Murray
v.
Comm'r of Internal Revenue

Tax Court of the United States.Mar 31, 1954
21 T.C. 1049 (U.S.T.C. 1954)

Docket No. 37486.

1954-03-31

E.J. MURRAY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Frederick H. Torp, Esq., for the petitioner. G.N. Cromwell, Esq., for the respondent.


Frederick H. Torp, Esq., for the petitioner. G.N. Cromwell, Esq., for the respondent.

1. petitioner mortgaged a piece of business property in 1932 as security for a loan of $64,000. The mortgages foreclosed and transferred the property to third parties in 1936. In 1937, petitioner instituted suit in an Oregon court claiming a right to redeem the property from the third parties, and in 1942, the Oregon Supreme Court held that the petitioner had an equity of redemption and that the third parties were mortgagees in possession, holding the property for the benefit of the petitioner. After an accounting, it was determined in 1947 that petitioner was entitled to credit toward redemption of $57,512.64 which represented the net balance of rents received from the property by the mortgagees, offset by interest and expenses of maintaining the property during the years since 1937 when they were in possession. Held, the petitioner received ordinary

income in the amount of $57,512.64 in the year 1947.

2. Held, further, the petitioner is entitled to deduct, in the year 1947, (a) income taxes paid to the State of Oregon, and (b) one-half the attorneys' fees and court costs incurred in obtaining possession of his property.

3. Held, further, petitioner is also entitled to deduct depreciation on his property for the years he was not in possession.

This proceeding involves deficiencies for the years 1946 and 1947 in amounts of $1,967.95 and $36,656.04, respectively. The case has been submitted on stipulated facts. The deficiency for 1946 arises over differences between the Commissioner and the petitioner concerning the appropriate adjusted basis on which to determine the long-term capital gain on securities sold in 1946. This matter has been settled by the parties. The deficiency for 1947 arises over differences between the Commissioner and the petitioner on the tax treatment to be accorded an involved and long-litigated real estate transaction which is fully described below.

FINDINGS OF FACT.

The petitioner, E.J. Murray, resided in Klamath Falls, Oregon, at substantially all times material to this action. He filed his individual income tax returns for 1946 and 1947 with the collector of internal revenue for the district of Oregon, reporting the following:

+------------------------------------+ ¦Tax year ¦Net income ¦Income tax ¦ +----------+------------+------------¦ ¦1946 ¦$5,480.85 ¦$1,040.27 ¦ +----------+------------+------------¦ ¦1947 ¦549.56 ¦9.41 ¦ +------------------------------------+

During all years material, petitioner kept his books and records and filed his income tax returns on the cash basis.

Issue I— Year 1946

In 1946 petitioner sold 33 shares of the capital stock of the Central Hotel Company, an Oregon corporation, for $28,071.33. This stock was acquired by petitioner on September 7, 1920, and, at the time of sale, it had an adjusted basis of $5,000. Petitioner realized a capital gain of $23,071.33 from the sale of this stock.

Issue II— Year 1947

In 1928, petitioner and his wife, Rebecca J. Murray, purchased as tenants by the entirety certain unimproved real estate situated in Klamath Falls, Oregon. To finance construction of a building on the property (the property and its improvements being hereinafter referred to as the Murray Building), petitioner and his wife borrowed $64,000 from the Pacific Savings & Loan Association, Tacoma, Washington, giving in return a first mortgage on the property.

On August 20, 1932, there was a balance of approximately $57,000 due on the loan. On that date, petitioner and his wife conveyed the Murray Building to the Conger Corporation, an Oregon Corporation, by deed warranting against all encumbrances ‘existing mortgage, liens and taxes.‘ The Conger Corporation was organized on August 5, 1932, the sole stockholders being W. A. Wiley, G. Q. D'Albini and Marie D'Albini, wife of G. Q. D'Albini. Wiley and D'Albini were petitioner's attorneys and petitioner was indebted to them for professional services theretofore rendered. The transaction was handled in the following manner: Wiley and D'Albini borrowed $5,000 from a bank and deposited it to the credit of the Conger Corporation in purported payment for its stock. The Conger Corporation then issued its check for $5,000 to petitioner as purported consideration for the deed of the property to the corporation, whereupon petitioner returned the money to the lending bank in liquidation of the bank's loan to Wiley and D'Albini, whose notes were returned to them. Petitioner also paid a $10 charge for the use of the money.

