Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Sep 30, 1948
11 T.C. 538 (U.S.T.C. 1948)

Docket No. 17195.



Edward R. Larence, Esq., for the petitioner. S. W. Herzfeld, Esq., for the respondent.

Held: (1) That certain property constituted a capital asset and not real property used in taxpayer's trade or business.

(2) Where taxpayer claims a specific deduction of taxes paid he may not also claim the standard deduction of $500.

(3) A certain bad debt proven to be worthless in the taxable year allowed as a deduction. Edward R. Larence, Esq., for the petitioner. S. W. Herzfeld, Esq., for the respondent.

The respondent determined a deficiency of $1,387.61 in petitioner's income tax liability for the year 1945. The issues raised are:

(1) The propriety of the deduction of $2,563.60 as a loss incurred on the sale of a lot claimed by petitioner to be an ordinary loss;

(2) A deduction in the sum of $868.66 for taxes paid on such lot claimed by petitioner, who also claimed the standard deduction; and

(3) A deduction of $2,025.25 as a business debt alleged to have become worthless in the taxable year.


The petitioner is an individual, residing at Aspinwall, Pennsylvania, whose return for the taxable period herein was filed with the collector of internal revenue for the twenty-third district of Pennsylvania.

In 1923 the petitioner was engaged in the automobile business in Pittsburgh, being a stockholder and manager of Automotive Corporation. The corporation sold Mitchell automobiles. During the year 1923 the Automotive Corporation sold a Mitchell car to one Reid for $1,500. As a part of the same transaction, Reid sold to petitioner a lot located on Harvard Street, Pittsburgh, for $2,500. The deed was dated September 28, 1923.

Petitioner bought the lot with the purpose and intent of erecting thereon a paint shop for the purpose of painting automobiles.

On August 9, 1923, the first zoning ordinance of the city of Pittsburgh was enacted. This ordinance zoned the lot at 5711 Harvard Street, later acquired by petitioner, as residential, prohibiting the erection of a commercial building thereon.

After petitioner acquired the lot he prepared plans for a building to be erected on the lot and applied to the city of Pittsburgh for a permit, which was refused because of the zoning law prohibiting the erection of a commercial building on the lot.

On December 7, 1945, petitioner sold the Harvard Street lot to Granville Hart and Gladys T. Hart for a total consideration of $811.

During the year 1945 petitioner paid city, school, and county taxes on the lot in the sum of $868.66.

In the early part of 1941, when petitioner was in the automobile business in Verona, Allegheny County, Pennsylvania, he entered into a joint venture with Robert B. Vaughn for the promotion and sale of certain plastic products manufactured by Dr. Glenn Casto Co. of Spencer, West Virginia. Petitioner loaned various sums to Vaughn for expenses, who agreed to give him an interest in the business.

From March 23, 1941, until July 31, 1942, petitioner loaned Vaughn the aggregate sum of $3,136.39. Petitioner made one sale of Dr. Casto products, the proceeds being $725, which amount he retained and credited on the amount due from Vaughn, making the net amount due on said loans $2,411.39. Of this amount petitioner claims the sum of $2,025.25 as a bad debt.

On December 22, 1941, Vaughn wrote petitioner as follows:

Since you have loaned me various sums of money on this Plastic business— I shall pay over to you all my half of the commissions on acetone and butyl alcohol which I am now selling in carload lots, etc.— through J. C. Ackerman, Importer and Exporter, Oliver Building, Pittsburgh, Pa. until the entire amount you have advanced is repaid you.

Mr. Ackerman advised he has at the present time a volume of twelve carloads he can place— as soon as the first carload— sold to Neville Company is delivered.

On February 5, 1942, R. B. Vaughn wrote to petitioner as follows:

This letter is to advise you that all funds advanced me to date, is done on a basis of protecting you with the Life time contract between Dr. Glenn Casto and the writer; in other words, as soon as we can spare money and time to organize a corporation you are to have all monies returned and such interest as the State and Federal Laws permit me to give you for an interest, stock, etc.

On April 17, 1942, R. B. Vaughn wrote to petitioner as follows:

As per our verbal agreement, relative to a division of interest in Dr. Casto rubber and plastic contracts, duly signed by Dr. Glenn Casto Co. to the writer, I hereby agree that you are to have all monies advanced on developing this business, from the time you became interested financially in same by paying draft on tooth brush shipment, to the present, returned to you in full. Then what interest we manage to save by promoting both businesses, you are to share equally with me.

As explained to you, certain individuals advanced certain expense money to me before you came in with me. These parties are to be taken care of in a fair and equitable manner, either in stock or interest. I am sure you will approve of this.

The products made by the Dr. Glenn Casto Co. consisted of toothbrushes, various powders, and other dental supplies, together with rubber substitutes.

Vaughn furnished petitioner with copies of his agreements with Dr. Glenn Casto Co. The agreement dated June 30, 1941, granted Vaughn the exclusive right to sell and market the Dr. Casto toothbrushes, acrelic the exclusive right to sell and market the Dr. Cast toothbrushes, acrelic powder, and all other hard plastic products manufactured by Dr. Glenn Casto Co. The agreement dated February 16, 1942, granted Vaughn an option for the entire output of substitute rubber materials for use in auto tires.

Petitioner entered into a written agreement with Louis M. Robinson, dated January 11, 1943, by the terms of which petitioner agreed to assign his one-half interest in the synthetic rubber contract between Vaughn and Dr. Glenn Casto. The agreement was contingent upon Vaughn also assigning his interest.

