*176 Decision will be entered under Rule 50.
1. Corporation A, which was organized in 1945, had a franchise from the Studebaker Corporation under which it carried on a business of buying and selling automobiles. It carried on its business in rented space. All of the outstanding stock of corporation A, 250 shares, was owned by petitioner. Studebaker required that the corporation should obtain better facilities and space for the conduct of its business. Two unimproved lots located on different streets were purchased with the intention of constructing a building, on the better of the two locations, in which the corporation would carry on its business. A building was constructed on one of the lots. Upon the facts it is held, that corporation A, rather than petitioner, was the owner of the 2 lots and of the new building, and that corporation A owned the lots and the building prior to a corporate reorganization.
2. In 1949, in pursuance of a plan of reorganization, corporation A transferred the 2 lots and the building to a newly organized corporation, B, in exchange for all of B's stock. Shortly thereafter, as part of the plan of reorganization, A transferred all of the stock *177 of B to petitioner in exchange for one-fifth of the stock of A which petitioner owned. Held, there was "business purpose" in the transfer of real estate assets of A to B, that there was "continuity of interest" in the exchange, and that the transaction was a statutory reorganization under section 112 (g) (1) (D) of the 1939 Code; and that the exchange by the stockholder of A, the petitioner, of one-fifth of her stock in A for all of the stock of B, the new corporation, was an exchange upon which no gain will be recognized under the provisions of section 112 (b) (3). Chester E. Spangler, 18 T.C. 976">18 T. C. 976, followed.
*351 The Commissioner determined a deficiency in income tax for 1949 in the amount of $ 23,204.85. Petitioner does not contest a minor adjustment. The chief questions are whether there was a statutory reorganization under section 112 (g) (1) (D) of the 1939 Code, and whether an exchange of part of the stock of one corporation for all of the stock of another corporation was a tax-free exchange within section 112 (b) (3). Other related questions are whether certain pieces of real estate and the improvements on one of the pieces of real estate were assets of Farr Motor Sales, Inc., immediately prior to the reorganization.
FINDINGS OF FACT.
The stipulated facts are found as stipulated. The stipulation is incorporated herein by reference.
The petitioner is a resident of Shaker Heights, Ohio. Her return for 1949 was filed with the collector of internal revenue for the eighteenth district of Ohio.
Petitioner is the widow of George A. Farr who died testate in September 1944. He bequeathed to petitioner, his sole legatee, a sole proprietorship business known as Farr Motor*179 Sales, located at 350 East 152d Street, Cleveland, Ohio. Farr was the sole owner of the business which was the selling at retail and the servicing of new and used Studebaker automobiles and trucks. A service garage was operated in a rented building about 46 feet by 140 feet. George A. Farr had a franchise from the Studebaker Corporation. It terminated upon his death.
*352 After the death of George A. Farr, petitioner continued to operate the business of Farr Motor Sales as proprietor and manager until December 31, 1945.
At some time after the death of her husband, the petitioner discussed with representatives of the Studebaker Corporation her desire to obtain a new franchise from Studebaker. Studebaker officials advised petitioner that Farr Motor Sales ought to have a new building containing larger space and better facilities than the building which it was then renting at 350 East 152d Street provided, and that they considered that it would be desirable for her to make arrangements to have a man associated with her in the business as a manager and as a part owner. Petitioner agreed to meet the conditions imposed by Studebaker. Accordingly, she purchased, on September 26, *180 1945, an unimproved lot for $ 6,050 at 800 East 152d Street. She intended to construct a building on the lot which would provide the facilities which Studebaker had requested. At about the same time, she hired John Algoe as general manager of Farr Motor Sales.
Studebaker granted a franchise to petitioner in the spring of 1946.
Farr Motor Sales, Inc., hereinafter referred to as Motor Sales corporation, was organized under the laws of Ohio on December 24, 1945. Alfred Roemisch, Clarence Berndsen, and the petitioner were elected directors. The petitioner was elected president and treasurer; Berndsen, vice president; and Roemisch, secretary. Berndsen was the service manager of Farr Motor Sales; Roemisch was petitioner's attorney. He was also the owner of interests in several automobile dealerships in the Cleveland area.
On December 31, 1945, the following assets were carried on the books of the sole proprietorship, Farr Motor Sales, in the amounts set forth below:
| Cash in bank | $ 7,984.39 |
| Accounts receivable | 641.91 |
| Used-car inventory | 1,075.00 |
| Studebaker parts and accessories inventory | 4,166.59 |
| Gas, oil and grease inventory | 78.12 |
| Paint and paint material inventory | 387.35 |
| Prepaid sales tax | 15.02 |
| Machinery tools and equipment | 3,801.12 |
| Office furniture and fixtures | 557.55 |
| Leasehold and improvements | 242.95 |
| 800 East 152d Street lot | 6,050.00 |
| $ 25,000.00 |
*181 At the first meeting of the directors of Motor Sales corporation on January 2, 1946, a resolution was adopted that the entire capital stock of the corporation would be issued to petitioner in exchange for her transfer to the corporation of all of the assets of the proprietorship. *353 The capital stock consisted of 250 shares of common stock without par value, but having a declared value of $ 100 per share. The asset accounts in the books of Motor Sales corporation were opened with the assets set forth above, and petitioner received all of the stock of Motor Sales, 250 shares.
Although the resolution required petitioner to execute all of the papers necessary to accomplish the transfer of all of the assets, she failed to deliver the deed to the lot at 800 East 152d Street to the corporation and it never had the record title to the property. However, during 1946, 1947, and 1948, the lot was carried as an asset on the books of the corporation at a cost of $ 6,050. Also, during these years the lot was listed as an asset of the corporation in the monthly financial statements which Motor Sales corporation issued to the Studebaker Corporation; it was listed in the corporate franchise*182 returns filed with the secretary of state of Ohio, in the corporation's "return of taxable property" filed with the auditor of Cuyahoga County, Ohio, and in the corporation's Federal income tax returns. Motor Sales corporation paid the real estate taxes on the lot through 1948. It was intended by petitioner and the directors of Motor Sales corporation that all of petitioner's interest in the lot would pass to the corporation as part of the exchange of all of the assets of the proprietorship for the stock of Motor Sales corporation.
