Klein
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Jul 19, 1950
15 T.C. 26 (U.S.T.C. 1950)

Docket No. 19310.

1950-07-19

ADOLPH KLEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Julian Ruslander, Esq., for the petitioner. Louis A. Boxleitner, Esq., for the respondent.


During the period 1935 to 1944 petitioner acquired by purchase various mortgage pool participations, mortgage participations and mortgage certificates which were in the process of liquidation. In the taxable year 1944 petitioner received various payments thereon, and on his income tax return treated the amounts received in excess of his cost as long-term capital gains. The respondent determined the gains to be taxable as ordinary income. Held:

(1) Petitioner was not a dealer in mortgage pool participations, mortgage participations, and/or mortgage certificates.

(2) The mortgage pool participations and the mortgage participations were not securities as defined by section 117(f), Internal Revenue Code, and there was no ‘sale or exchange‘ thereof entitling petitioner to the benefits of the capital gain tax provisions.

(3) The mortgage certificates were ‘securities‘ within the purview of section 117(f), Internal Revenue Code, and the payments received in the taxable year were in ‘retirement‘ thereof and are to be considered as received in ‘exchange‘ therefor. The gain realized thereon constitutes capital gain. Julian Ruslander, Esq., for the petitioner. Louis A. Boxleitner, Esq., for the respondent.

This proceeding involves a deficiency in income tax for the calendar year 1944 in the amount of $2,808.94. The issue is whether amounts received by petitioner in the taxable year on various mortgage participations in excess of the amounts paid therefor are taxable as ordinary income or capital gain. The proceeding was submitted on a stipulation of facts and the petitioner's income tax return for 1944. The facts are found to be as stipulated, and for present purposes may be summarized as follows:

FINDINGS OF FACT.

Petitioner is an individual residing at Pittsburgh, Pennsylvania. He filed his income tax return for 1944 with the collector of internal revenue for the twenty-third district of Pennsylvania. Prior to and in the taxable year, petitioner was primarily engaged in the insurance business as a general agent.

In the period from June 1935 to July 1944, petitioner, by written assignments, acquired from 110 individuals or estates mortgage participations in eight separate mortgage pools. The participations acquired by petitioner consisted of three different types, to wit: (a) participations in mortgage pools, also called general investment funds or general trust funds of mortgages; (b) undivided interests in individual or separate mortgages which were not a party of any mortgage fund or pool (all of such mortgages except one has been paid in full and satisfied of record); and (c) mortgage certificates issued by Potter Title & Mortgage Guarantee Company (name changed to Pittsburgh Title & Mortgage Guarantee Company). Such mortgage certificates were due January 1, 1935, and had interest coupons attached. Each time principal payments were made, the mortgage certificates were so marked and on final liquidation were required to be surrendered for cancellation. All the participations involved herein, except one in which in the taxable year 1944 the petitioner realized a profit of $10, had been held for more than six months.

Mortgage pool participations constituted undivided interests in a pool of mortgages and bonds and in the proceeds thereof held by corporate fiduciaries and did not constitute individual ownership in any bond or mortgage included in the pool. The mortgage pools involved herein were created and operated prior to 1933 in accordance with the statutes of the State of Pennsylvania. In 1933 a statute was enacted prohibiting the establishing of such mortgage pools, but providing that bonds or participation certificates issued prior to its effective date should not be affected thereby.

In April 1934 the Orphans' Court of Allegheny County, Pennsylvania, took custody of and jurisdiction over all mortgage pools, directed that no payments other than from income should be made therefrom except by its direction, and enjoined all litigation against the funds.

The Orphans' Court designated the specific trust company as its bailiff and as an officer of the court in liquidating the particular mortgage pool which had been created and operated by that particular corporate fiduciary. From 1934 until final accounts were filed and final distributions made in 1947 and 1948, the trust companies could not sell any asset of the fund without appropriate court order and could not make any distributions of principal without filing a proper account and having a decree of distribution entered. The corporate fiduciaries were not relieved of their responsibility until final accounts were filed and approved and final distributions made in accordance with the court's decree.

After the closing of the various mortgage pools the corporate fiduciaries in the administration of their individual mortgage pools sold real estate acquired by foreclosure or deed, collected principal debt and interest on mortgages, satisfied mortgages, assigned mortgages, rented, managed and rehabilitated acquired real estate, collected rents and made sales under the jurisdiction of the court.

Petitioner's mortgage pool participations were evidenced either by certificates of participation issued by the corporate fiduciary in petitioner's name after assignment, or by certificates of participation assigned thereon to petitioner, or by separate written assignments. At various times when mortgage pool participations were acquired, petitioner gave the assignor an option in writing entitling the assignor to repurchase the interest assigned at a fixed price and within a definite period. Petitioner was able to acquire many of these mortgage pool participations by reason of giving such option. A total of 43 options was given, and 22 were exercised. In the taxable year 1944, only one such reassignment was made. Only three participations were sold to third parties between 1935 and 1944. No such sale occurred in the taxable year 1944.

In his 1944 income tax return petitioner applied the principal payments from each participation, as received, against his cost thereof. Where his cost had been recovered in or prior to 1944, all principal payments in excess of cost were reported as long-term capital gain. Principal payments where cost had not been recovered were not reported. All payments of interest on participations were reported as ordinary income. The respondent determined that the entire amount of profit received in 1944 was taxable as ordinary income.