Vaughn refused to assign his interest in the Casto contract in 1945 and in that same year turned the contract, which was then in default, back to Dr. Casto.

In 1945 petitioner made an investigation of the Vaughn loan to determine if it was collectible. After investigation he ascertained the loan to be worthless. Vaughn was ill in 1945 and died in the early part of 1946.

The debt of Vaughn to petitioner became worthless in the taxable year. It was a business debt.

As item 2 of his individual income tax return for the year 1945, petitioner reported income in the amount of $9,212.19. As item 4, he claimed as a deduction the loss of $4,588.85. On schedule D of the return, petitioner claimed two losses, one of $2,563.60 arising from the sale for $811.06 of the Harvard Street lot, against which he claimed as expense of sale $874.60, this item, in fact, being taxes paid. Petitioner also reported a loss of $2,025.25 on account of a bad debt. Petitioner also claimed the standard deduction of $500.

The respondent disallowed both items of loss in the respective amounts of $2,563.60 on account of the sale of the lot, and $2,025.25 claimed as a bad debt. Respondent further held that, if petitioner was entitled to any loss on account of the lot, the loss would be limited by the provisions of section 117(d)(2) (sale of capital asset). In computing the deficiency, respondent allowed the $500 standard deduction.



The respondent disallowed any loss on account of the sale of the Harvard Street property because petitioner had not established his cost or other basis. At the hearing this defect was remedied and a cost of $2,500 was proven.

The petitioner contends in respect of the loss that the Harvard Street lot was real property used in his trade or business; that it was accordingly excluded from the category of capital assets; and that the loss sustained on its sale was deductible as an ordinary business loss. We disagree. At the time petitioner bought the lot in 1923 it was restricted property, zoned residential. Had he taken the pains to inquire he could have learned this fact. This he did not do. The consequence was that he bought a lot which he was expressly forbidden by local law from using in his trade or business. As a matter of fact also, petitioner never used the lot in his trade or business. As a matter of fact also, petitioner never used the lot in his trade or business. Thus this case differs basically from those where a business use existed in fact and differs basically from those where a business use existed in fact and was later abandoned or where the use ceases to be possible because of changed conditions. Cf. Carter-Colton Cigar Co., 9 T.C. 219, and Solomon Wright, Jr., 9 T.C. 173.

We hold that petitioner's property constituted a capital asset and that the loss deduction is accordingly limited by section 117.

The facts as to the second issue appear chiefly in petitioner's tax return. He reported gross income of $9,212.19 and adjusted gross income of $4,623.34. His return showed losses aggregating $4,588.85, consisting of a bad debt of $2,025.25 and loss on the sale of the Harvard Street property in the amount of $2,563.60, which was computed as follows: From the selling price of $811 he deducted the cost of $2,500 and to the resulting figure he added taxes paid in the amount of $874.60 as expenses of sale, resulting in the figure of $2,563.60. Although the taxes were improperly added to the loss as above shown, respondent admits that taxes in the amount of $874.60 were deductible. Respondent contends, however, that if the deduction of $874.60 be allowed as a specific deduction for taxes paid, petitioner may not also claim the standard deduction of $500 on line 2 of the tax computation.

The instruction on line 2 in the tax computation read as follows:

Enter DEDUCTIONS (if deductions are itemized above, enter the total of such deductions; if adjusted gross income (line 1, above) is $5,000 or more and deductions are not itemized, enter the standard deduction of $500).

Petitioner's adjusted gross income was less than $5,000. Nevertheless and in the face of the above instructions, he claimed the standard deduction of $500. Though claimed indirectly, petitioner's treatment of the taxes paid resulted in a deduction of the item of $874.60. The consequence was that petitioner, with an adjusted gross income of $4,623.34, claimed deduction (directly or indirectly) of $1,374.60.

Section 23(aa)(3)(D) of the Internal Revenue Code reads, in part, as follows:

* * * If the adjusted gross income shown on the return is less than $5,000, but the correct adjusted gross income is $5,000 or more, then an election by the taxpayer under subparagraph (B) to pay the tax imposed by Supplement T shall be considered as his election to take the standard deduction; and his failure to elect under subparagraph (B) to pay the tax imposed by Supplement T shall be considered his election not to take the standard deduction.

Respondent thereupon argues that:

The correct adjusted gross income as determined by respondent is in excess of $5,000. Petitioner failed to pay the tax indicated on the table (Supplement T) which includes the optional standard deduction. By such failure, in the light of the above-quoted statutory provision, petitioner elected ‘not to take the standard deduction.‘ It, therefore, follows that the $500 deduction claimed by him should be disallowed.

We are inclined to agree with the result indicated by respondent's argument. We are satisfied that petitioner may not have the benefit of both the standard deduction and other specific deductions— that he was entitled to the deduction of $874.60 as taxes paid. He was not entitled also to a standard deduction of $500. In the recomputation consequent on this opinion the standard deduction will be disallowed.

There remains for consideration the bad debt issue as to which we have made an ultimate finding of fact favorable to petitioner. The record establishes that the money was lent by petitioner to Vaughn in connection with their business relation under a promise of reimbursement, which reimbursement was never made. It is also proven that all reasonable efforts to collect were made without result. Investigation made as to the prospects of repayment resulted in the conclusion that the debt was uncollectible and became worthless in 1945. We agree and have so found. The sum of $2,025.25 will be allowed as a bad debt on recomputation.

Decision will be entered under Rule 50.