Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Dec 24, 1957
29 T.C. 520 (U.S.T.C. 1957)

Docket No. 57284.



N. A. Townsend, Jr., Esq., for the petitioners. Hubert E. Kelly, Esq., for the respondent.

N. A. Townsend, Jr., Esq., for the petitioners. Hubert E. Kelly, Esq., for the respondent.

Petitioner was an officer and director of a corporation which promoted and developed shopping centers and residential real estate developments. He also did some promoting and developing of residential and shopping centers as an individual. Petitioner was asked to take part in developing acreage for industrial use. Before he would accept this proposition he caused a survey to be made of the industrial potential of the general area and certain specific sites. Held, on the facts, that this survey was for the purpose of determining whether petitioner would enter a new trade or business and, as such, the cost thereof is not deductible under section 23(a)(1)(A), (a)(2), or (e), I.R.C. 1939.

Respondent determined a deficiency in income tax for the year 1952 in the amount of $1,451.04. In an amendment to this answer, pursuant to section 272(e) of the Internal Revenue Code of 1939, respondent asserted an increased deficiency of $742.94. The petitioner raised three issues, two of which have been settled by the stipulation filed herein. The remaining question for our decision is whether the $5,000 paid by petitioners in 1952 for a survey and report is deductible under the provisions of section 23(a)(1)(A), (a)(2), or (e), 1939 Code.


Some of the facts have been stipulated. The stipulation and the exhibits annexed thereto are incorporated herein by this reference.

Petitioners, J. W. York (hereinafter referred to as petitioner) and Mary P. York, are individuals who reside in Raleigh, North Carolina. They are husband and wife, and for the taxable year 1952 they timely filed a joint income tax return with the director of internal revenue for the district of North Carolina on the cash receipts and disbursements basis.

The Urban Land Institute (hereinafter sometimes referred to as U.L.I.) is a nationally recognized research and educational organization in the field of urban development. It was organized in 1936 and operates as an independent, nonprofit organization to study trends in real estate and to advance education and research in urban planning and development. It is governed by a board of trustees, and its membership is composed of individuals and firms located throughout the United States. U. L. I. operates through three councils known as The Industrial Council, The Community Builders' Council, and The Central Business District Council. These councils, through panels composed of several council members, make studies of specific areas, such as a city or a county, and of specific sites, and prepare and submit reports about the development potential of the subject of the study recommending solutions for the problems connected with such development. Such studies are made under the sponsorship of a local group, corporation, firm, or individual, and they include an intensive, on-the-ground inspection and interviews and discussions with local agencies, officials, and individuals. The expense of making a study is defrayed by the sponsor.

Cameron Village, Inc., is a corporation organized and incorporated under the laws of North Carolina on or about March 11, 1948. Cameron Village, Inc., owns a large shopping center known as Cameron Village and several subsidiary corporations owning rental apartment units located in Raleigh, North Carolina. The construction of apartments was started in June 1948 and the shopping center in May 1949. The shopping center was opened in 1949 and now consists of 53 retail outlets occupying 425,000 square feet of space. Surrounding the shopping center area are 560 rental units. Petitioner is, and was during the years 1948 through 1952, employed as president of Cameron Village, Inc., and as such directs the corporation's affairs in the management of its properties. He is also a substantial stockholder in the corporation.

In the planning and development of the Cameron Village Center, before and after its incorporation, petitioner utilized the facilities of U.L.I. He presented plans for the development to a session of The Community Builders' Council of U.L.I. at Chicago in January 1948. He also received assistance from other developers whom he contacted through association with The Community Builders' Council.

In addition to his activities with Cameron Village, petitioner has participated through the years in the building business and in residential development both individually and as president and 50 per cent stockholder of the York Building Company.

The bulk of petitioner's income as reported in his 1952 return was in the form of salaries from Cameron Village, Inc. He also reported other income of $1,289.72, composed of the following:

+----------------------------+ ¦Dividends ¦$1,012.50 ¦ +-----------------+----------¦ ¦Interest ¦789.10 ¦ +-----------------+----------¦ ¦Farm ¦256.33 ¦ +-----------------+----------¦ ¦Commissions ¦226.12 ¦ +-----------------+----------¦ ¦Miscellaneous ¦5.67 ¦ +-----------------+----------¦ ¦Net capital loss ¦(1,000.00)¦ +-----------------+----------¦ ¦ ¦ ¦ +-----------------+----------¦ ¦ ¦ ¦ +-----------------+----------¦ ¦Total ¦1,289.72 ¦ +----------------------------+

Raleigh Development Center (hereinafter referred to as R.D.C.) was organized as a North Carolina corporation on or about June 14, 1949. It was organized by a group of individuals who were interested in promoting the industrial development of Raleigh, North Carolina. One member of the group was Patrick B. McGinnis (hereinafter referred to as McGinnis) who was then chairman of the board of directors of the Norfolk & Southern Railroad Company. Shortly after its organization R.D.C. leased approximately 600 acres of land from the heirs of James H. Pou for a term of 99 years. This land was located adjacent to the highway known as U.S. 1 approximately 1 mile north of Raleigh. It was also adjacent to the tracks of the Norfolk & Southern Railroad Company.