Petitioner, during the periods involved herein, was not engaged in the business of buying and selling mortgage pool participations, mortgage participations and/or mortgage certificates. Such property was not held by petitioner for sale to customers in the ordinary course of his business.

OPINION.

LEECH, Judge:

The primary question presented is whether all or any part of the profit realized by the petitioner in the taxable year 1944 with respect to the various mortgage participations is taxable as ordinary income or capital gain. The respondent contends that these participations constituted stock in trade or property held primarily for sale to customers in the ordinary course of petitioner's trade or business and therefore were not capital assets as defined in section 117(a)(1) of the Internal Revenue Code. Whether petitioner was a dealer or an investor as to the participations in question, and they were, therefore, so held, presents a question of fact. Various factors are considered and applied, no one of which is controlling. The purpose of acquiring the property, the continuity and frequency of the sales and the means employed in selling are important criteria in determining one's status.

The record establishes that petitioner made no sales in the taxable year 1944 and only three sales to third persons in the entire period 1935 to 1944, inclusive. Petitioner was able to acquire 43 mortgage participations because of his willingness to give the assignor an option to repurchase within a fixed period. Only 22 assignors exercised their options during the entire period and only one such option was exercised in the taxable period here involved. Since petitioner acquired the 43 participations burdened with the obligation to resell to the assignors, it may be doubted that they were sales in the ordinary sense, but even if regarded as regular sales, they were not of such continuity and frequency as to constitute petitioner a dealer in securities. There is no evidence of any sales activity or solicitation or advertisement for the purpose of effecting a sale. Petitioner was not a general dealer in securities. His primary business was that of an insurance agent. The securities were all in the process of liquidation at the time of their acquisition by petitioner, and we think it is obvious they were acquired for investment or speculation.

We conclude that petitioner's status was not that of a dealer and that the mortgage participations were therefore not property held primarily for sale to customers in the ordinary course of a trade or business, but were capital assets.

The respondent, however, contends that even if the participations are held to be capital assets, there was no ‘sale or exchange‘ within the purview of section 117(a)(4) of the Internal Revenue Code. Not every gain growing out of a transaction concerning capital assets is allowed the benefits of the capital tax provisions. Those are limited by the definition to the ‘sale or exchange‘ of capital assets. Section 117(a)(2), (3), (4) and (5).

Petitioner argues that there was an ‘exchange‘ effected by the retirement in whole or in part of the various participations involved. Section 117(f) of the Internal Revenue Code provides with respect to the class of securities therein mentioned that the amounts received on their retirement ‘shall be considered as amounts received in exchange therefor.‘ Petitioner does not contend that the mortgage pool participations are securities of the class defined in such section, and we are convinced that they do not qualify as such securities. Cf. Cumberland County v. LeMoyne, 318 Pa. 85, 178 Atl. 32. Petitioner, however, takes the position that even though that be so, the execution of the releases to the liquidating fiduciaries in accordance with the orders of the Orphans' Court on the audit of the fiduciary accounts constitutes an ‘exchange‘ within the purview of section 117(b) of the Internal Revenue Code. This position is not sound. No acquisition of property by the liquidator occurred. There was a settlement or compromise but no sale or exchange of anything. The interest of petitioner in these mortgage participations was extinguished, not sold or exchanged. Hale v. Helvering, 85 Fed.(2d) 819. See also Helvering v. Flaccus Oak Leather Co., 313 U.S. 247. Nor do we think there is any merit in petitioner's further contention that the payments on these mortgage pool participations and mortgage participations qualify as ‘exchanges‘ as defined in section 169 of the Internal Revenue Code. This latter section relates to ‘common trust funds‘ as defined therein. This record does not establish that the funds involved here were within that definition. Without going further, it need only be noted that there is no evidence that the funds here were maintained by banks in conformity with the rules and regulations of the Board of Governors of the Federal Reserve System as provided in section 169(a)(2). We, therefore, conclude that there was no ‘sale or exchange,‘ within the accepted meaning of those terms, of these particular capital assets, to wit: the mortgage pool participations and the mortgage participations. The respondent properly treated the proceeds from these mortgage participations as ordinary income.

We think, however, that the mortgage certificates are in a different category. They were issued in the form of bonds with interest coupons attached. They have a specific maturity date and are guaranteed as to principal and interest by the Potter Title & Mortgage Guarantee Company. The fact that these mortgage certificates at the time of their acquisition by petitioner were in the orderly process of liquidation under the control of the Orphans' Court does not affect their character as securities of the issuing corporation. We are of the opinion that these mortgage certificates were corporate securities within the purview of section 117(f). Rieger v. Commissioner, 139 Fed.(2d) 618; George Peck Caulkins, 1 T.C. 656, affd., 144 Fed.(2d) 482. Cf. Hamilton National Bank v. United States, 99 Fed. (2d) 570, certiorari denied, 306 U.S. 653; Title Guarantee & Trust Co. v. Bowers, 67 Fed.(2d) 892, certiorari denied, 292 U.S. 628. The payments received in the taxable year 1944 contributed to the retirement of these mortgage certificates and are to be considered as amounts received in ‘exchange therefor.‘ Howard Carleton Avery, 13 T.C. 351. The respondent erred in treating the amounts received in the taxable year on these mortgage certificates as ordinary income.

Respondent acquiesces. 1950-1 C.B. 1.

Effect will be given to any stipulated adjustments in the recomputation under Rule 50.

Decision will be entered under Rule 50.