During 1946, Studebaker officials continued to express their desire that a man should be a part owner of Motor Sales corporation. Motor Sales received about 26 new automobiles from Studebaker during 1946. Petitioner believed that a considerably larger number would have been received if part of the stock of Motor Sales had been owned by a man as had been suggested.
Algoe left Motor Sales in the spring of 1947. Richard Michael was employed as general manager on April 15, 1947, at the suggestion of Roemisch. Michael had gained considerable experience selling automobiles. He had been sales manager of East End Nash Company, Cleveland, in which Roemisch*183 held a majority of stock. Michael's compensation was fixed at $ 100 per week, plus a bonus of 15 per cent of profits before taxes. Petitioner and Michael agreed that Michael would have an opportunity to purchase Motor Sales stock if his services were satisfactory. On many occasions thereafter Michael was urged by the petitioner and by Studebaker to acquire stock in Motor Sales. However, during these conversations, no mention was made of a specific number of shares of stock or the amount of an investment to be made by Michael. In 1947, Michael did not have sufficient funds to acquire any substantial interest in Motor Sales corporation. The possibility of his borrowing funds to purchase stock was not discussed.
*354 At some time prior to July 1947, petitioner and Michael were of the opinion that Euclid Avenue, Cleveland, would be a better location for Motor Sales corporation than East 152d Street. Michael found 2 neighboring lots on Euclid Avenue. He believed that the 2 lots would be a good location if both could be purchased. He advised petitioner to carry on the negotiations for one of the lots because he believed she could get the property for a lower price if it were*184 not disclosed that Motor Sales corporation was the buyer. Michael undertook negotiations for the other lot in his own name, but eventually the owner, the Texas Company, required that the intended use of the land should be disclosed and Michael's negotiations collapsed. In the meantime, petitioner was successful in making a contract to purchase one of the lots on Euclid Avenue for $ 7,000 and the contract was executed. However, when Michael was unable to negotiate satisfactorily for the adjoining lot, and when Studebaker pressed petitioner to take action with respect to acquiring a new place for Motor Sales corporation, it became necessary to give up the idea of locating Motor Sales on Euclid Avenue rather than on East 152d Street. The net result was, nevertheless, that one lot was acquired on Euclid Avenue. It is referred to hereinafter as the Euclid lot.
The purchase of the Euclid lot was handled in the following way: On August 4, 1947, Motor Sales corporation issued its check for $ 4,000 to petitioner. On September 22, 1947, petitioner gave her personal check to the seller of the lot in the amount of $ 7,000, and title was taken in petitioner's name. Petitioner loaned $ 3,000*185 to Motor Sales. Petitioner acted for Motor Sales corporation in purchasing the Euclid Avenue lot, and purchased it in behalf of the corporation. The corporation's advance of $ 4,000 on August 4, 1947, was intended as, and was, partial payment for the lot; it was not a payment of "salary" to petitioner. Motor Sales repaid $ 3,000 to petitioner on June 19, 1949.
Beginning with the statement of January 1, 1948, the monthly financial statements of Motor Sales corporation, which were forwarded to Studebaker, showed as an asset of the corporation, the Euclid lot at a cost of $ 7,000. Also, the Euclid lot was reflected on the corporation's certified financial statements dated December 31, 1948.
On April 24, 1947, petitioner received a letter from Studebaker pointing out the failure to construct the previously suggested new building. The tenor of the letter suggested that immediate action should be taken to acquire new facilities. Accordingly, on the same day, Motor Sales corporation applied for authority to construct a building on the lot at 800 East 152d Street. Authority was granted by the Office of the Housing Expediter on June 3, 1947.
*355 At about the same time, petitioner*186 initiated negotiations with the Bank of Ohio, Cleveland, to obtain a construction loan. The following terms were agreed to: Motor Sales corporation would put up the first $ 20,000, and the bank would loan the additional amount required, up to $ 25,000. Motor Sales was to deposit the $ 20,000 with the bank, which was to make all disbursements of funds directly to the builders.
At some time during the above negotiations it was observed that the petitioner still held the record title to the lot. For that reason, the bank's loan was "processed" in her name, and she signed a note and mortgage for the loan. All financial statements which were submitted to the bank during the negotiations were those of Motor Sales corporation.
On November 3, 1947, Motor Sales corporation delivered its check for $ 20,000 to the Bank of Ohio, and shortly thereafter construction operations began. It was intended at all times that Motor Sales corporation was to construct and own the building, and that the $ 20,000 which it deposited with the Bank of Ohio was to constitute a payment by the corporation of the construction costs. There was never any intention of the corporation's making a loan of $ 20,000*187 to petitioner. The bookkeeper of Motor Sales corporation, Jane Grimm, nevertheless erroneously recorded on the corporation's books a loan to petitioner of $ 20,000, which was corrected and adjusted soon thereafter in the year-end audit of Motor Sales' books, as will be set forth more fully hereinafter.
Many of the construction bills for the building at 800 East 152d Street were paid directly by Motor Sales corporation and were not presented to the Bank of Ohio for payment. An example is a payment of $ 1,538.65 by the corporation to a roofing company.
Sometime in November 1947, after construction had started, an account was opened in the corporation's general ledger to record these expenses. This account is referred to hereinafter as the construction account. In an audit of Motor Sales' books which was made in January or February 1948, by the firm of Warren, Eide and Warren, certified public accountants, Jane Grimm, the corporation's bookkeeper, was directed to make the following adjusting entries under the date of December 31, 1947:
(1) Wipe out the $ 20,000 charge to loans receivable from petitioner, and charge the construction account;
(2) Wipe out the $ 4,000 charge to accrued*188 payroll, [Euclid Avenue lot] and charge the construction account;
(3) Charge the construction account $ 1,538.65 to reflect the payment by Motor Sales of a bill rendered by the Lake Shore Roofing Company in connection with the construction at 800 East 152nd Street.