In May 1934 the Pacific Savings & Loan Association brought suit to foreclose its first mortgage on the Murray Building and on March 23, 1935, the property was sold pursuant to a decree of foreclosure for the unpaid balance of $56,984.78, the mortgagee being the purchaser.

On March 21, 1936, the Conger Corporation, which appeared as the record owner of the Murray Building, gave notice of intention to redeem the property.

On March 23, 1936, which was the last day of the statutory redemption and delivered a bargain and sale deed to the Murray Building to Mary L. Moore, Merle S. West, Charles J. Martin and Thomas B. Watters, hereinafter referred to as the Watters Group. The same day the Watters Group exercised their purported right of redemption by redeeming the property, and paid to the sheriff of Klamath County the sum of $63,711.60, entered into possession, and thereafter claimed to be the owners in fee of the property, free from any claim of the petitioner.

At the time of the conveyance of the Murray Building to the Watters Group, the property was subject to liens for Federal income tax in the amount of $3,148.60 assessed against petitioner and Rebecca J. Murray. In November 1936 the Watters Group advised the deputy collector in charge of collection of such tax to sell the property at public sale and that the Watters Group would buy it at such sale, thereby better perfecting their title.

In April 1937 the United States collector of internal revenue at Portland, Oregon, proceeded to sell the Murray Building to collect the tax, and it was bid in by the Watters Group for $16,500, who were forced to that price by competitive bids although the tax liens amounted only to $3,148.60.

On March 22, 1938, petitioner and his wife, Rebecca J. Murray, filed suit in the Circuit Court of Oregon for the County of Klamath entitled ‘E. J. Murray and Rebecca J. Murray, Plaintiffs, v. W. E. Wiley, G. Q. D'Albini, Marie N. D'Albini, Mary L. Moore, Merle S. West, Emma West, Charles J. Martin, Lynna Martin, Thomas B. Watters, Evelyn Watters, and J. W. Maloney as Collector of Internal Revenue for the United States of America, Defendants,‘ wherein it was prayed that the court (a) decree that the plaintiffs were the beneficial owners of all right, title, and interest in and to the Murray Building; (b) decree that the defendants, other than J. W. Maloney, were trustees holding the premises for the sole and exclusive benefit of the plaintiffs; (c) direct the defendants as trustees to convey the property to plaintiffs; and (d) require the defendants to render an accounting with respect to the operation of the Murray Building. On motion, defendant, J. W. Maloney was dismissed for lack of jurisdiction of the court. Rebecca J. Murray died on August 8, 1938, prior to any hearing, and petitioner succeeded to her right, title, and interest in the Murray Building as surviving tenant by the entirety.

On December 18, 1940, the Circuit Court of Oregon for the County of Klamath, by written opinion, held for defendants, whereupon the plaintiff, E. J. Murray, took an appeal to the Supreme Court of Oregon.

On June 30, 1942, the Supreme Court of Oregon in Murray v. Wiley, 169 Ore. 381, 127 P.2d 112, reversed the lower court and held:

(a) That petitioner's conveyance of the Murray Building to the Conger Corporation was made to secure his indebtedness to his attorneys, Wiley and D'Albini, and that the Conger Corporation was the alter ego of Wiley and D'Albini, who were in the position of second mortgagees.

(b) The Conger Corporation held the property as a mortgagee in possession and its purported assignment of that statutory right of redemption affected property belonging to the petitioner and not to Wiley and D'Albini.

(c) The Watters Group, which received a conveyance from the Conger Corporation together with an assignment of the right of redemption, were the assignees of rights which in equity belonged to the petitioner and upon exercising the statutory right of redemption became mortgagees in possession, having the right to foreclose against petitioner but being subject to his right to redeem upon payment of the sums found to be due them.

(d) The petitioner was the beneficial owner of the property subject to the liens of the various defendants who were mortgagees in possession.

