*949 Under an agreement of April 23, 1934, the petitioner relinquished his interest in mortgaged real estate and obtained a release from the mortgage debt. Held, that the loss was a capital net loss and that the deduction is limited to $2,000 by section 117(d) of the Revenue Act of 1934.
*951 This is a proceeding for the redetermination of a deficiency in income tax for 1934 in the amount of $5,951.91. The petition alleges that the respondent erred in the determination of the deficiency :1) in including in gross income $233.34 as petitioner's share of the profits from a joint venture when there was no profit; and :2) in failing to allow the deduction from gross income of $40,456.87 representing the petitioner's share of the 1934 loss from the joint venture.
*952 The respondent, on the other hand, contends that he erred in the determination of the deficiency in that allowed in computing the net income of the joint venture of Polin, Markovitz & Krekstein for 1934 as a capital loss resulting from the disposition of the property known as*950 1214-20 Filbert Street, Philadelphia, Pa., in that year and that the petitioner was allowed his prorata share thereof in the computation of the taxable net income reflected in the deficiency notice did not dispose of the property known as 1214-20 Filbert Street, Philadelphia, Pa., during the year 1934 and the allowance of a prorata share of the deduction for a capital loss in the deficiency notice is erroneous and should be eliminated in the computation of the deficiency. moved for an increase in the deficiency based upon the claimed error.
FINDINGS OF FACT.
1. The petitioner is a resident of Philadelphia, Pennsylvania.
2. In 1922 the petitioner, Samuel Krekstein, Max Markovitz, and David Markovitz, as tenants in common, purchased at auction the premises in Philadelphia known as 1214-20 Filbert Street, and proceeded to erect thereon a garage building. Each of the four individuals contributed one-fourth of the purchase price of the premises plus one-fourth of the cost of erecting the garage building. On September 19, 1922, the four individuals named deeded the property to the *953 Real Estate Title Insurance & Trust Co. of Philadelphia hold title to the said property*951 as and for their agent subject to the terms of this memorandum. responsible for the collection of rents or for the management of the property and was to receive a fee of $50 per year for acting as the agent of the cotenants. The agreement provided:
The said principal parties £ cotenants] to and among themselves on or before the 15th day of August of each year each to pay one-quarter of the taxes assessed by the City of Philadelphia against the said property, and on or before the 15th day of May of each year each to pay one-quarter of the water rent charged against the said property; and further, promptly to pay one-quarter of the interest on mortgage against the property.
The agreement further provided:
It is intended that this memorandum shall not constitute a partnership among the principal parties hereto, but shall be an evidence of the manner in which the property is held and to be governed; the principal parties hereto state that they each have contributed one-quarter of the cash required to acquire the abovementioned property and to pay the expenses incident to the transfer of it. Further, the principal parties hereto £the cotenants] authorize the Company to issue*952 certificates to each of them which shall be substantially in the following form:
hereby certifies to you that it holds the title to the premises 1214-16-18-20 Filbert Street, Philadelphia, as agent under the terms of the agreement dated September 19th, 1922, in which agreement it is stated that your interest in the property is one-quarter.
3. On February 23, 1924, the Real Estate Title Insurance & Trust Co. of Philadelphia transferred title to the premises 1214-20 Filbert Street to David Markovitz, max Markovitz, Morris Polin, and Samuel Krekstein. This was for the purpose of enabling the cotenants to borrow $150,000 upon the property as security. On the same date the cotenants gave their bond to the Philadelphia Saving Fund Society in the sum of $300,000 for a loan of $150,000, payable three years from date thereof with interest at 6 percent per annum. The bond was not paid at maturity and the mortgagee for many years was content merely to receive the interest upon the money loaned at the rate of 6 percent.
4. The total cost of the land and building at 1214-20 Filbert Street was $353,129.93.
5. After the garage building was completed the premises were leased to a*953 tenant on a fixed rental basis. By arrangement with the tenant the rents were paid to one Cloak, who was an employee of Markovitz Brothers. The money as received was divided by him equally among the four cotenants. Each of the four cotenants contributed his share of the taxes, insurance premiums, and interest on the mortgage loan as they became due and payable. No partnership agreement was ever entered into between the cotenants and the relationship between them was always that of tenants in common.
6. In about 1932 the tenant was unable to pay the full amount of the accrued rental. The books of the cotenancy which had theretofore been kept by Cloak were turned over to the petitioner. He thereafter received the rents. At first he divided them equally among himself and his three associates; but when the rental receipts were insufficient to pay interest and taxes the petitioner deposited the money in the bank in a special fund for the cotenancy.