*356 The construction account thus reflected a debit balance of $ 25,538.65 as of December 31, 1947. It was carried as an asset to reflect the corporation's investment in the new building. The following explanation for the first two adjusting entries set forth above appears in the journal: "To charge the cost of constructing new garage building located at 800 East 152nd Street, Cleveland, Ohio."
The building at 800 East 152d Street was completed sometime during the middle of 1948, and shortly thereafter Motor Sales moved all of its operations except the "body shop" to the new building. The latter department remained at the rented premises at 350 East 152d Street.
In 1948, Motor Sales paid additional construction expenses in the net amount of $ 10,383.81, which were charged to the construction account. The total cost of the new building was $ 50,460.30, which was paid for in the following way:
| Payments by | ||
| Motor Sales to | ||
| Direct payments | Bank of Ohio for | |
| by Motor Sales to | disbursement to | Advances by |
| suppliers | suppliers | Bank of Ohio |
| $ 11,922.46 | $ 20,000 | $ 18,537.84 |
*189 The sum of $ 31,922.46, paid by Motor Sales, was expended on its own behalf. The expenditures were not intended by Motor Sales or by petitioner as an advance to or a loan on behalf of the petitioner. It was intended and understood by all parties concerned that the corporation "owned" the land and the building at 800 East 152d Street and the Euclid lot. Although petitioner held record title to the properties, it was understood that she would execute and deliver the necessary deeds to Motor Sales corporation in the event Motor Sales desired to make any conveyances of the properties. Petitioner was trustee for the corporation.
The petitioner continued to believe that the Studebaker franchise would be lost eventually if a substantial part of her interest was not sold to a man. Michael's services had been highly satisfactory, and she desired that he purchase part of her stock. But Michael did not have sufficient funds to acquire any substantial stock interest, and the petitioner realized that any sale to him would have to be made at a price which was considerably below the fair market value of the stock of Motor Sales corporation.
During 1948, petitioner, Roemisch, Michael, and Robert*190 E. Warren, the head of the accounting firm, Warren, Eide and Warren, discussed the possibility of having a second corporation own the two parcels of property and the new building. The proposed separation of the real estate from the automobile sales and service business was designed to preserve the Studebaker franchise by having Michael purchase part of petitioner's stock in Motor Sales corporation. It was believed that *357 a sale to Michael would be facilitated if the value of the Motor Sales stock was brought down, closer to his financial means. Also, the petitioner desired to retain exclusive control of the real estate in the event she sold part of her Motor Sales stock to Michael. In November 1948, Warren completed a plan of reorganization designed to accomplish the separation of the real estate from the other assets of Motor Sales corporation. Although the plan was conceived and subsequently carried out in order to facilitate a sale of Motor Sales stock to Michael, there was no binding agreement between petitioner and Michael concerning any details of a sale at any time prior to the execution of the plan of reorganization, or for some time thereafter.
At a meeting of*191 Motor Sales' directors on January 6, 1949, the petitioner submitted a letter, the pertinent part of which is as follows:
As owner of all of the outstanding stock of Farr Motor Sales, Inc., I desire to limit the activities of that corporation to the operation of an autombile sales agency and service garage, and to divorce the ownership and operation of the real estate now owned by the corporation from such activities.
In order to effectuate this desire I submit for your approval and the necessary action by your board and by the shareholders a plan of reorganization which will accomplish the following desired business purposes:
1. Segregate the real estate holdings now utilized in the business conducted by Farr Motor Sales, Inc.;
2. Minimize the amount of investment required of any one to whom it may be desirable to sell all or part of my holdings in Farr Motor Sales, Inc., when and if I desire to retire in whole or part from the active management of the automobile business, and
3. Enable me to retain my entire equity in the real estate through the ownership of the stock of a separate corporation in the event I desire to liquidate in whole or in part my investment in the automobile *192 sales and service business.
The plan of reorganization is as follows:
1. Farr Motor Sales, Inc. will subscribe for 100 shares of the common capital stock of the Farr Realty Corporation, an Ohio corporation;
2. Farr Motor Sales, Inc., will transfer to Farr Realty Corporation the following assets at the cost thereof to the transferor such cost to be the agreed-upon value and the consideration for the issuance of 100 shares of Farr Realty Corporation stock, subscribed for as set forth in "1" above:
| Lot on East 152 Street, Cleveland, Ohio | $ 6,050.00 |
| Building on above lot | 50,460.30 |
| Lot on Euclid Avenue, Cleveland, Ohio | 7,000.00 |
| 63,510.30 |
The lot on East 152 Street and the building thereon is subject to a mortgage payable to the Bank of Ohio, Cleveland, Ohio, in the amount of $ 18,537.42 which is to be assumed by Farr Realty Corporation.
3. Upon receipt of the 100 shares of stock of Farr Realty Corporation, which shares will constitute all of the shares of that corporation's stock which are to be issued at this time, Farr Motor Sales, Inc., will issue to me in exchange for 50 shares of stock of Farr Motor Sales, Inc. the 100 shares of Farr Realty Corporation's stock received*193 in exchange for the assets transferred.
*358 4. Farr Realty Corporation will lease the premises on East 152 Street to Farr Motor Sales, Inc. for a period of three years, renewable for an additional period of two years, for an annual rental of $ 8,400 plus $ 10 for each new and used car and truck sold during each of the years covered by the lease.
You will note that when the directors and stockholders of Farr Motor Sales, Inc. and Farr Realty Corporation, by appropriate action, approve this plan of reorganization, and when the officers of the corporations take the necessary steps to effectuate it, I will own all of the issued and outstanding shares of stock of both corporations. The equity underlying said shares, or the combined net assets of both corporations, will be identical with my present equity, represented by my shares of stock in Farr Motor Sales, Inc. which at present has all of the net assets.