The supreme court ordered the proceeding remanded for an accounting, directing that the defendants were entitled to:

1. Credit of $63,711.60 paid in redeeming the property, plus interest at 6 per cent per annum from the date of payment.

2. Credit of the amount of the Federal tax lien against the property with interest at 6 per cent per annum and to receive from the collector the balance of funds in his hands over the amount needed to satisfy such lien.

3. Reasonable fees for the legal services performed by Wiley and D'Albini prior to and owing on August 20, 1932, less offsets for certain cash realized by Wiley and D'Albini on their sale to the Watters Group. Defendants Wiley and D'Albini were also entitled to a lien subsequent to that of the Watters Group for any excess of the attorneys' fees remaining unpaid after crediting such cash offsets.

Upon full accounting being had, covering the matters indicated and all dealings by the Watters Group as mortgagees in possession, the Supreme Court of Oregon ordered that a decree be entered fixing the amount, if any, in which the Murray Building would be subject to a lien in favor of the Watters Group and also fixing the amount, if any, in which the Murray Building would be subject to a subsequent lien in favor of Wiley and D'Albini for attorneys' fees. The decree should provide that upon payment to the Watters Group and Wiley and D'Albini of the amounts of their respective liens, the defendants be directed to reconvey the property to petitioner, and in default of such reconveyance the decree stand in lieu thereof.

Thereafter, the defendants petitioned the Supreme Court of Oregon for rehearing and on September 29, 1942, that court denied the petition, adding:

(a) That matters relating to defendants' credits for cost of management and repairs to the Murray Building could be determined only by a subsequent accounting and not on the record then before the court.

(b) That the proceeding was a suit by a mortgagor to redeem and not by a mortgagee to foreclose, and the court therefore modified the previous opinion to provide that, unless petitioner did redeem the property from the liens, the decree of the circuit court should specify a reasonable time within which petitioner might redeem from both liens or be forever barred.

The matter was returned to the Circuit Court of Oregon for the County of Klamath and a hearing was held upon the disputed issues arising from the accounting of defendant mortgagees in possession. The circuit court held:

(a) That defendants were entitled only to interest at 6 per cent on $65,000 paid to redeem.

(b) That defendants were not entitled to credit of $16,500 paid on tax foreclosure sale but were entitled to $3,152.95, the amount of the lien, and the expenses of the public sale, together with interest thereon at 6 per cent per annum.

(c) Defendants were not entitled to credit for fees for supervision of the property.

(d) Defendants were not entitled to a credit for premiums paid on insurance policies on the Murray Building from which petitioner received no benefit.

(e) Defendants were not entitled to fees paid in attempting to get a refund of the excess paid to the collector of internal revenue over the amount of the lien against the property.

(f) Defendants were not entitled to credit for accounting expenses in preparing their account in the action.

(g) Petitioner was not entitled to surcharge defendant for alleged mismanagement of the Murray Building.

(h) A balance was due on the accounting of rents and profits in favor of defendants and judgment should be entered against petitioner.

Both parties appealed said decision to the Supreme Court of Oregon, which heard argument thereon on November 19, 1946, and by written opinion dated January 14, 1947, reported as Murray v. Wiley, 180 Ore. 257, 176 P.2d 243, affirmed the trial court in all issues except that it directed that the decree be modified to provide that defendants have a lien upon the mortgaged property in the amount of the ascertained balance but eliminating the personal judgment against petitioner. The cause was remanded to the trial court for a further accounting of the rents and profits as to the period subsequent to that covered by the previous accounting. The circuit court was again directed to specify a reasonable time within which petitioner might redeem from the lien of the defendants' mortgage or be forever barred by the dismissal of his suit.

