Docket No. 50787.
Theodore Propp, Esq., for the petitioner. Robert J. Cowan, Esq., for the respondent.
X corporation, of which petitioner was transferee, was formed in 1945 for the purpose of acquiring title to certain real estate and selling it at a profit after obtaining tenants in the improved portion of the real estate in order to facilitate its sale. In the same year X sold the real estate at a profit and took a purchase money mortgage securing the unpaid portion of the purchase price. No other real estate was acquired or sold by X. Held, the interest on the purchase money bond received by X in 1947 did not constitute ‘rents' within the meaning of section 502(g) of the Internal Revenue Code of 1939. Theodore Propp, Esq., for the petitioner. Robert J. Cowan, Esq., for the respondent.
The respondent determined a deficiency in personal holding company surtax for 1947 in the amount of $232.49 against the 1356 Fifth Avenue Corporation and the liability of petitioner therefor as transferee. The sole issue is whether certain interest received by the transferor in the taxable year constituted ‘rent’ under section 502(g) of the Internal Revenue Code of 1939.
FINDINGS OF FACT.
A stipulation of facts was filed by the parties and we find the facts to be as stipulated. The pertinent parts of said stipulation read as follows:
1. 1356 Fifth Avenue Corporation was incorporated under the laws of the State of New York on January 24, 1945. Clause SECOND of the certificate of incorporation sets forth the purposes for which the said corporation was formed. The first paragraph of clause SECOND which enumerates the purposes reads as follows:
To acquire, by purchase or lease, or otherwise lands and interests in lands, and to own, hold, improve, develop and manage any real estate so acquired, and to erect, or cause to be erected on any lands owned, held or occupied by the Corporation, buildings or other structures, with their appurtenances, and to manage, operate, lease, rebuild, enlarge, alter or improve any buildings, or other structures, now or hereafter erected on any lands so owned, held or occupied, and to mortgage, sell, lease or otherwise dispose of any lands or interests in lands, and any buildings or other structures, and any stores, shops, suites, rooms or part of any buildings or other structures, at any time owned or held by the Corporation.
Harry Hosach was the sole stockholder of 1356 Fifth Avenue Corporation for the years 1945, 1946 and 1947.
2. At or about January 25, 1945, 1356 Fifth Avenue Corporation acquired title by warranty deed from Ell Harlem Holding Corporation to the properties known as 1346-1356 Fifth Avenue, New York, N.Y. The aforementioned properties consisted of two contiguous parcels, each 75 feet wide and 100 feet deep, one of which was vacant and unimproved land, and the other of which was a store building with a second story superimposed over the rear portion of the store. The two properties at 1346-1356 Fifth Avenue, New York, N.Y., constitute the only real property acquired or owned by 1356 Fifth Avenue Corporation during the years 1945, 1946 and 1947.
3. At or about December 27, 1945, the said premises referred to in paragraph 2 were sold for $25,500. The contract of sale was entered into with Harold O. and Elvira K. Stavenas, and the conveyance was made by a warranty deed to 1352 Fifth Avenue Corporation, to whom Harold and Elvira Stavenas had assigned the contract. $20,000 of the purchase price was represented by a purchase money bond and mortgage issued by the purchaser to 1356 Fifth Avenue Corporation. The profit on the sale amounted to $10,843.75.
4. During the calendar year 1947, 1356 Fifth Avenue Corporation received interest payments totaling $437.50 from the purchaser who had executed the purchase money mortgage referred to in paragraph 3. The only other income received by 1356 Fifth Avenue Corporation during the year 1947 was $158.82 of dividend income from two corporations whose stock was owned by 1356 Fifth Avenue Corporation since April 1945.
6. In its tax returns for 1945, 1946 and 1947, the corporation income tax return (Form 1120) filed for 1356 Fifth Avenue Corporation stated that its ‘kind of business' was ‘real estate,‘ and under the heading of ‘Business Group Serial Number (from Instruction N),‘ number ‘182’ was reported, which number for the years 1945, 1946 and 1947 corresponded to the following: ‘Owner-operators of improved property and lessors of buildings.’ This stipulation shall not be construed as an admission of the accuracy or propriety of such business description or characterization.
7. For the year 1945, 1356 Fifth Avenue Corporation received and reported on its income tax return gross rental income of $7,756.54 from the improved parcel of the properties described in paragraph 2, supra, and dividend income of $49.85, and $2,338.85 of taxable profit, attributable to 1945 on the sale of the said properties, the taxpayer having elected to report the profit on the instalment basis under section 44 of the Internal Revenue Code of 1939. Although the taxpayer reported the profit on the sale of the realty as capital gain, it is not conceded that it was properly reportable as capital gain.
At some time prior to January 24, 1945, the brother of Harry Hosach's son-in-law suggested that Harry (whose regular business is not disclosed by the evidence herein) purchase the property described above which was vacant and located in the Harlem district of New York City, and, after finding ‘a couple of tenants to fill it up,‘ sell it at a profit over the proposed acquisition cost of about $15,000. Harry's son-in-law and the latter's brother were associated in the practice of law and in the real estate business. Harry was advised to organize a corporation which should carry on the proposed transaction in order to avoid any personal criminal liability under the Housing and Building Codes of New York City. Harry's son-in-law and the latter's brother aided Harry in getting two tenants for the building and then advised him to sell the property as quickly as possible ‘while the tenants were in, because of the condition of Harlem property in general,‘ and arranged for the sale of the property on December 27, 1945, as described in the stipulation.
