $250 per month. In addition there was a rent of $30 per month for the use of an office on the premises. The lessees were obligated to make all repairs and replacements, to pay all utilities and operating expenses, to procure licenses and pay taxes other than ad valorem taxes on the leased property. The lessees were not obligated to insure the property.

The lessees were obligated to and did deposit $5,000 with the lessor as security against default in payment of rent and for loss, damage, or expense which the lessor might incur by destruction of or damage to the property. The unused portion of the deposit was to be returned at the expiration or termination of the lease.

All obligations of the lessees were binding on them individually and jointly and severally and upon any partnership that might be formed for the purpose of operating or using the leased property or any part thereof.

In case of default in payment of rent or any other substantial default by the lessees, the lessor, Holman, could give written notice of the default, and if the default was not cured in 30 days, he could terminate the lease on 10 days' notice.

In July 1943 the petitioner and Dr. Harper formed a partnership known as the Tower Lumber Company, hereinafter sometimes referred to as the Tower partnership, which operated the leased lumber mill and yard and paid the rental. Boyd contributed to the partnership equipment valued by the partners at $11,500 and Dr. Harper contributed an equal amount in cash, part of which was used for the $5,000 deposit. Each partner had a 50 per cent interest in the assets and income of the partnership. The Tower partnership computed and reported its income on the accrual basis of accounting. During its existence, the partnership paid to Holman rents varying from $350 to $1,254 per month.

On August 1, 1944, the petitioner, in his individual capacity, and the lessor, Holman, entered into a contract whereby Holman agreed to sell to the petitioner the leased property. Dr. Harper was getting old and wished to retire; he refused to become a party to the contract.

The purchase price was $36,000, payable at the rate of $1,000 per month beginning September 1, 1944. The contract provided that the monthly sums paid to Holman under the lease for August 1944 and thereafter were to be credited to the $1,000 monthly payments due under the contract.

Pursuant to the contract, the petitioner also agreed to pay $100 per month to the wife of Holman and $50 per month rent to his son for the land and improvements on which the leased property was situated.

The contract provided that:

Buyer takes possession of all the property herein agreed to be sold, at his own risk, and the loss, destruction or damage of any of said property shall not reduce the purchase price herein agreed to be paid by Buyer to Seller. Buyer agrees to carry adequate fire and extended coverage insurance on said property at his own expense and agrees to make said insurance policies payable to Seller as Seller's interest may appear, for the protection of Seller hereunder and of all of Seller's rights under This Contract as well as under Original Lease.

Title to the property remained in Holman until the petitioner made full payments of all amounts due to Holman and the latter's wife and son, and full discharged all obligations under the contract.

The contract also provided that if the plant is maintained in good working condition and the petitioner did not default in any way, then he could return the plant to Holman in full discharge of future purchase payments and terminate the lease provisions upon giving 3 months' notice, provided that he paid all unpaid balances on the $1,000 monthly payments and all rents or other amounts then due with interest. Petitioner insisted that there be included in the contract the clause which permitted him to terminate the contract and return the property under certain conditions, for he did not wish to burden his wife with a large debt if he were called to military service.

The contract further provided that it was made subject to the lease, and that Holman was entitled to receive all amounts due to the lessor, Holman, under the lease, and that the petitioner assigned to Holman all rights under the lease which he acquired under the contract.

After execution of the contract, the Tower partnership continued to pay the rent to Holman. The petitioner failed to perform his terms of the contract. Aside from the rent paid by the partnership, Holman did not receive any sums from the petitioner under the contract, nor did his wife and son at any time receive any of the rent required under the contract for the use of their real property. The petitioner did not pay taxes or insurance or make any other payments required by the contract. The contract was simply allowed to lapse. The only possession or control petitioner had of the property covered by the contract was that which he obtained and exercised under the lease.

The respondent determined that during the years 1944 and 1945 the petitioner received net rental income in the amounts of $2,074.53 and $3,313.58, respectively, from the property leased to petitioner and Harper with which the Tower Lumber Company carried on its operations.

In the spring of 1945 Dr. Harper wished to retire from the Tower partnership and to dispose of his interest in the assets of that organization. Petitioner wished to continue in business. With the view to acquiring Harper's interest, the wife, son, and daughter of Albert Holman and one Guy Rutledge suggested the formation of a new partnership together with petitioner, in which the new members would buy out the Harper interest and petitioner would contribute his share in the assets of Tower.