My equity, however, upon completion of the plan, will be in such form that I can more readily dispose, should I so desire, of either that part of my equity represented by the net assets used in the automobile business or of that part that is represented by real estate.
Previous*194 thereto, on December 29, 1948, the Farr Realty Corporation (hereinafter referred to as Realty corporation) was organized under the laws of Ohio. Realty's capital was $ 10,000, consisting of 100 shares of common stock without par value, for which Motor Sales corporation was the sole subscriber. At the meeting on January 6, 1949, the directors of Motor Sales approved the plan contained in petitioner's letter. The directors also authorized entering into a lease agreement with Realty for the premises and facilities at 800 East 152d Street at a rent of $ 700 per month, plus $ 10 for each car or truck sold by Motor Sales. The directors of Realty approved the lease on the following day.
On January 16, 1949, petitioner executed and delivered deeds of 800 East 152d Street and of the Euclid lot to Realty. The deed to the Euclid lot was recorded. The deed to the 152d Street property was not recorded. Petitioner's interest in the properties was limited to her record title and to her personal liability on the construction mortgage held by the Bank of Ohio.
During January 1949, in the annual audit of Motor Sales' books, auditors from Warren's firm directed that the following entries be made*195 under the date of December 31, 1948:
1. An asset account for the Euclid lot was opened and two charges were entered in the respective amounts of $ 4,000 and $ 3,000. The corresponding entry to the $ 4,000 charge wiped out the charge of $ 4,000 which had been entered in the construction account as of December 31, 1947. The corresponding entry to the $ 3,000 charge was a credit to accounts payable to petitioner.
2. The balance of $ 31,922.46 remaining in the construction account, which equalled the total payments made by Motor Sales for the construction of the building, was wiped out and a corresponding debit was made to an asset account titled "Building."
The financial statements and tax returns of Motor Sales for 1948 carried as assets the building, in the amount of $ 31,922.46, and the Euclid lot in the amount of $ 7,000, as of December 31, 1948. The *359 building was not carried at its total cost of $ 50,460.30, because the balance of the cost, $ 18,537.84, was paid for through the construction mortgage held by the Bank of Ohio and was treated as a liability of the petitioner.
Realty's books were opened on April 1, 1949, with the following accounts:
| Land | $ 13,050.00 | |
| Buildings | 50,460.30 | |
| Mortgage payable | $ 18,537.84 | |
| Capital stock | 10,000.00 | |
| Paid-in surplus | 34,972.46 | |
| $ 63,510.30 | $ 63,510.30 |
*196 On the same date, the following entries were made in Motor Sales' books to reflect the transfer of property to Realty in exchange for 100 shares of Realty's stock, and the transfer of 100 shares of Realty stock to petitioner in exchange for 50 shares of Motor Sales stock:
| Investment in Farr Realty Corp | $ 44,972.46 | |
| Land, Euclid Ave | $ 7,000.00 | |
| Land, E. 152d St | 6,050.00 | |
| Building | 31,922.46 | |
| To record transfer of real estate to Farr Realty | ||
| Corporation in exchange for 100 shares (being 100%) | ||
| of that corporation's outstanding common stock. | ||
| Treasury stock | $ 5,000.00 | |
| Earned surplus | 39,972.46 | |
| Investment in Farr Realty Corp | $ 44,972.46 |
To record exchange by Mrs. Rena B. Farr (owner of 100%) (of outstanding stock) of 50 shares of Farr Motor Sales, Inc., common capital stock for 100 shares of stock of Farr Realty Corporation, which was received upon transfer of real estate by Farr Motor Sales, Inc., to Farr Realty Corporation.
Note: Above 50 shares to be held as Treasury shares or to be retired.
On May 6, 1949, 100 shares of Realty corporation stock were transferred by Motor Sales corporation to the petitioner in exchange for which the petitioner conveyed 50 shares*197 of Motor Sales stock to Motor Sales.
With respect to the loan of $ 18,537.84 from the Bank of Ohio, this indebtedness was handled in the following way: From December 29, 1948, to May 1, 1949, Motor Sales made payments aggregating $ 3,437.86 on the indebtedness, and recorded the disbursements as an account receivable from Realty, Realty having assumed petitioner's obligation on the bank loan. On July 5, 1949, petitioner paid the balance of $ 15,503.05 with her personal funds, but as of August 31, 1949, Realty set up an account payable to petitioner for this amount, *360 and repaid petitioner this sum in five installments during the period March 8, 1950, to February 21, 1952.
The following table sets forth Motor Sales' net income, net income after provision for taxes, cash and Government bonds on hand, accumulated earnings, and dividends paid, for the years 1946 through 1949:
| Bonds and | Accumulated | ||||
| Net after | cash on | earnings | |||
| Year | Net income | provision | hand on | on | Dividends |
| for taxes | December 31 | December 31 | paid | ||
| 1946 | $ 16,631.69 | $ 12,906.31 | $ 14,813.26 | $ 12,038.93 | |
| 1947 | 58,046.12 | 35,946.12 | 37,099.77 | 46,985.05 | $ 250.00 |
| 1948 | 65,270.51 | 40,270.51 | 36,233.73 | 87,048.13 | 250.00 |
| 1949 | 47,046.09 | 29,732.64 | 19,975.11 | 76,755.52 | 250.00 |
*198 The accumulated earnings for 1949, $ 76,755.52, reflect the reduction of $ 39,972.46 made on Motor Sales' books to record the exchange of Realty stock for 50 shares of Motor Sales stock owned by petitioner.