On or about February 28, 1947, the defendants served upon petitioner an accounting of the rents and profits of the property. A recapitulation of the accounting is shown below:

+-----------------------------------------------------------------------+ ¦Statement of account, February 28,1947 ¦ +-----------------------------------------------------------------------¦ ¦ ¦ ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦Redemption certificate ¦$65,000.00¦ ¦ +------------------------------------------------+----------+-----------¦ ¦Interest on $65,000 at 6% from Mar. 23, 1936, to¦ ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦Feb. 28, 1947 ¦42,658.87 ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦ ¦ ¦$107,658.87¦ +------------------------------------------------+----------+-----------¦ ¦Collector of internal revenue, tax lien ¦3,152.95 ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦Interest on $3,152.95 at 6% from Apr. 26, 1937, ¦ ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦to Feb. 28, 1947 ¦1,862.36 ¦ ¦ +------------------------------------------------+----------+-----------¦ ¦ ¦ ¦5,015.31 ¦ +------------------------------------------------+----------+-----------¦ ¦Disbursements, Mar. 23, 1936, to Feb. 28, 1947 ¦25,501.01 ¦ ¦ +-----------------------------------------------------------------------+

Interest at 6% on monthly balances of disbursements, Mar. 23, 1936, to Feb. 28, 1947 8,273.31 33,774.32 Total disbursements Mar. 23, 1936, to Feb. 28, 1947 $146,448.50 Receipts, Mar. 23, 1936, to Feb. 28, 1947 $102,589.45 Interest at 6% on monthly balances of receipts, Mar. 23, 1936, to Feb. 28, 1947 33,218.74 135,808.19 Balance Feb. 28, 1947 $10,640.31

On February 28, 1947, petitioner paid to the clerk of the Circuit Court of Oregon for the County of Klamath the sum of $10,640.31 and there was thereupon entered a final decree declaring that the petitioner had satisfied in full all liens upon the property and was thereby entitled to have the legal title reconveyed to him. The defendants were directed to reconvey to him within 10 days or have the reconveyance occur through operation of the decree.

From and after February 28, 1947, the defendants surrendered possession of the Murray Building and the rents were thereafter payable to petitioner.

In 1947, petitioner paid to his attorneys the sum of $10,000 as attorneys' fees for the conduct of the aforementioned litigation and reimbursed the attorneys for disbursements incurred therein in the amount of $42.09.

Petitioner did not file income tax returns for any of the years 1937 to 1946, inclusive, prior to July 15, 1947. On that date, he filed returns for the years 1937 to 1946, inclusive, in which he reported business income (consisting of rent on the Murray Building), deductions for taxes, repairs, and depreciation, and net business income in the amounts shown by the following tabulation:

+-------------------------------------------------------------+ ¦ ¦ ¦ ¦Repairs ¦ ¦Net ¦ +-----+----------+----------+---------+------------+----------¦ ¦Year ¦Rent ¦Taxes ¦and other¦Depreciation¦business ¦ +-----+----------+----------+---------+------------+----------¦ ¦ ¦ ¦ ¦expenses ¦ ¦income ¦ +-----+----------+----------+---------+------------+----------¦ ¦1937 ¦$11,225.00¦$2,055.78 ¦$472.22 ¦$2,347.62 ¦$6,349.38 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1938 ¦9,350.00 ¦1,835.86 ¦222.68 ¦2,347.62 ¦4,943.84 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1939 ¦8,125.00 ¦1,941.18 ¦155.63 ¦2,347.62 ¦3,680.57 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1940 ¦8,771.40 ¦1,911.03 ¦733.88 ¦2,347.62 ¦3,778.87 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1941 ¦8,500.00 ¦1,817.13 ¦101.07 ¦2,347.62 ¦4,234.18 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1942 ¦8,100.00 ¦1,808.86 ¦1,182.04 ¦2,347.62 ¦2,761.48 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1943 ¦8,100.00 ¦1,763.72 ¦258.99 ¦2,347.62 ¦3,729.67 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1944 ¦9,450.00 ¦1,944.54 ¦165.71 ¦2,347.62 ¦4,992.13 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1945 ¦10,100.00 ¦2,250.41 ¦39.84 ¦2,347.62 ¦5,462.13 ¦ +-----+----------+----------+---------+------------+----------¦ ¦1946 ¦11,109.32 ¦2,686.23 ¦94.62 ¦2,347.62 ¦5,980.85 ¦ +-----+----------+----------+---------+------------+----------¦ ¦Total¦$92,830.72¦$20,014.74¦$3,426.68¦$23,476.20 ¦$45,913.10¦ +-------------------------------------------------------------+

The rentals reported by petitioner in his returns for 1937 to 1946, inclusive, as summarized in the above tabulation, were the sums which were used in the accounting approved by the trial court, and the deductions for taxes, repairs, and other expenses claimed in such returns are the sums included in the accounting approved by the court. However, through inadvertence, only $155.71 was deducted as repairs and other expenses in the 1944 return in lieu of $165.71.