After the purchase of the property here involved by the 1356 Fifth Avenue Corporation, and during the taxable year, the brother of Harry's son-in-law suggested that other properties in the same locality might be purchased by the corporation at equally advantageous terms and caused inquiries to be made among the owners of such properties as to whether their properties were for sale, and if so, the prices asked therefor, but no such purchases developed although the information resulting from such inquiries was communicated to Harry at the latter's request.
Neither Harry's son-in-law nor the latter's brother was an officer, director, or employee of the transferor corporation. One Kravit, a personal friend of Harry's son-in-law, was ‘the nominal president’ of the corporation, and he also received the information resulting from the inquiries referred to above.
The narrow question presented by this proceeding is whether the interest payments received by the transferor corporation during the taxable year upon the purchase money bond and mortgage executed in connection with the sale of its real estate in 1945, constitute ‘rents' under the terms of section 502(g) of the Internal Revenue Code of 1939, set out in the margin hereof. If they do, then ‘rents constituted more than 50 per centum of the corporation's gross income and the corporation would not be subject to tax as a personal holding company. Obviously, a different result would be reached if the interest payments should be considered to be interest rather than rents.
SEC. 502. PERSONAL HOLDING COMPANY INCOME.For the purpose of this subchapter the term ‘personal holding company income’ means the portion of the gross income which consists of:(a) Dividends, interest (other than interest constituting rent as defined in subsection (g)), * * *(g) RENTS.— Rents, unless constituting 50 per centum or more of the gross income. For the purposes of this subsection the term ‘rents' means compensation, however designated, for the use of, or right to use, property, and the interest on debts owed to the corporation, to the extent such debts represent the price for which real property held primarily for sale to customers in the ordinary course of its trade or business was sold or exchanged by the corporation; but does not include amounts constituting personal holding company income under subsection (f).
The language in the quoted section of the Code which is pertinent to our question first appeared in section 403 of the Revenue Act of 1938. At the time of its enactment the Congressional intent was expressed in House of Representatives Report No. 1860, 75th Congress, 3d Session (Mar. 1, 1938), reprinted in 1939-1 C.B. (Part 2) 728, in which the following appears at page 765:
INTEREST ON DEBTS CONSIDERED AS RENT.
In order to relieve from the surtax imposed by Title IA of the bill certain operating companies whose principal business consists in the development of real estate for sale, section 403 makes a change in the treatment of certain types of interests as compared with the corresponding provision of the Revenue Act of 1936, as amended. This is done by including within the term ‘rents,‘ as defined in subsection (g), interest on debts owed to the corporation, to the extent such debts represent the price for which real estate held primarily for sale to customers in the ordinary course of business was sold or exchanged by the corporation. This change will help those bona fide real estate operating companies which might otherwise find themselves find themselves subject to tax under Title IA of the bill in years in which, by reason of an inactive market for the sale of real estate, the greater part of their income is derived from interest on second mortgages on property previously sold by them and from rent from property leased pending its sale and the rents in themselves do not constitute 50 per cent or more of gross income. In such cases rent and interest combined will usually exceed 50 per cent of the gross income. Under the proposed definition of ‘rents,‘ such companies will not be classified as personal holding companies.
In construing the language of a statute such as the one now before us, it is proper to consider the purpose which Congress had in mind when it was enacted. See Webster Corporation, 25 T.C. 55.
An examination of the quoted Congressional Report indicates that Congress intended that interest on debts should be considered as rent in cases where bona fide operating companies are engaged in the business of developing real estate for sale over a period of years, and in some years an inactive market for the sale of real estate results in such companies having the greater part of their income derived from interest on mortgages on property previously sold by them. To be deemed ‘rent,‘ the interest must arise from debts representing ‘the price for which real estate held primarily for sale to customers in the ordinary course of business was sold or exchanged by the corporation.’
In the instant case the transferor corporation was formed in 1945 for the purpose of acquiring title to two contiguous parcels of real estate and disposing of the real estate as a whole at a profit as quickly as possible after obtaining tenants in the improved parcel for the purpose of making easier the disposition of the real estate. The real estate, which it acquired by one deed, was sold by it during the same year and conveyed by one deed. Except for obtaining tenants for the building on the property, the record indicates that nothing was done by the transferor with regard to any development of the property. No other property was ever acquired or sold by the corporation. While suggestions were made to its sole stockholder that other property in the general locality might be profitably bought and sold and inquiries were made on its behalf concerning available properties, no officer or director or employee testified that it ever had the intention of buying and selling or holding any other real estate in spite of its corporate powers so to do.
Whether real property was held primarily for sale to customers in the ordinary course of trade or business presents a question a fact. The factors generally considered by the courts faced with such a problem are the purpose of the acquisition and disposal, the number, frequency, continuity, and substantiality of the sales, the period of time covered, and the extent of the activities of the seller in developing, improving, and disposing of the property. W. T. Thrift, Sr., 15 T.C. 366.
Expressly limiting ourselves to the facts present in the instant case, we are of the opinion that the interest on the purchase money bond and mortgage received by the transferor corporation in the taxable year did not constitute ‘rents' within the meaning of section 502(g) of the Internal Revenue Code of 1939.
Decision will be entered for the respondent.