Petitioner was not a member of the group which organized R.D.C., and prior to 1951 he had no experience in or association with the development of industrial property.

In the summer or early fall of 1951 petitioner was approached by McGinnis about directing the corporate affairs of R.D.C. in the promotion and development of the property under lease to it. At this time R.D.C. had been in existence for about 2 years, but, due to a lack of interest and effort by the local people connected with the corporation, had accomplished nothing. McGinnis was anxious for some progress to be made by R.D.C. and, being familiar with the successful operation of Cameron Village, Inc., he undertook to interest petitioner in taking over the management of R.D.C.

By way of remuneration for managing R.D.C., McGinnis proposed to give petitioner a 25 per cent interest in the stock of the corporation and a 5 per cent commission on any transaction he effected for the corporation with respect to the property it had under lease in lieu of salary. However, when this proposition was made, petitioner and McGinnis ‘were in a strictly talking stage.’ Petitioner advised McGinnis that he had had no experience with industrial property and that the development of industrial property presented different problems from those arising in the area of his experience. He also told McGinnis about U.L.I. and the manner in which it operated, and suggested that the questions of Raleigh's industrial potentialities and the adaptability for industrial development of the land under lease to R.D.C. as well as surrounding sites be submitted to a U.L.I. panel for study. If the situation looked encouraging after such a study, petitioner told McGinnis that he would assume the management of R.D.C. McGinnis agreed to have these questions submitted to a U.L.I. panel and also agreed that he and an associate, William T. Griffin, would bear one-half of the cost of the panel study, petitioner to bear the other half of such cost.

Petitioner contacted the U.L.I. late in 1951 and arranged for a panel study. A contract was executed on November 2, 1951, which was entitled ‘Agreement Between J. W. York, President, York Building Company, and The Urban Land Institute.’ It recited that the sponsor desired to retain the services of the Institute for the purpose of obtaining its advice and recommendations regarding certain problems relating to the planning and present and future development of a certain area of land designated by the sponsor. The contract provided that a panel would visit Raleigh on or about December 5, 1951, for a 3-day period; that the panel would study the area and consult local officials and organizations; and that a written report of the panel's conclusions and recommendations would be furnished to the sponsor. The contract provided for the remuneration in the amount of $15,000 or its equivalent in the form of $100 sustaining memberships. This contract was signed for the sponsor by ‘J. W. York, Pres.,‘ which signature was attested to by ‘E. W. Collette, Secretary,’ and for U.L.I. by ‘P. W. Kniskern, President,‘ which signature was attested to by ‘Max S. Wehrly, Executive Director.’

On December 6, 7, and 8, 1951, a 7-member panel of the U.L.I.‘s Industrial Council visited Raleigh and made a study of the problem presented by petitioner. In its study, the panel assembled a large volume of statistical information about the city of Raleigh and the State of North Carolina. It visited the industrial areas of Raleigh and the property under lease to R.D.C., and interviewed various local officials and other individuals who were familiar with the Raleigh area and its problems and potential. In its study the panel was concerned first with the industrial development potential of the Raleigh area and second with the industrial development possibilities of a specific parcel of property and surrounding parcels.

Shortly after its visit to Raleigh the U.L.I. panel prepared and submitted a written report to petitioner. The report contained a detailed transcript of the panel's proceedings, a summary of pertinent statistical data, statements by various members of the panel, and a summary of the panel's recommendations. The report concluded that the Raleigh area had a potential to attract certain types of industrial establishments and that the R.D.C. property and surrounding sites were well suited for industrial development, provided certain problems could be overcome. It suggested that as the initial step in developing the R.D.C. property a serious effort be made to locate a major industry in the area to act as a leader in obtaining future manufacturing installations.

The remuneration due to U.L.I. was reduced by agreement from $15,000 to $10,000 because the sponsor elected not to have the U.L.I. continue with the second part of the study, viz, a more detailed study of the R.D.C. site. The $10,000 fee was paid by petitioner to U.L.I. in two equal installments on November 2, 1951, and December 9, 1952. In June 1953 Griffin and McGinnis reimbursed petitioner in the amount of $5,000 per their agreement.