On or about June 13, 1947, petitioner prepared and filed for the State of Oregon, income tax returns with the State tax commission, Salem, Oregon, for each of the years 1937 through 1946, and made payment of the taxes and interest shown to be due thereon, as follows:

+-------------------+ ¦Taxes ¦$1,099.70 ¦ +--------+----------¦ ¦Interest¦1.62 ¦ +--------+----------¦ ¦ ¦$1,101.32 ¦ +-------------------+

On March 15, 1948, petitioner filed his Federal income tax return for the calendar year 1947 with the collector of internal revenue at Portland, Oregon, and paid the amount of $9.41, the tax shown to be due thereon. The reported business income consisted of the rentals shown for the months of January and February 1947 in the accounting referred to above and the rentals thereafter received by petitioner for the remainder of the year. The business deductions shown thereon consisted of the repairs shown for the months of January and February in the accounting, the repairs and taxes thereafter paid by petitioner in the remainder of the year, depreciation of $2,347.62, and an interest deduction in the amount of $19,575.80, being the difference between the interest credits and debits shown in the accounting.

It is agreed between the parties that the annual rate of depreciation on the Murray Building is $2,347.62.

Petitioner had no income in any of the tax years 1942 through 1945.

The 33 shares of the capital stock of the Central Hotel Company sold by petitioner in 1946 had an adjusted cost basis of $5,000.

The petitioner realized ordinary income in the amount of $57,512.64 in the taxable year 1947 as a result of the termination of the litigation involving the Murray Building.

Petitioner is entitled to deduct the following expenses in the taxable year 1947:

(a) Income taxes paid to the State of Oregon in the amount of $1,101.32.

(b) Interest charged to him in the litigation over the Murray Building in the amount of $19,575.80.

This item was in effect allowed by the Commissioner in his determination of the deficiency for the year 1947.

(c) One-half of the attorneys' fees and court costs incurred in the litigation over the Murray Building.

Petitioner is also entitled to a deduction for depreciation on the Murray Building in the amount of $2,347.62 in each of the years from 1942 through 1947.

OPINION.

ARUNDELL, Judge:

This proceeding involves deficiencies for the years 1946 and 1947. The basic issue involved in the controversy over 1946 concerns the proper basis for determining the gains from stock sold by the petitioner in that year. This matter has now been settled by agreement between the parties and it has been stipulated that the securities had an adjusted basis of $5,000 when they were sold by petitioner. Adjustment of the deficiency for 1946 caused by our decision on the issues concerning 1947 can be effected through a computation under Rule 50.

The principal issue involves the tax treatment of a rather complicated real estate transaction. The history of this transaction is set forth in some detail in our Findings of Fact and we will restate the facts only so far as necessary to point up the question we have for decision.

In 1928, the petitioner owned a parcel of unimproved real estate in Klamath Falls, Oregon. He borrowed $64,000 to construct a building on the property, giving in return a first mortgage. In 1932, petitioner was running behind on his payments on the mortgage, and had accumulated certain other obligations, notably some attorneys' fees. In this year, in temporary satisfaction of the latter, he transferred legal title to the property to a corporation controlled by the attorneys and gave up possession of the property.

Petitioner and his wife would be exact. However, she has since died and he has succeeded to her interest, and we shall therefore refer throughout only to petitioner.

The corporation entered into possession but the payments on the mortgage made from rent ran behind and in 1934 the first mortgagee brought suit to foreclose. Foreclosure was obtained in March 1935 pursuant to a decree indicating an unpaid balance on the mortgage of almost $57,000.