7. Upon the failure of the mortgagors to pay interest and taxes as they became due the mortgagee threatened to foreclose the mortgage, no part of the principal of which had been paid. Interest and taxes were in arrears. After*954 some negotiations the mortgagors and the mortgagee on April 23, 1934, entered into a written agreement which provided in part as follows:
WHEREAS the bond held by the Society is in default with respect to the payment of principal and interest and with respect to the payment of the taxes on the mortgaged premises; and
WHEREAS the parties of the first part have asserted a claim against the Society for damage caused by the construction and operation of a garage at the Northwest corner of 12th and Filbert Streets, Philadelphia; and
*954 WHEREAS the parties hereto desire to adjust and settle their respective claims arising in the premises on the terms hereinafter contained;
NOW THEREFORE, in consideration of the premises and of the mutual covenants hereinafter contained, it is agreed as follows:
1. The parties of the first part covenant and agree as follows:
:a) At the time of the execution and delivery of this agreement, they will cause to be paid to the Society the sum of $13,000.
:b) They jointly and severally, for themselves and each of them, their and each of their respective heirs, executors, administrators, successors and assigns, do hereby remise, release*955 and forever discharge the Society, its successors and assigns, of and from all and all manner of actions and causes of actions, suits, claims and demands whatsoever, in law or equity, which against the Society they or any of them ever had or now have or hereafter may have by reason of the construction and/or operation of a garage at the Northwest corner of 12th and Filbert Streets, in the City of Philadelphia.
:c) At the time of the execution and delivery of this agreement, they will cause the tenants of the martgaged premises to execute and deliver to the Society a release similar in substance to that given by the parties of the first part in subparagraph :b) of this section.
:d) They will cause the tenants of the said mortgaged premises to deliver to the Society full and complete possession of the mortgaged premises on or before May 1, 1934; and they covenant and agree that all net earnings from the operation of the mortgaged premises on and after April 16, 1934, shall be paid to the Society. For the purpose of this agreement, shall be taken to mean all gross receipts of any kind, less only :1) cost of gasoline, oils and greases, :2) cost of materials and supplies, and :3) *956 salary and wages of employees.
For the purpose of carrying into effect the provisions of this subparagraph, the parties of the first part shall and will, at the time of the execution of this agreement, cause to be assigned and delivered to the Society the interest of the lessors in the lease for the mortgaged premises.
2. The Society, upon the execution and delivery of this agreement and upon the receipt of the sum of $13,000 to be paid by the parties of the first part, and on the assignment of said lease, as hereinabove provided, covenants and agrees as follows:
:a) The parties of the first part and each of them shall be released from all liability of any kind for delinquent taxes on the mortgaged premises and for all interest due on the said bond.
:b) The principal sum, interest, costs and other obligations due on the said bond and the lien of any judgment obtained thereunder or pursuant to the warrant of attorney annexed thereto, shall be restricted to and collectible only out of the property described in the mortgage accompanying said bond, and the Society, for itself, its successors and assigns, agrees that no other property or estate, real, personal or mixed, now*957 owned or hereafter owned by the obligors in said bond, or any of them, their or any of their heirs, executors or administrators, shall be liable for the debt, interest, costs or other obligations evidenced by said bond.
* * *
:e) The Society will, at its own expense, proceed in due course to foreclose the mortgage securing the said bond and upon completion of the foreclosure proceedings will mark the said bond cancelled and deliver the same to Morris Polin for the parties of the first part. If in such proceedings the Society acquires *955 title to the mortgaged premises, the parties of the first part will cause all fire insurance policies now held as security for the mortgage to be assigned absolutely to the Society.
8. The agreement referred to above was carried out and the premises were delivered on May 1, 1934, to the mortgagee. None of the cotenants received any benefits of any kind from the property after May 1, 1934. On December 30, 1934, the Philadelphia Saving Fund Society, pursuant to the agreement, instituted a foreclosure proceeding under the bond and mortgage and acquired the property at the foreclosure sale on April 1, 1935, on its bid of $75.
9. *958 The bond was canceled by the mortgagee on April 27, 1935.
10. The petitioner's cost of his one-fourth interest in the property was one-fourth of $353,129.93 or $88,282.48, and his share of the liability on the $150,000 mortgage indebtedness was $37,500. The total depreciation sustained, written off, and deducted in tax returns to the date of abandonment was $49,369.09, one-fourth of which applied to petitioner's interest. Petitioner's loss on his original investment upon the abandonment and surrender of the property was $38,440.21.