The book value of 250 shares of stock of Motor Sales at the end of 1946, 1947, and 1948 was $ 148.16, $ 287.94, and $ 448.19, per share, respectively. Prior to the distribution of the stock of Realty corporation to petitioner, the book value of stock of Motor Sales was not less than $ 448.19 per share. Immediately after the exchange with petitioner, the book value of the 200 outstanding shares of Motor Sales was not less than $ 335.38 per share. On December 31, 1949, the book value of each share was $ 483.78.
On November 16, 1950, by written contract, Michael purchased 85 shares of stock of Motor Sales corporation from petitioner for $ 18,000, or approximately $ 211.76 per share, which he paid for in two installments. The sum of $ 18,000 was accumulated by Michael during his employment as manager from salary and bonus payments which he received from Motor Sales corporation. The book value of Motor Sales stock on November 16, 1950, was not less than $ 483.78 per share. Petitioner*199 also delivered 30 of her remaining 115 shares of stock of Motor Sales to Roemisch, her attorney, "as trustee," without consideration. This was done as a precaution, according to the wishes of the parties, so that if any dispute should arise between Michael and petitioner, Roemisch would be in a position to resolve the dispute. Also, on November 16, 1950, Realty and Motor Sales executed a 5-year lease by which Realty leased the premises at 800 East 152d Street at a rental of $ 700 per month to Motor Sales, with an option to renew the lease for an additional 5 years. Petitioner, Michael, and Roemisch also executed a stockholder's agreement which provided that they would elect themselves directors of Motor Sales; that Michael would be elected president; petitioner, secretary and treasurer; and Roemisch, *361 vice president. The agreement also contained provisions concerning the purchase of stock by the survivors in the event of the death or disability of any of the stockholders.
The deed to the Euclid lot which petitioner gave to Realty on January 16, 1949, was recorded on May 26, 1951, and shortly thereafter, Realty sold the property.
The Commissioner treated the petitioner's*200 exchange of 50 shares of stock of Motor Sales for 100 shares of stock of Realty corporation, as a taxable dividend to the petitioner in the amount of $ 44,972.46, under sections 22 and 115 of the 1939 Code. That determination gave rise to most of the deficiency for the taxable year 1949.
OPINION.
The main issue is whether petitioner's receipt of 100 shares of Realty corporation stock from Motor Sales corporation in exchange for 50 shares of Motor Sales stock, constituted a taxable dividend to the petitioner, in the amount of $ 44,972.46, under the provisions of section 115 (a) and 115 (g)1*201 of the 1939 Code, as the Commissioner has determined, or constituted a tax-free exchange of stock, under section 112 (b) (3), 2 pursuant to a reorganization as defined in section 112 (g) (1) (D). 3
The respondent makes several contentions, the ultimate contention being that the petitioner's surrender of 50 shares of stock of Motor Sales and her receipt of 100 shares of stock of Realty corporation was "essentially equivalent to the distribution of a taxable dividend" under section 115 (g) (1). Respondent construes the evidence as *362 supporting the view that petitioner*202 owed $ 6,050 to Motor Sales because she did not transfer the title to 800 East 152d Street to Motor Sales corporation after it was organized; that Motor Sales had made advances of $ 35,922.46 to petitioner for which she was indebted to Motor Sales; and that Motor Sales, in 1949, paid $ 3,000 to petitioner to reimburse her for that amount of the purchase price of the Euclid Avenue lot. These three amounts total $ 44,972.46. The next step in the respondent's theory is that petitioner's surrender of 50 shares of stock of Motor Sales had the effect of wiping out petitioner's indebtedness to it of $ 6,050, and $ 35,922.46, and enabling Motor Sales to pay $ 3,000 to petitioner. It is part of the respondent's theory that the Euclid Avenue lot was purchased by petitioner for herself and that it was not purchased for Motor Sales corporation, and that it never was Motor Sales' property.
Accordingly, the respondent contends that petitioner owned the realty and the building at 800 East 152d Street; that she owned the Euclid Avenue lot; and that she transferred these properties to Realty corporation in 1949. It follows, the respondent argues, that since petitioner, rather than Motor Sales *203 corporation, made the transfers of the properties to Realty corporation there was no reorganization within the scope of section 112 (g) (1) (D), which applies to "a transfer by a corporation of all or a part of its assets to another corporation." Respondent contends that Motor Sales corporation was not "a party to a reorganization" under section 112 (g) (2), 4 and that the exchange of stock of Realty corporation for stock of Motor Sales corporation does not come within the provisions of section 112 (b) (3) because Motor Sales was not "a party to a reorganization."
The petitioner contends that Motor Sales owned the land and building on East 152d Street and the Euclid Avenue lot*204 prior to the alleged reorganization; that there was an exchange by Motor Sales corporation of properties for all of the stock of Realty corporation; that such exchange of property for stock constituted a reorganization within section 112 (g) (1) (D); and that petitioner's exchange of 50 shares of stock of Motor Sales for 100 shares of stock of Realty was a nontaxable exchange under section 112 (b) (3).
The preliminary questions are, therefore, whether the realty at 800 East 152d Street, and the improvements constructed thereon, and the Euclid Avenue lot were assets of Motor Sales corporation prior to the alleged reorganization.
*363 Consideration is given first to the question of the ownership of the Euclid Avenue lot which was purchased on September 22, 1947, for $ 7,000. The evidence establishes that Motor Sales corporation paid for the lot. The corporation treated the property as an asset; it carried it as an asset in its financial statements and tax returns. The fact that Mrs. Farr negotiated for and closed the purchase of the lot is not inconsistent with ownership by the corporation. She was its president. She carried on the negotiations for the lot in such way as to*205 serve the financial interests of the corporation for which she tried to obtain a low price. The lot was purchased in the course of satisfying the requirement of Studebaker that Motor Sales acquire a better location. The motive behind the purchase of the lot was wholly related to the business of Motor Sales. Mrs. Farr did not purchase the lot for herself, or as a personal investment. We are satisfied from the evidence that there was a bona fide intention of devoting the lot to the use of Motor Sales and of obtaining for it the best location for its business. It is true that the lot was not used as a building site but the petitioner has given a satisfactory explanation for the failure of the plan to so use the lot.