The statutory period of redemption in Oregon is 1 year from date of foreclosure. On the last day of the redemption period, the corporation transferred its right of redemption to a third party, hereinafter called the Watters Group, and that group exercised the right to redeem and paid the first mortgagee $63,000 in principal and interest and entered into possession of the premises. This occurred in March 1936. Thereafter, the Watters Group also paid off a Federal income tax lien on the property, another of petitioner's obligations, in the amount of $3,152.95.

In 1938, petitioner instituted suit in an Oregon court to have himself declared legal owner of the property and for an accounting of the rents and profits of the property since he had lost possession. After lengthy litigation, terminating with a judgment of the Supreme Court of Oregon in 1942, it was determined that the petitioner was the legal owner of the property and that the Watters Group were mortgagees in possession, holding the property for the benefit of the petitioner. The court directed that the property be conveyed to the petitioner subject, however, to the satisfaction of liens in favor of the Watters Group and of the petitioner's attorneys for the amounts expended by them to redeem the property from the first mortgagee, and expenses incurred in operating the property or on account of the petitioner's indebtedness.

Following this decree, it took 5 years and another appeal to the supreme court to settle on an accounting between the litigants. Finally, in January 1947 the Supreme Court of Oregon decreed that, with the payment of $10,640.31 by petitioner to the Watters Group, he should have possession of his property. Petitioner paid this sum into court and entered into possession in February 1947.

From the time he had conveyed the property to his attorneys in 1932 until he regained possession in 1947, none of the rents from the property were paid to petitioner. During all this period, the rents were paid to those who were in possession. The rents were accounted for and applied to the mortgage indebtedness which the Watters Group had paid when they redeemed the property, or to the expenses of operating the property while they were in possession.

Petitioner, who was a cash basis taxpayer during the years in issue, did not file income tax returns for any of the years 1937 through 1945 until after he regained possession of the property. He had no income during these years. In July 1947 he filed separate returns for all the years 1937 to 1946, inclusive, in which he reconstructed the income he would have had from his property in each of those years had he been in possession, taking all the appropriate deductions for taxes, repairs, and depreciation and paying the tax computed on the net business income from the property for each of the years. Then, in March 1948, he filed a return for the year 1947 taking, in addition to deductions for taxes, repairs, and depreciation, a deduction of $19,575.80 for interest which he had been charged in the accounting to the Watters Group on disbursements which they had made while in possession and for which he had no offsetting interest credits.

The Commissioner determined that, as a result of the foregoing transactions, the petitioner realized ordinary income of $57,512.64 /3/ in 1947, that attorneys' fees and court costs of $10,042.09 incurred in the litigation between 1938 and 1947 were not deductible as ordinary and necessary business expenses, that certain taxes paid to the State of Oregon by petitioner were not deductible, that petitioner was not entitled to deduct depreciation on the property for the period he was not in possession, and that petitioner could not deduct the entire interest charge of $19,575.80 in the single year 1947, if he were allowed to reconstruct his income and deductions, year by year, for the period he was out of possession. (However, the respondent would allow the petitioner to deduct the full amount of the interest charge in the single year 1947 if it were held that the full amount of net income realized by petitioner were taxable in that year.)

3. The respondent's conclusion that petitioner received $57,512.64 in ordinary income in 1947 was determined as follows: The gross rents from the property for the entire period petitioner was deprived of possession amounted to $102,589.45. Interest on these rents allowed petitioner in the accounting amounted to $33,218.74, resulting in total gross receipts recognized of $135,808.19. Against these credits, petitioner was charged with expenses of maintenance in the amount of $25,501.01, and interest on the mortgage, and the other disbursements amounting to $52,794.54, or an aggregate charge of $78,195.55. Subtracting these offsets from the credits above ($135,808.19— $78,295.55) the Commissioner determined that the effect of the litigation and the accounting as shown above resulted in ordinary income to petitioner in the amount of $57,512.64.Respondent has now conceded that these taxes are deductible.

The petitioner contends that he did not realize income from the litigation which restored his building to his possession. To the contrary, he argues that at the termination of the litigation and the accounting proceeding, he received no money; indeed, he had to pay the defendants $10,640.31 to obtain possession of the property in 1947. Moreover, during all the years he was out of possession, he had not constructively received any money or benefit, and no personal liability had been relived by the litigation.