In June 1945 a new partnership known as Albert Holman Lumber Company was formed and the assets formerly held by tower were transferred to it. Petitioner obtained a 35 per cent interest in the new partnership, having in connection with the transaction disposed of 15 per cent of his interest in the asset of Tower. Of the 15 per cent interest, 5 per cent was acquired by Rutledge and 10 per cent was acquired by a brother of petitioner, and the assets so acquired by these two were contributed to the new partnership of which they became members.

In December 1946 the petitioner sold his 35 per cent interest in the Albert Holman Lumber Company for $32,000.

No part of the deficiency in the income tax liability of the petitioners for the taxable year 1944 was due to negligence or intentional disregard of rules and regulations.

The deficiency in the petitioners' income tax liability for the taxable year 1945 was due to negligence of the petitioner H. Eugene Boyd.



The first issue arises from the respondent's action in taxing to petitioner the rentals paid by the Tower partnership to Holman for the use of the lumberyard. The theory seems to be that the contract of purchase whereby Boyd was to acquired the lumberyard from Holman was a completed transaction that served to put Boyd in possession of the property in his own right and thereby made him the equitable owner of the property so that any income from the use of the property became the income of Boyd.

While money paid for the use of property, which money in fact is applied on the purchase price thereof, may not ordinarily be deducted as a rental, Chicago Stoker Corporation, 14 T.C. 441, it is quite another thing to include in the taxable income of a purchaser of property the very money he is paying to the seller for the acquisition of the property. It is equally difficult to see how money paid by a third person, namely, Harper, can be considered as income to Boyd, when, in fact, it was paid to Holman, and Harper was in nowise a party to the Boyd and Holman contract.

But, even if the Tower partnership is treated as a separate entity, we again have the problem of treating the rental paid to Holman as income of Boyd, for the Tower partnership was in nowise a part to the purchase of the property, and the fact that Holman may have agreed to apply this rental on the purchase price may have resulted in no more than a reduction of the purchase price.

But, more important, we do not think the facts warrant treating the contract between Holman and Boyd as other than an executory contract and not a contract of sale whereby the possession and equitable title to the property passed to Boyd. The contract of purchase was never complied with and was allowed to lapse. The only possession Boyd had of the property was by reason of the lease. Harper and Boyd continued to pay the rentals to Holman. The contract of purchase was never carried out, the property remained Holman's, the rentals were retained by him, and Boyd never acquired any of the so called payments and under the contract could not have recovered any of them. The rentals were never either actually or constructively received by Boyd and he should not be taxed on them. On this issue the petitioner is sustained.

The second issue arises from the respondent's treatment of the transaction whereby the Tower partnership went out of business and a new partnership was formed as one where there was a sale by Tower of its assets to a new partnership known as the Albert Holman Lumber Company. We think the facts do not justify this conclusion. Harper, a member of the Tower partnership, wanted to retire and new interests bought him out. The resulting profit and tax from this transaction is not in dispute. Boyd wanted to, and did, continue in the new partnership, and a part of the assets in Tower went over to the Albert Holman Lumber Company as Boyd's contribution to the new partnership. Incident to the transaction, he disposed of 15 per cent of the 50 per cent he formerly held in Tower to the persons named in our findings. Boyd's interest in the new partnership was 35 per cent.

The respondent's determination, in effect, treats a contribution of property to the capital of a partnership as a sale in which the interest in the partnership is treated as a price received for the property. We think there is no support in law for this position. Cf. sec. 113(a)(13), Internal Revenue Code, Regulations 111, sec. 29.113(a)(13)-1. On this issue the petitioner should prevail.

There remains the question of the application of the negligence penalty imposed for the years 1944 and 1945. The only adjustment for the year 1944, other than an issue determined in petitioner's favor, is the addition of $5.22 to income, which adjustment was not disputed. In the circumstances, we are of the opinion that there was no negligence or intentional disregard of rules and regulations in this omission which would warrant the imposition of the 5 per cent negligence penalty for the year 1944.

Although we have decided the major issue for the year 1945 in favor of the petitioner, there are other adjustments that gave rise to the deficiency which the petitioner does not dispute or attempt to explain. In view of the fact that the negligence penalty applies even if only part of the deficiency is due to negligence, we think, in the circumstances here present, that the respondent's determination of the 5 per cent negligence penalty must be sustained.

Decision will be entered under Rule 50.