The respondent's chief argument is directed to the point that title to the lot was taken in petitioner's name. Petitioner meets this argument with the assertion that petitioner was a trustee for Motor Sales corporation and that there was a constructive trust. The evidence supports petitioner's contention and there is good legal authority which gives support to the contention. Petitioner, as the president of Motor Sales corporation, acted for the corporation, and she*206 acted in a fiduciary capacity. Of course, she was the sole stockholder and the manager of the corporation. Here, however, the evidence does not show any lack of good faith. To the contrary, the conduct of Mrs. Farr was constantly and consistently directed to the affairs and problems of the corporation. She was endeavoring to develop the business, to satisfy Studebaker, and to retain the Studebaker franchise. It is concluded that Motor Sales became the equitable and true owner of the lot on September 22, 1947, and that Mrs. Farr was no more than the trustee of the legal title. 1 Perry, Trusts (7th ed.) par. 166; Newton v. Taylor, 32 O. S. 399 (Supreme Court of Ohio); Hasselschwert v. Hasselschwert, 90 Ohio App. 331">90 Ohio App. 331; Shaw et al. v. Perry, 58 Ohio Law Abs. 114">58 Ohio Law Abs. 114; Kucks v. Sommers, 59 Ohio Law Abs. 412">59 Ohio Law Abs. 412, 413. Cases cited by respondent do not apply here, namely, Lescaleet v. Rickner, 16 Cir. Ct. 461, and Stockton v. Matson, 15 Cir. Ct. (N. S.) 12. In those cases the parties were not acting as agents and they did not stand in a confidential relationship.
We*207 next consider whether Motor Sales corporation owned the property at 800 East 152d Street and the building which was constructed. Mrs. Farr purchased that lot for $ 6,050 while she carried on the motor *364 sales business as a proprietorship and before Motor Sales corporation was organized. She purchased it for the business, the reason being that Studebaker urged her to acquire a better building for the business and she was endeavoring to retain the Studebaker license. The lot was carried on the books of the proprietorship business as an asset at $ 6,050, and represented part of total assets of $ 25,000. Upon the organization of Motor Sales corporation, 250 shares of stock having a declared value of $ 25,000 were issued to petitioner. We are satisfied from all of the evidence that petitioner included the lot in the assets which the corporation took in exchange for its stock. The testimony of petitioner and others that it was understood that the lot became an asset of the corporation is borne out by documentary evidence such as the financial statements of the corporation, the corporation franchise returns, county and Federal tax returns, and minutes of a meeting of the corporation's*208 directors. The corporation paid the taxes on the property.
There is a substantial amount of evidence about the necessity for the corporation's acquiring a suitable building for carrying on its business and about the insistence of Studebaker that it do so. It is made entirely clear that the construction of a building was a condition of keeping the franchise and continuing the business. The corporation constructed the building. It filed the application for a building permit. Michael, the general manager, obtained bids for material and labor; it advanced its funds to pay construction costs. Petitioner acted for the corporation in obtaining a construction loan. Finally, the corporation took possession of and occupied the building, and conducted its business there. It paid for the insurance on the building.
The respondent, in this instance also, attacks petitioner's contention that she was not the true owner of the realty and the building on East 152d Street on the ground that legal title was in her name. We are satisfied from all of the evidence that petitioner was a trustee of the legal title for Motor Sales corporation; that she acted for the corporation and was in a fiduciary*209 relationship to the corporation.
Respondent relies upon Tressler v. Commissioner, 206 F. 2d 538, in support of his contention that petitioner, rather than Motor Sales corporation, owned the land and building. The conclusion in the Tressler case was based upon the record in that case. The taxpayer failed to carry his burden of proof. There was lack of credibility of testimony and inadequacy of proof. The Tressler case is distinguishable on its facts.
Respondent argues that petitioner could not have been compelled to convey her legal title to the land at 800 East 152d Street to Motor Sales corporation. He suggests that the Statute of Frauds, Page's Ohio General Code, section 8620, would defeat the corporation's claim to the property.
*365 The minutes of the first meeting of Motor Sales' directors on January 2, 1946, contain petitioner's offer, and the directors' acceptance, to exchange all her proprietorship assets, including the land at 800 East 152d Street, for stock of the corporation. The evidence shows that the corporation paid for the land in full by issuing its stock, that it incurred and paid substantial expenditures in constructing*210 a building on the land; and that it entered into possession of the premises. Upon all of the evidence, we conclude that the corporation could have enforced a claim of ownership of the land and building and that the statute of frauds would be no bar. See Artcraft Specialty Co. v. Center Woodland Realty Co., 40 Ohio A. Rep. 125, 178 N. E. 213; Kemp v. Feldman, 84 Ohio App. 154">84 Ohio App. 154, 81 N. E. 2d 319; Schroeder v. Schultz, 24 Ohio Circuit Court Reports (N. S.) 268; affd. 68 Ohio St. 690">68 Ohio St. 690, 70 N. E. 1130; Thibodeau v. Kevern, 19 Cir. Ct. (N. S.) 374; affd. 88 Ohio St. 603">88 Ohio St. 603, 106 N. E. 1064; and Francev. McKenzie, 20 Cir. Ct. 209, affd. 60 Ohio St. 565">60 Ohio St. 565, 60 N.E. 1132">60 N. E. 1132; Topper v. Bohn, 12 Nisi Prius (N. S.) 177, 22 Ohio Dec. 537">22 Ohio Dec. 537. The foregoing applies equally to the Euclid Avenue lot.
Consideration has been given to the matter of various bookkeeping entries which respondent points to as constituting some contradiction of petitioner's*211 claims. They have been satisfactorily explained and are not entitled to much weight in view of the preponderance of evidence in petitioner's favor. On the whole, the bookkeeper made errors due to lack of knowledge of facts, and the errors were promptly corrected.
