dissenting: I respectfully dissent from the majority’s conclusion that petitioners, under the facts of this case, must report gain in 1968 upon the transfer by them of certain real property for the promise to pay an annuity. Specifically, I believe the opinion is erroneous in its determination that the annuity in this case has an ascertainable fair market value.
As a general rule, section 1001 requires the recognition of any gain or loss realized upon the sale or other disposition of property. In this context, the gain realized, and thus reportable, is the amount by which “the sum of any money plus the fair market value of the property (other than money) received” exceeds the adjusted basis of the property transferred. If that which is received has no ascertainable fair market value,1 the transaction is held “open” and the taxpayer is permitted to first recover his basis in the transferred property before recognizing any gain.
In the instant case, petitioners transferred certain real property in exchange for 212 Corp.’s promise to pay an annuity. Before the measure of petitioners’ realized gain, if any, and the year it is reportable, can be ascertained, it is necessary to first determine the fair market value of 212 Corp.’s promise to pay. The Third Circuit, to which this case is appealable, has previously addressed this question.
In Evans v. Rothensies, 114 F.2d 958 (3d Cir. 1940), the taxpayer, Evans, transferred 3,000 shares of preferred stock to his son-in-law, Adams, for $84,000. The purchase price was payable in semiannual installments in the form of an annuity for the life of Evans and his wife. Under the annuity agreement, 2,956 of the 3,000 shares transferred were placed in an escrow account as security for the annuity payments due. The preferred stock contained certain dividend requirements from which the annual payments to Evans would be made. Specifically, the annual dividends on the stock exceeded the annuity payments by $3,000 to $9,500. Further, except for the dividends paid on the stock, Adams was without the means to make the annuity payments. Evans sought to deduct as a loss the difference between his basis in the stock transferred and what he believed to be the fair market value of the annuity. In disallowing the claimed loss, the court specifically found that the annuity had no ascertainable fair market value. In so doing, it noted that an annuity contained certain elements of value which were incapable of appraisal, viz, security, assurance of income, regularity of payments, and relief of responsibility attending to investment. The court further stated:
whether Evans would ever receive any annuity payments under the contract with Adams depended in a very real sense upon whether the company continued to earn and pay dividends wherewith Adams could make the payments called for by the annuity. Unless Adams was so enabled to pay, Evans’ right of redress for a default by Adams in annuity payments was definitely limited by the contract to such satisfaction as was obtainable through the security of the escrowed stock. Particularly, in these circumstances, the contract of annuity could not be said to have a fair market value * * * [114 F.2d at 962.]
Although the facts in Evans differ slightly from those of the present case, certainly the relevant factors upon which the court based its decision are not sufficiently distinguishable to warrant a different conclusion respecting the fair market value of the . annuity.2
In the instant case, petitioners transferred property to a corporation owned by their sons in return for the corporation’s promise to pay an annuity. As in Evans, the property transferred was security for the transferee’s promise to pay. As in Evans, the income generated by the property transferred was to be the source of the annuity payments. Further, as in Evans, except for the income from the transferred property, the transferee would be unable to make the annuity payments. Moreover, as in Evans, whether petitioners would ever receive any annuity payments depended upon the continued success of a corporation — in this case, Schultz Co.3 Despite the cognovit clause, petitioners’ only redress in the event 212 Corp. did not pay was, as in Evans, limited to such satisfaction as was obtainable through the property transferred. In addition, as in Evans, the value of the security was also directly related to the success of a corporation.4
When the above factors are coupled with the additional uncertainty of each annuitant’s lifespan, under the Third Circuit’s approach, I would hold that the annuity received by petitioners has no ascertainable fair market value.5
Under .a finding that the annuity, had no ascertainable fair market value, the payments received by petitioners would consist of two components for tax purposes. At the outset, a portion of each payment would be ordinary income under section 72 and the balance would constitute a recovery of petitioners’ basis in the property transferred. Once petitioners had fully recovered their basis, any payments received thereafter would also consist of two components. Specifically, a portion would be ordinary income under section 72 and the remainder would be capital gain. Before the ordinary income portion under section 72 can be computed, it is necessary to determine petitioners’ investment in the contract under section 72(c).6 In this respect, I would agree with the majority’s determination. In so doing, however, I must necessarily express my disagreement with the following statement made in the Estate of Bell v. Commissioner, 60 T.C. 469,476 (1973):
It would be manifestly inconsistent to find that the annuity contract had a fair market value for purposes of determining a taxpayer’s cost or investment in the contract under section 72(c), and yet to hold it had no determinable value for purposes of section 1001.