Secondarily, the petitioner contends that, if he did realize income from the litigation and the accounting proceeding, then the time of realization was in 1942— the date of the first judgment in the Oregon Supreme Court— when it was conclusively established that he was entitled to reconveyance of the property. That decision, petitioner argues, established the legal relationships between the litigants and the accounting proceeding could not upset those relationships.

As a third alternative, petitioner argues that assuming that he realized income from the litigation which successfully put him back in possession of his property, then the rental income was constructively received by him in each year from 1942 to 1947 during the pendency of the accounting proceeding during which time it had been determined that he was entitled to reconveyance of the property.

Petitioner, of course, contends that the full amount of the attorneys' fees incurred in the litigation is deductible as an ordinary and necessary expense and also that the interest for which he had no offsetting credit should be deductible in full in the single year 1947 even though it should be held that he constructively realized income from the property in 1942, or in the period 1942 through 1946, and that he is not entitled to a deduction for depreciation during the years he was not in actual possession.

We think that without question the petitioner realized income from his property when he was restored to possession. In the accounting procedure, he was credited with $135,808.19 in rent and interest on the rent for the period from 1936 until 1947 during which time he was out of possession. There would be no doubt that, had he been in possession during this period, and had actually received the rents, he would have been required to return them as ordinary income— offset, of course, by permissible deductions. The fact that the rents were realized only after great delay and then through the medium of a judicially ordered accounting proceeding does not change the character of rent from a tax viewpoint. Cf. Palm Beach Aero Corporation, 17 T.C. 1169.

The petitioner relies on Hilpert v. Commissioner, (C.A. 5) 151 F.2d 929, in arguing that the net proceeds of the accounting proceeding were not income. However, when that case was before this Court, we held that the excess of income received by the mortgagee in possession over the expenses and interest due him was ordinary income to the taxpayer-mortgagor in the year in which the litigation was terminated. We said, ‘The real nature of this item is * * * a species of postponed or delayed income— the net proceeds from the rental of property covering a number of years— which, due to the peculiar circumstances, was received in accumulated form in the tax year in issue. This payment was taxable when received, and it was clearly income * * *.‘ Anna I. Hilpert, 4 T.C. 473, 477.

There were circumstances in the Hilpert case which influenced the fifth circuit considerably in reversing our decision in that case. For example, Hilpert had treated the original transfer of the property to his mortgagee as a sale and had paid a tax accordingly. He also sold the property after having successfully contended before the Florida courts that the original transfer was a mortgage and not a sale, and he paid another tax on that transaction. The fifth circuit observed that the practical effect of our decision was to tax the same sale twice. The facts which influenced the court of appeals in the Hilpert case are absent in the instant proceedings and we do not think that that decision should be regarded as at all binding on us. It is our opinion that the net proceeds realized by the petitioner in the accounting proceeding were income and, moreover, that they were taxable in the year they were ultimately realized, 1947. Swastika Oil & Gas Co., 40 B.T.A. 798, affd. 123 F.2d 382.

We think that there is little merit to petitioner's contention that, assuming he realized income from the litigation, then the year of realization was 1942 or, alternatively, each of the years between 1942 and 1947. The basic premise of these arguments is that the petitioner had constructive receipt of the rent from his property after the Supreme Court of Oregon decided in 1942 that the Watters Group were mortgagees in possession, holding the property for the benefit of the petitioner. However, the petitioner was still out of possession until the conclusion of the accounting proceeding, and he had no control over the rents until he ultimately satisfied the balance in favor of the mortgagees and nothing was set aside for petitioner or available to him from the rents received during these years.