Early in 1952 Westinghouse Electric Corporation became interested in establishing a manufacturing plant at Raleigh and selected 100 acres of the R.D.C. land as a tentative site. Representatives of Westinghouse, together with certain local parties, approached petitioner about buying the site from R.D.C. Westinghouse was interested in acquiring a fee simple title to these 100 acres. The Pou heirs who owned the fee demanded $1,000 per acre to transfer the fee, the same amount offered by Westinghouse. Some R.D.C. stockholders were unwilling to transfer R.D.C.‘S interest in the land without earning some profit. Because of the improved industrial development potential that would result from locating the Westinghouse plant on this site, petitioner agreed to purchase the stock of the dissenting stockholders. On May 9, 1952, petitioner tendered his check for $25,000 in payment for a one-half stock interest in R.D.C. On the same date the Pou heirs and R.D.C. transferred a fee title to the 100 acres to Westinghouse. Although the actual stock transfer did not take place until May 24, 1953, petitioner was regarded as the owner of a 50 per cent interest in R.D.C. from May 9, 1952.

On or about August 7, 1952, petitioner acquired an option to purchase two parcels of land which are known as the Kimbrough-Jones land. This property is located in the same general area as the R.D.C. property. Petitioner assigned the option to York Building Company which exercised it on or about October 10, 1952. The Kimbrough-Jones land was originally acquired for residential development, but this purpose was abandoned when the North Carolina State Highway Commission condemned a right-of-way for a dual-lane highway through the middle of the tract. After this right-of-way was acquired by the North Carolina State Highway Commission, the property was rezoned for industrial use. To date the property has not been developed for any purpose.

On May 27, 1953, York Building Company purchased a 59.95-acre tract, in the same area as the above properties, known as the North Carolina Warehouse Company land.

As part of the promotion and development of the industrial area, petitioner represented both R.D.C., holder of a leasehold on the Pou land, and York Building Company, holder of a fee title to the Kimbrough-Jones and North Carolina Warehouse Company lands. Because the two corporations were not owned by the same interests and in order to avoid any possible controversy or conflict of interest, petitioner and McGinnis agreed to form the York-McGinnis Industrial Center, Inc., later changed to York Industrial Center, Inc. (hereinafter referred to as Y.I.C.). Y.I.C. was incorporated under the laws of the State of North Carolina on February 19, 1953. Petitioner was issued 50 per cent of the stock, McGinnis and Griffin receiving 25 per cent each.

At the time Y.I.C. was organized it was agreed that petitioner would be paid a 5 per cent commission upon any sales or leases of its property negotiated by him as compensation in lieu of his salary for serving as the Y.I.C.‘S president.

It was also agreed that petitioner, McGinnis, and Griffin would advance funds to Y.I.C. with which the corporation would purchase the Kimbrough-Jones and North Carolina Warehouse Company lands. McGinnis did not live up to the agreement and York Building Company refused to transfer the lands for less than the agreed-upon payment. In December 1954 petitioner and others bought the Y.I.C. and R.D.C. stock owned by McGinnis and Griffin and completed the purchase of these two parcels from York Building Company.

Since that time there has been some industrial development in the area adjacent to the R.D.C. and Y.I.C. properties. Three warehouses have been built in the area and a fourth warehouse site has been acquired. Y.I.C. has sold part of the North Carolina Warehouse Company land for various industrial and commercial purposes. The development of the R.D.C. land has not been successful due to the problems involved in the lease of the Pou land. The York Building Company has done much of the construction work on the R.D.C. and Y.I.C. land.

Petitioner has received neither salary nor commissions from R.D.C. or Y.I.C. He received a salary in 1951 from the York Building Company but did not receive any salary from that company in 1952.

Raleigh Farmers Market, Inc. (hereinafter referred to as R.F.M.), is a corporation organized and incorporated under the laws of the State of North Carolina on February 15, 1955. Petitioner was vice president of R.F.M. and owned 33 /13 per cent of its outstanding capital stock. R.F.M. purchased part of the North Carolina Warehouse Company land from Y.I.C., upon which a large produce market and distribution center has been constructed. These facilities were constructed by the York Building Company. R.F.M. acquired additional land from Y.I.C. in 1955, part of which has been sold for various industrial and commercial enterprises.

Wake Industrial Center, Inc. (hereinafter referred to as W.I.C.), is a corporation organized and incorporated under the laws of the State of North Carolina on or about December 2, 1955. Petitioner is president of W.I.C. and owns and holds as custodian for his children just under one-third of its outstanding stock. W.I.C. contracted to buy 27 acres of the 80-acre tract of land owned by the Seaboard Air Line Railroad Company. This land is located near the property of R.D.C., Y.I.C., and R.F.M. As of November 15, 1956, the purchase of this property had not been completed.

Petitioner does not maintain a private office. The offices of Cameron Village, Inc., are used by petitioner as his principal office. York Building Company and R.F.M. also have offices which petitioner uses from time to time. Petitioner maintains personal books of account under the supervision of a firm of certified public accountants.