In Burnet v. Logan, 283 U.S. 404 (1931), the Supreme Court recognized that a contingent right to receive payments could have a fair market value for one purpose and yet not have a fair market value for another purpose. Thus, I do not believe it to be beyond the pale to find an annuity has a fair market value for purposes of section 72(c), and at the same time find that it has no fair market value for purposes of section 1001. Suffice it to say the sections are not concerned with the same matters.7 See also Estate of Hurlburt v. Commissioner, 25 T.C. 1286 (1956).
Finally, even if 212 Corp.’s promise to pay could be considered as having an ascertainable fair market value, the majority fails to discuss whether such promise also constitutes the equivalent of cash.
Under the accounting rules which have developed, a cash basis taxpayer is required to report income upon the receipt of cash or the equivalent of cash. If a taxpayer receives a deferred payment obligation which is not considered the equivalent of cash, then recognition of income is postponed until payments on the obligation are received. Western Oaks Building Corp. v. Commissioner, 49 T.C. 365 (1968). As previously stated, section 1001 generally requires the recognition of all gains realized upon the sale of property. In computing any gain on the sale, the “amount realized” includes any cash plus the fair market value of other property received by the vendor. If the property received has no ascertainable fair market value, the transaction is held “open” and the recognition of gain is deferred.8 Estate of Hurlburt v. Commissioner, supra. Normally, the accounting rules and the rules under section 1001 operate in tandem. That is to say, the conclusion which usually follows from a finding that a promise to pay is not the “equivalent of cash” (and thus not reportable under the accounting rules) is that such promise has no ascertainable fair market value, and therefore does not constitute an “amount realized” under section 1001. Johnston v. Commissioner, 14 T.C. 560 (1950). However, a potential conflict between the accounting rules and the rules under section 1001 arises when a vendor receives a promise to pay which has an ascertainable fair market value but which has characteristics of a promise which is not the equivalent of cash. The question then is which set of rules govern the reporting of the transaction.9
In Warren Jones Co. v. Commissioner, 60 T.C. 663 (1973), revd. 524 F.2d 788 (9th Cir. 1975), the taxpayer sold for $153,000 certain real property with an adjusted basis of about $62,000, thereby realizing a gain on the sale of $91,000. Under the terms of the sale, the taxpayer received a cash downpayment of $20,000 and a deferred payment obligation with a face value of $133,000 and a fair market value of approximately $77,000. To be decided was the manner in which the gain was to be reported. In holding for the taxpayer, we concluded that notwithstanding the fact that the obligation had an ascertainable fair market value, it nevertheless was not the equivalent of cash and as such did not constitute an “amount realized” in the year of sale.10 Under this analysis, the transaction was held “open” thereby permitting the taxpayer to recover its basis before the recognition of any gain. On appeal, the Ninth Circuit reversed and held that if a deferred-payment obligation has an ascertainable fair market value then, unless installment reporting is elected, the transaction is “closed” for reporting purposes, and the taxpayer must report any gain in the year of the sale.11
In the instant case, petitioners received a promise to pay which the majority has determined had an ascertainable fair market value. Under the rationale of our decision in Warren Jones, in determining whether petitioners are obligated to report any gain in the year of sale, our inquiry does not end at this juncture. In other words, we must further determine whether the payment obligation received by petitioners constituted the equivalent of cash. Under the facts, it would appear that it does not. In this connection, the promise received by petitioners was nonassignable,12 and was by its very nature not the type of obligation which would “commonly change hands in commerce.” Western Oaks Building Corp. v. Commissioner, 49 T.C. 365 (1968); Johnston v. Commissioner, supra; Ennis v. Commissioner, 17 T.C. 465 (1951). Under these circumstances, to be consistent with our holding in Warren Jones, petitioners should be permitted to report any gain realized by them under the cost recovery method.
If, by its holding herein, the majority intends to reject the approach set forth in our decision in Warren Jones, it should do so expressly. As it is now, without a significant policy justification therefor,13 I believe this case and our decision in Warren Jones are theoretically and regrettably irreconcilable.
Sec. 1.1001-l(a), Income Tax Regs., provides in part that “only in rare and extraordinary cases will property be considered to have no fair market value.”