We recognize that petitioner, as the president of the Motor Sales corporation, might have exercised more care about many formal matters. However, lack of experience rather than lack of good faith is involved. On the whole due care was, in fact, exercised, and the substance of what was done is given weight rather than the lack of form. Furthermore, the intent of the petitioner and her business associates is clear and is borne out by their conduct.
It is held that the two pieces of realty and the building were owned by Motor Sales corporation prior to the formulation and execution of the plan to organize Realty corporation and to effect a reorganization.
The findings and conclusions reached with respect to the above questions having been made in petitioner's favor, the issue of whether there was a reorganization under the provisions of section 112 (g) (1) (D) of the 1939 Code is reached. The ultimate question is whether*212 petitioner's exchange of 50 shares of stock of Motor Sales corporation for 100 shares of stock of Realty corporation is taxable. Petitioner contends that the transaction constituted a tax-free exchange of stock under section 112 (b) (3), pursuant to a plan of reorganization. Respondent contends that the distribution of the stock of Realty to petitioner, a stockholder of Motor Sales corporation, was a taxable *366 property dividend under section 115 (a) and, also, that the transaction accomplished a siphoning off of earned surplus of Motor Sales to the extent of $ 39,972.46 plus a redemption of $ 5,000 of petitioner's stock in Motor Sales.
The entire transaction consisted of two exchanges. Motor Sales first exchanged all of its improved and unimproved realty for all of the stock of Realty corporation. Section 112 (b) (4) is applicable to this transaction if the exchange was made by parties to and in pursuance of a plan of reorganization. The subsequent exchange consisted of distributing the Realty corporation stock to the shareholder of Motor Sales for one-fifth of her stock in Motor Sales. Section 112 (b) (3) is applicable if the distribution of Realty stock for Motor Sales*213 stock constituted an exchange and if the corporations were parties to and the exchange was made in pursuance of a plan of reorganization. See Chester E. Spangler, 18 T.C. 976">18 T. C. 976, 983 (acq. 1953-1 C. B. 6), where the same type of reorganization, sometimes called a "split-off," was considered. See, also, Riddlesbarger v. Commissioner, 200 F. 2d 165; and Rev. Rul. 289, 1953-2 C. B. 37.
Referring to the statutory requirements, we said in the Spangler case as follows:
Sections 112 (b) (3) and 112 (b) (4) both require that the exchanges be made in pursuance of a plan of reorganization and involve stocks, securities or property of a corporation a party to a reorganization. A reorganization is defined in section 112 (g) (1) (D) as "a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred * * *"
In this case the transaction under consideration meets the above definition in that after*214 the transfer of the real property for the stock of Realty corporation, Motor Sales corporation controlled Realty, the new corporation, by the ownership of all of its stock, and shortly thereafter the shareholder of Motor Sales owned all of the stock of Realty corporation. Sec. 112 (h). Since the exchange was made as part of the plan of reorganization and both Motor Sales and Realty were parties to the reorganization (section 112 (g) (2)), the exchange falls within the terms of section 112 (b) (4) if there are no other requirements.
The second transaction, the stock redemption exchange, was in pursuance of the reorganization. The plan had included the distribution of stock of Realty. Cf. D. W. Douglas, 37 B. T. A. 1122. Transfers made pursuant to a plan of reorganization are ordinarily parts of one transaction and should be so treated. Starr v. Commissioner, 82 F. 2d 964. Since the shares transferred were in corporations which were parties to the reorganization the literal requisites of section 112*367 (b) (3) have been met. Chester E. Spangler, supra, p. 984. We now turn to*215 respondent's arguments.
The respondent contends that the exchange of the real properties and the building for the stock of Realty corporation was not attended by a continuity of interest on the part of the person who was the owner of Motor Sales prior to the reorganization (see Regs. 111, sec. 29.112 (g)-1) because, he alleges, the petitioner did not contemplate retaining her interest in the business of Motor Sales after the transaction. The respondent asserts that the employment contract of April 1947 required petitioner to sell part of her stock in Motor Sales to Michael; that the sale of stock to Michael on November 16, 1950, was a fulfillment of that obligation; and that the reorganization and sale were parts of the same transaction. Respondent relies on Bassick v. Commissioner, 8">85 F. 2d 8, affirming Wilbur F. Burns, 30 B. T. A. 163, certiorari denied 299 U.S. 592">299 U.S. 592. The respondent contends, also, that Motor Sales' exchange of some of its assets for stock of Realty did not have a bona fide business purpose. This contention is intertwined with the contention that there was a lack of continuity*216 of interest; i. e., the respondent alleges that the purpose of the exchanges was to enable petitioner to sell her Motor Sales stock to Michael, and that such purpose was personal and was not "germane to the conduct of the venture at hand * * *." Helvering v. Gregory, 69 F. 2d 809, 811, affd. 293 U.S. 465">293 U.S. 465.
Upon all of the evidence it is found that neither the contract of employment with Michael nor any discussions between him and the petitioner prior to the reorganization required him to purchase, or petitioner to sell, any Motor Sales stock. After the plan of reorganization was consummated the petitioner remained free to retain her entire interest in Motor Sales, Michael was under no obligation to purchase any interest, and the petitioner alone had the risks and the benefits of Motor Sales' continuing operations. The exchanges in question were not interdependent upon petitioner's sale of some of her stock to Michael. That sale was not made until about 18 months later. The two corporations, Motor Sales and Realty, were in existence and could have continued to operate whether or not a sale of stock was ever made to Michael. *217 See Scientific Instrument Co., 1253">17 T. C. 1253, affd. 202 F. 2d 155; ACF-Brill Motors Co. v. Commissioner, 189 F. 2d 704, affirming 14 T.C. 263">14 T. C. 263, certiorari denied 342 U.S. 886">342 U.S. 886; and American Bantam Car Co., 11 T.C. 397">11 T. C. 397, affd. 177 F. 2d 513, certiorari denied 339 U.S. 920">339 U.S. 920. We are satisfied from the evidence before us that petitioner's eventual sale of stock to Michael was not made pursuant to an obligation which existed prior to the reorganization, and that it was not so interdependent with the reorganization as to violate the "continuity of interest" test required for reorganizations under section 112 (g) (1).