It may be true that during the period from 1942 to 1947, the Commissioner could not have demanded that the mortgagees return a tax on the net income from the property. Penn Athletic Club Building, 10 T.C. 919, affd. (C.A. 3) 176 F.2d 939. But it does not necessarily follow that, therefore, the Commissioner could have demanded a tax from the petitioner in these years on the net rents from the property. The petitioner could not have been compelled to pay a tax on something that he might never receive. Until the accounting proceeding was actually terminated, there was no definitive apportionment of the income from the property between the petitioner and the mortgagees in possession, and petitioner had no right to demand payment of the rents from the property and convert them to his own use. Therefore, we conclude that petitioner was not in constructive receipt of the rents from his property during the period involved in the accounting.

The remaining issues can be simply handled. The respondent now agrees that petitioner is entitled to deduct the sum of $1,101.32 for the taxable year 1947 which was paid in income taxes to the State of Oregon on June 13, 1947. Interest in the amount of $19,575.80 is properly deductible for the taxable year 1947, and respondent in his determination of the deficiency for that year has in effect allowed this amount in computing the net amount of $57,512.64 realized by the petitioner. Two issues remain. Each concerns additional deductions requested by the petitioner for (1) attorneys' fees incurred in the litigation to obtain possession of his property, and (2) depreciation on the property for the years he was out of possession.

Petitioner expended $10,000 in attorneys' fees and $42.09 in court costs in the litigation to obtain possession of the Murray Building. These fees were paid in 1947 when the lawsuit was finally concluded, and deducted in that taxable year as an ordinary and necessary expense. The respondent has disallowed the deduction, contending that the entire expense of the litigation should be capitalized. Petitioner suggests that if he is not entitled to deduct the full amount of legal expense, then part of it should be allocated to expense on the basis of a formula which would relate the time required for the accounting proceeding to the entire period required for the litigation. In the peculiar circumstances of this case, we think that an allocation is appropriate. Approximately one-half the entire period spent in litigation was devoted to the accounting proceeding after petitioner's right to the property had been conclusively determined. Accordingly, we conclude that one-half of the legal expenses may be deducted in the taxable year 1947, and the remaining one-half should be capitalized.

The accounting proceeding was concluded on February 28, 1947, when petitioner paid $10,640.31 into court and went into possession. The respondent would allow petitioner to deduct depreciation, at the rate of $2,347.62 annually, for only the 10 months of 1947 subsequent to petitioner's reentry. Respondent would also not permit a deduction for depreciation in any of the years that petitioner was not in possession.

Respondent's position is that before the reentry in February 1947, the Murray Building was not property ‘held‘ by the petitioner for the production of income within the meaning of section 23(a)(2) of the Internal Revenue Code.

We think that petitioner is entitled to depreciation on the property for the years he was out of possession. We have previously held that the right to deduct for depreciation does not absolutely depend upon the holding of legal title to a depreciable capital investment. There are situations where the taxpayer who retains an equitable interest in his capital investment is entitled to depreciate it though legal title may be in another party for security purposes. F. & R. Lazarus & Co., 32 B.T.A. 633, affd. (C.A. 6) 101 F.2d 728; affd. 308 U.S. 252. cf. Marion A. Blake, 8 T.C. 546.

Certainly the building was petitioner's investment in the beginning. Moreover, at least from the time of the decision of the Supreme Court of Oregon in 1942 establishing petitioner's right to reconveyance, he had an equitable interest in the property. The fact that legal title was continued in the mortgagees in possession pending the settlement of an accounting for the rents received by them really meant in substance that they held the property only as security for the expenditures they had incurred in redeeming the property and in maintaining it. After the 1942 decision we think that petitioner was entitled to deduct depreciation on the building, even though he was not actually in possession.

However, in this proceeding, we can give full effect to petitioner's right to deduct depreciation only to the taxable years 1946 and 1947. Depreciation allocable to previous years can only be allowed insofar as it may affect the taxes for the 2 years before us. Frank Holton & Co., 10 B.T.A. 1317. There will be some effect since petitioner had no income in the years 1944 and 1945 and allowance of depreciation for those years would give him loss carry-overs applicable to 1946 and 1947. The parties have recognized these principles and agree that, in a computation under Rule 50, effect can be given to these loss carry-overs against the taxes for 1946 and 1947. As we indicated in our findings, the annual rate of depreciation to be allowed petitioner is $2,347.62.

Decision will be entered under Rule 50.