Comm'r of Internal Revenue

Tax Court of the United States.Dec 4, 1952
19 T.C. 384 (U.S.T.C. 1952)

Docket No. 24920.



R. M. O'Hara, Esq., and Robert G. Surridge, Esq., for the petitioner. Cyrus A. Neuman, Esq., and Charles Speed Gray, Esq., for the respondent.

R. M. O'Hara, Esq., and Robert G. Surridge, Esq., for the petitioner. Cyrus A. Neuman, Esq., and Charles Speed Gray, Esq., for the respondent.

CAPITAL GAIN OR ORDINARY INCOME— SALE OF ACCRUED INTEREST ON INDEBTEDNESS.—The excess of the amount received by a creditor from a third party for notes and accrued interest of a debtor over the principal loaned on the notes is ordinary income under section 22(a) and not capital gain under section 117.

The Commissioner determined a deficiency of $52,496.94 in income tax for 1944. The only issue for decision is whether $66,150.56 received by the petitioner in 1944 represented ordinary income or whether it represented a long term capital gain.


The petitioner filed his individual income tax return for 1944 with the collector of internal revenue for the district of Michigan. He kept his records and filed his returns on a cash receipts and disbursements calendar year basis.

A Florida corporation was indebted to the petitioner on September 1, 1944, in the principal amount of $133,849.44 evidenced by its 2-year 6 per cent notes. The petitioner on that date was entitled to receive unpaid interest on those notes in the amount of $75,574.29.

The petitioner, on September 1, 1944, was indebted to Prime Securities Corporation in the amount of $167,475, representing principal and interest on his demand note held by that corporation.

The petitioner offered to transfer to Prime the notes of the Florida corporation held by him and his right to interest on those notes for $200,000 and to permit Prime to apply his indebtedness to it in the amount of $167,475 in payment of a part of the $200,000 purchase price. Prime accepted the offer, canceled the indebtedness of the petitioner to it as agreed, and paid the petitioner the $32,525 balance of the purchase price in cash on September 1, 1944. Thereafter, Prime received payments of interest and principal on the Florida notes during the years 1944 through 1950 in which latter year the final payment satisfying the debts was made.

The above transactions were all bona fide.

The petitioner, on his income tax return for 1944, reported $66,150.56 as a long term capital gain on a sale by him to Prime of the notes of the Florida corporation in the principal amount of $133,849.44 with interest of $75,574.29.

The Commissioner, in determining the deficiency, added $66,150.56 to net income as disclosed by the return and eliminated $33,075.28 from capital gains reported. He explained:

(a) It is held that you realized a gain of $66,150.56 on the disposition of certain Miami Beach Heights notes held by you, having a face value of $133,849.44 upon which notes interest of $75,574.29 stood accrued, for a selling price of $200,000.00, no part of which, under the sales agreement, was to be applied in payment for accrued interest, and that said gain is taxable as ordinary income under the provisions of Section 22(a) of the Internal Revenue Code.

In accordance with the foregoing the computation of taxable gain is made as follows:

+-------------------------------------+ ¦Selling price¦$200,000.00 ¦ ¦ +-------------+------------+----------¦ ¦Cost basis ¦133,849.44 ¦ ¦ +-------------+------------+----------¦ ¦ ¦____________¦$66,150.56¦ +-------------------------------------+

He explained further that capital gain was reduced by

+---------------------------------------------------------------------------+ ¦50% of $66,150.56 gain on sale of Miami Beach Heights notes held¦ ¦ +----------------------------------------------------------------+----------¦ ¦to be ordinary income, see item (a) foregoing ¦$33,075.28¦ +---------------------------------------------------------------------------+

The facts stipulated by the parties are incorporated herein by this reference.



The petitioner claims that the notes of the Florida corporation which he held and the accrued unpaid interest thereon up to September 1, 1944, was property, that property was a capital asset which he had held for more than six months at the time of the sale, he sold it at a profit of $66,150.56, and that profit was a long term capital gain, only one-half of which had to be included in gross income, all in accordance with section 117. The parties are in agreement that the petitioner's basis for the notes was $133,849.44. The unpaid interest which accrued on that indebtedness up to September 1, 1944, while it was owned by the petitioner was $75,574.29. The petitioner was not required by law to report and he did not report any of that amount as income as it currently accrued. He transferred the notes and his right to the interest to Prime for $200,000. The record shows no allocation of the $200,000 between principal and interest, but it must be assumed that the purchaser paid no more than $133,849.44 for the notes and it must have paid at lease $66,150.56 for the interest rights. All of that interest accrued while the petitioner was the creditor and his right to receive it was a right to receive ordinary income, since the definition of gross income contained in section 22(a) specifically includes interest. Thus, the petitioner in the taxable year sold his right to receive ordinary income. A sale of a right to receive in the future ordinary income already accrued produces ordinary income rather than a capital gain.

Interest is a payment for the use of money. The petitioner, as owner of money, loaned it and allowed it to be used by the Florida corporation for a number of years. He thereby became entitled to be paid interest and the borrower became obligated to pay it but delayed in meeting that obligation. The petitioner then had a transaction with Prime in which the latter substituted itself as the lender, paid to the petitioner his principal, and also paid him $66,150.56 to compensate him for the time his money had been used by the borrower. Prime thus acquired the petitioner's rights to be reimbursed by the borrower for those payments. The petitioner does not escape tax on the amount received by him for the use of his money merely because it was paid to him by Prime instead of by the borrower. This is not different from the every day situation in which a bond is sold and the purchaser not only pays for the bond but also pays the seller the accrued interest to the date of the sale. The latter reports the amount as interest not as a part of the ‘amount realized‘ on the sale. Perhaps the decided cases most nearly in point are those in which a retiring partner is paid for his share of accrued partnership earnings not yet received by the firm. Louis Karsch, 8 T.C. 1327, citing Helvering v. Smith, 90 F.2d 590, 592; Bull v. United States, 295 U.S. 247, 256. Cf. Doyle v. Commissioner, 102 F.2d 86, 88. No authority to the contrary has been cited and, following the principle of the cited cases, this issue is decided for the respondent.

Decision will be entered for the respondent.