*368 Consideration has been given to Bassick v. Commissioner, supra, which is cited by respondent. The Bassick case involved section 202 (c) (3) of the Revenue Act of 1921, the predecessor of section 112 (b) (5) of the 1939 Code. The issue was whether the taxpayers, who transferred property to a corporation*218 for its stock, were in control of, or owned, at least 80 per cent of the shares of the corporation immediately after the transfer. They had received for their property 147,500 shares, or 100 per cent of the stock, but prior to the exchange, they had contracted to transfer 65,000 shares, or more than 40 per cent, to a third party. It was held that because a pre-existing obligation to convey the 65,000 shares existed the taxpayers were not in control of the corporation immediately after the transfer, although they might literally have received 100 per cent of the shares. See, also, S. Klein on the Square v. Commissioner, 188 F.2d 127">188 F. 2d 127, affirming 14 T. C. 786, certiorari denied 342 U.S. 824">342 U.S. 824.
It is not denied by petitioner that the immediate purpose of the transactions in question was to reduce the value of the stock of Motor Sales so as to place a substantial part of petitioner's Motor Sales stock closer to Michael's means in the event stock should be offered to him. The evidence shows, however, that the sale of part of petitioner's stock in Motor Sales to Michael was desired only in order to*219 preserve the Studebaker franchise. The record establishes that Studebaker postponed granting the franchise for more than 1 year, until 1946; that its desire to have a man in control of the dealership was clearly and repeatedly brought to the attention of the petitioner; that Michael and the petitioner were both urged to arrange for a purchase and sale of stock; and that at least one other male purchaser was referred to petitioner by the Studebaker corporation. We are satisfied that petitioner, Michael, and Roemisch, her attorney, reasonably believed that the franchise eventually would be lost unless a man was brought into the business of Motor Sales with petitioner.
Although the presence of a business purpose is not controlled by the motive of the stockholder, Estate of John B. Lewis, 10 T. C. 1080, affd. 176 F. 2d 646, we are satisfied that the petitioner, as a stockholder and director, and that the other directors of Motor Sales, approved and carried out the reorganization in order to preserve Motor Sales' franchise. The preservation of the franchise clearly was germane to the conduct of the business of Motor Sales.
In*220 the Lewis case consideration was given to the question of the existence of a business purpose in connection with a reorganization under section 112 (g) (1) (D). The old corporation, which operated three different lines of business, tried to sell its entire business. It was able to sell only two branches of its business for which it received cash and securities. It then conveyed the remaining assets and a portion *369 of the cash to a new corporation in exchange for the entire capital stock of the new corporation, and was promptly liquidated. The shareholders of the old corporation received the entire capital stock of the new corporation and the securities and the balance of the cash possessed by the old corporation. The business operations of the old company were carried on by the new corporation without interruption, and without change of location, policy, or personnel, for almost 3 years. We held that the exchange of the stock of the new corporation for part of the assets of the old corporation constituted a reorganization under section 112 (g) (1) (D). What was said in the Lewis case, at pages 1085 and 1086, is appropriate here:
Here, the petitioners organized*221 a new company to conduct a business. They brought about a transfer of the operating assets from the old company to the new company. This they did with the intention that the new company carry on the business with those assets. For aught that any of the interested persons could foretell at that time, the new company would continue to conduct that business indefinitely, albeit the petitioners hoped that the business could eventually be sold for a fair price. The new company did in fact continue to conduct the business, without interruption, for a period of at least three years. Certainly, this transfer of assets from the old to the new company was for the very purpose of conducting a corporate business. That is what was done. It was no sham. Neither the transferor nor the transferee was ephemeral. Neither was a mere device or conduit for the conveyance of assets to a stockholder.
As in the Lewis case, the transfer of property by Motor Sales was made for the purpose of continuing the operations of Motor Sales, and the business, in fact, was continued in the modified corporate form. If anything, this is a stronger case than the Lewis case, for the ultimate purpose of*222 the transfers in this case was to assure the continuance of the business operations of Motor Sales through the preservation of the Studebaker franchise. Neither Motor Sales nor Realty was a short-lived corporate shell designed to serve as a conduit for the conveyance of assets to the petitioner. Cf. Helvering v. Gregory, supra.We are satisfied that the use of the two corporations to carry on the business formerly carried on by Motor Sales alone, with petitioner's interest in the assets, as a sole shareholder, unchanged, was a genuine reorganization attended by continuity of interest and by an adequate business purpose.
It is held that the exchange of Motor Sales' real estate assets for Realty's entire capital stock was a reorganization within the meaning of section 112 (g) (1) (D). Realty and Motor Sales each was a "party to a reorganization" within the meaning of section 112 (g) (2), and the petitioner's exchange of 50 shares of stock of Motor Sales for the entire capital stock of Realty was a tax-free exchange under the provisions of section 112 (b) (3) of the 1939 Code.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 115. DISTRIBUTION BY CORPORATIONS.
(a) Definition of Dividend. -- The term "dividend" * * * means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. * * *
* * * *
(g) Redemption of Stock. --
(1) In general. -- If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.↩
2. SEC. 112. RECOGNITION OF GAIN OR LOSS.
(b) Exchanges Solely in Kind. --
* * * *
(3) Stock for stock on reorganization. -- No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.↩
3. (g) Definition of Reorganization. -- * * *
(1) The term "reorganization" means * * * (D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred * * *↩
4. SEC. 112. RECOGNITION OF GAIN OR LOSS.
(g) Definition of Reorganization. -- * * *.
* * * *
(2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of a reorganization resulting from the acquisition by one corporation of stock or properties of another.↩