The Third Circuit in Evans v. Rothensies, 114 F.2d 958 (3d Cir. 1940), held that the annuity received by the taxpayer had no ascertainable fair market value for purposes of determining whether he sustained a less on the transferred stock. In our case, the issue involves the realization of a gain on the transferred property.
However, whether the issue involves the realization of a gain or a loss on the transaction does not affect the. question of whether the annuity promise has an ascertainable fair market value. Commissioner v. Kann’s Estate, 174 F.2d 357 (3d Cir. 1949).
Specifically, the rent received by 212 Corp. and used to pay the annuity was dependent upon Schultz Co.’s success.
The facts indicate that without Schultz Co. as a tenant the fair market value of the transferred property dropped significantly.
Moreover, I believe the majority’s use of actuarial tables to establish the fair market value of petitioners’ annuity is questionable at best. The concept of “fair market value” has been oft-defined as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Although there are no findings as to what a “willing buyer” (indeed, if one could even be found) would have paid petitioners for their annuity, it is highly unlikely that they could have obtained a price even close to the $169,000 figure which the majority found as the fair market value.
Under sec. 72(c) the investment in the contract is basically the cost of the contract to the annuitant. However, where the parties are related and there is no evidence to show that they were dealing at arm’s length, the possibility of a partial gift on the transfer of the property exists. It is therefore necessary to look elsewhere to determine the investment in the contract. For this purpose, the majority used the annuity tables under sec. 20.2031r-7(f), Estate Tax Regs.
I also disagree with the majority’s use of its determination of the fair market value of the annuity under sec. 20.2031-7(f), Estate Tax Regs., as evidence of the fair market value of the real property exchanged therefor. The use of this method in cases of this type was explicitly rejected by the Third Circuit in Evans v. Rothensies, supra.
Furthermore, as support for its conclusion in this determination, the majority cites United, States v. Davis, 370 U.S. 65 (1962). The pertinent portion of that case was predicated on the fact that the parties were dealing at arm’s length. The majority specifically found that not to be the case herein. Davis simply is inapposite. Under our facts, with all the inherent uncertainties embodied in sec. 20.2031-7(f), Estate Tax Regs., if the value of the annuity determined thereunder were equal to the value of two parcels of income-producing real property, it would be nothing more than pure coincidence.
This assumes no valid installment sales election is made pursuant to sec. 453. See sec. 1001(d).
Essentially, the question is whether “fair market value” and “cash equivalence” are interchangeable terms for purposes of computing gain under sec. 1001. See MacDonald v. Commissioner, 55 T.C. 840, 860-861 (1971). Stated otherwise, is a promise to pay which has a fair market value necessarily the equivalent of cash?
The finding of no cash equivalence was premised on the fact that the obligation could only be marketed at a discount greater than 40 percent of its face value.
Presumably, under the Ninth Circuit’s approach, the taxpayer would likewise have to recognize a loss if its adjusted basis exceeded the “amount realized.” For example, if the taxpayer in Warren Jones Co. v. Commissioner, 60 T.C. 663 (1973), revd. 524 F.2d 788 (9th Cir. 1975), had a basis in the transferred property of $100,000, absent sec. 453, it would have had a recognizable loss of $3,000 in the year of sale ($100,000 basis less $97,000 cash plus fair market value of note received). This result would follow notwithstanding the fact that the property was sold at a gain of $53,000 ($153,000 sales price less $100,000 basis).
Furthermore, since the transaction is closed in the year of the sale, any amounts subsequently collected by the taxpayer in excess of the obligation’s fair market value would apparently constitute ordinary income. See Osenbach v. Commissioner, 17 T.C. 797 (1951), affd. 198 F.2d 235 (4th Cir. 1952). However, in light of the decision in Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and the cases which have emanated therefrom, the result in Osenbach appears questionable. See Federal Bulk Carriers, Inc. v. Commissioner, 66 T.C. 283 (1976), affd. 558 F.2d 128 (2d Cir. 1977).
Although it does not appear in the majority’s factual findings, the record shows that the contract of payment received by petitioners was nonassignable. On this point, see Rev. Rui. 68-606,1968-2 C.B. 42.
Admittedly, private annuity transactions differ from typical sale transactions in that in the former situation the total price to be paid is contingent on the annuitant’s survival. However, this factual distinction does not warrant a change in the applicable law. Rather, I believe the contingent nature of the sales price is merely a factor to be considered in determining whether the obligation has an ascertainable fair market value.