In the joint income tax returns filed by petitioners for the taxable years 1951 and 1952 they claimed as a deduction promotion expense in the amount of $5,000 paid by petitioner J. W. York to U.L.I. in each of those years. The deductions so claimed by petitioners have been disallowed by respondent.


KERN, Judge:

The sole remaining issue in this case is whether the $5,000 paid by petitioner to U.L.I. in 1952 is deductible as an ordinary and necessary business expense under section 23(a)(1)(A), as an expense for the production of income under section 23 (a)(2), or as a loss under section 23(e). The Commissioner contends that petitioner was not engaged in a trade or business to which this expenditure was proximately related. He argues that this survey was for the purpose of determining whether petitioner should enter a particular trade or business, and had no connection at its inception with any transaction entered into for profit, or in the course of his trade or business. Petitioner argues that since his business was that of developing and promoting real estate developments and since he had used the U.L.I. services previously in this business this survey was an ordinary and necessary business expense.

We agree with respondent that petitioner used this survey as a means of determining whether he should enter a new business. Petitioner's business for a number of years prior to 1951 was that of being an officer and director of both Cameron Village, Inc., and the York Building Company, which had developed and built the Cameron Village Shopping Center and residential development. He also participated in some residential development as an individual. Assuming, arguendo, that petitioner's trade or business was that of promoting and developing shopping centers and residential developments, there is no evidence that this trade or business ever encompassed industrial development such as those contemplated by McGinnis and R.D.C. Petitioner's experience had been limited to residential and shopping center developments. Indeed, when approached by McGinnis, he indicated his lack of knowledge of the industrial real estate picture, and requested a U.L.I. survey before he would entertain the proposition put forth by McGinnis. Petitioner was well aware that different factors were involved in an industrial development. He candidly admitted his lack of experience with such factors. The very nature of the survey was that of a preliminary investigation, the purpose of which, as conceived by petitioner, was to overcome his lack of knowledge of the factors involved in such developments. Petitioner stated at the hearing of this case:

I told Mr. McGinnis of the various councils of the Urban Land Institute and how they operated and that I would like to get a panel; that I had never had any experience in developing industrial property, that all my experience had been in residential and shopping centers. I told him there were different problems in industrial development and I wanted to get a panel to come down and study the situation and if it looked encouraging then I would like to go into it; but if it was not, then I would not be interested in it.

As further evidence of the specialization within the real estate development field it is only necessary to inspect the operation of the U.L.I. U.L.I. operates three separate and distinct panels covering three separate and distinct real estate areas, i.e., The Community Builders' Council, The Industrial Council, and The Central Business District Council. In our opinion it is readily apparent that the trade or business of promoting and developing residential and shopping center areas is separate and apart from that of promoting and developing industrial acreage, and that petitioner's trade or business at the time of the survey was restricted to promotion and development of residential and shopping center properties.

Expenditures made in investigating a potential new trade or business and preparatory to entering therein are not deductible under section 23(a)(1)(A). George C. Westervelt, 8 T.C. 1248 (1947); Morton Frank, 20 T.C. 511 (1953); Frank B. Polachek, 22 T.C. 858 (1954). We have already concluded that at the time the U.L.I. survey was being conducted petitioner was not in the trade or business of promoting and building industrial developments. In our opinion, therefore, this expenditure falls within the doctrine set forth in George C. Westervelt, supra, and is not deductible under section 23(a)(1)(A).

The preliminary nature of the investigation also precludes deduction of this expenditure under section 23(a)(2). This survey could not of itself lead to the production or collection of income. There was no existing interest or right here that had to be protected. Rather, this expenditure looked to the creation of a new interest or right and as such is not deductible under section 23(a)(2). McDonald v. Commissioner, 323 U.S. 57 (1944).

Nor can petitioner deduct this expenditure as a loss under section 23(e). Petitioner was not in the trade or business of promoting and developing industrial properties, and we are unable to agree that this survey was itself a transaction entered into for profit. There was no transaction entered into for profit by petitioner until after the survey had been made, when petitioner purchased the shares of those R.D.C. stockholders who objected to the Westinghouse transaction. The question of gain or loss from that transaction is not involved herein. At the time of the survey the negotiations between petitioner and McGinnis ‘were in a strictly talking stage.’ It is clear from the evidence that the U.L.I. survey was to be the determinative factor in deciding whether petitioner would continue negotiations with McGinnis. Petitioner had not made any agreement concerning this new field of business and would not make any such agreement until the survey was completed.

We conclude that petitioner cannot deduct this expenditure in 1952 under the applicable provisions of the 1939 Code.

Decision will be entered under Rule 50.