11. A return on from 1065 :partnership return) for Polin, Markovitz & Krekstein was filed for 1934, in which it was stated that the nature of the organization of Polin, Markovitz & Krekstein was a "tenancy in common."
12. The books of account of the cotenants and of the petitioner for the year 1934 were kept and returns filed on the cash receipts and disbursements basis.
13. The total gross income of the cotenancy for 1934 from the operation of the garage building was $6,610.86, consisting of rents collected prior to April 23, 1934. The depreciation sustained on the garage property up to April 23, 1934, was $1,007.53. Miscellaneous expenses*959 were paid of $669.97. The $13,000 paid to the mortgagee pursuant to the agreement of April 23, 1934, came out of the fund which the petitioner held in the bank to the credit of the tenancy in common.
OPINION.
SMITH: In this proceeding the petitioner contends that the tenants in common sustained a loss in 1934 from the operation of the garage property of $8,066.64 and that petitioner is entitled to deduct from his gross income one-fourth of that amount, or $2,016.66. He further contends that he is entitled to deduct from gross income the full amount of his share of the loss upon the surrender of the property, which is admitted to be $38,440.21.
The respondent, on the other hand, contends that the tenants in common, making their returns upon a cash receipts and disbursements basis for 1934, had a profit from the operation of the garage property *956 of $4,933.36, one-fourth of which, or $1,233.34, is includable in the petitioner's gross income. He further contends that the tenants in common are not entitled to the benefit of any deduction whatever for the payment of the $13,000 to the Philadelphia Saving Fund Society in 1934, nor entitled to the deduction from gross*960 income of any part of their capital investment in the garage property, upon the ground that the loss was not sustained in 1934.
We shall first consider the question as to whether the claimed loss upon the abandonment and surrender of the garage property in 1934 fell within the year 1934 or, as claimed by the respondent, in 1935. It is alleged in the petition and admitted in the answer that loss upon abandonment and surrender of the property $38,440.21. (This computation does not take into account any part of the $13,000 paid by the tenants in common to the Philadelphia Saving Fund Society.) How then can the respondent argue that the loss did not fall within the year 1934 when it is clear that the abandonment and surrender of the property, which he admits occasioned the loss, occurred within that year?
Entirely aside from the pleadings in this case, however, the Board is satisfied that the loss fell within the year 1934. Pursuant to the agreement of April 23, 1934, the tenants in common of the property surrendered possession thereof and all beneficial interest therein on or before May 1, 1934. The bondholder, the Philadelphia Saving Fund Society, agreed to foreclose the property*961 at its own expense and in its own good time. The plain intent of the agreement is that the tenants in common were to divest themselves of all interest in the property on or before May 1, 1934. They did this. All that they could hope to receive on and after May 1, 1934, was the cancellation of the bond. The loss was sustained by the tenants in common when they divested themselves of all their interest in the property and not when the foreclosure sale took place.
The next question for consideration is the determination of the amount of the deductible loss. Independently of the admitted loss of $38,440.21 the petitioner contends that the tenants in common sustained a loss in 1934 of $8,066.64, computed as follows:
| :rents)Gross income | $6,610.86 | |
| Deductions: | ||
| Paid the Philadelphia Saving Fund Society | $13,000.00 | |
| Expenses | 669.97 | |
| Depreciation | 1,007.53 | |
| 14,677.50 | ||
| Loss | 8,066.64 |
The petitioner contends that one-fourth of this amount, or $2,016.66, constitutes an operating loss deductible from his gross income.
*957 The respondent computes the results of operation as follows:
| Gross income :rents) | $6,610.86 | |
| Deductions: | ||
| Expenses paid | $669.97 | |
| Depreciation | 1,007.53 | |
| 1,677.50 | ||
| Gain | 4,933.36 |
*962 The petitioner's share of the gain is computed to be $1,233.34, which the respondent contends should be included in his gross income. The respondent does not concede that the $13,000 paid the Philadelphia Saving Fund Society pursuant to the agreement of April 23, 1934, is a deductible item.
We do not think it necessary to pass upon the question as to whether the $13,000 was an ordinary and necessary expense of operating the garage in 1934. Clearly these funds were assets of the tenants in common and were paid by them to the Philadelphia Saving Fund Society pursuant to the agreement of April 23, 1934. The entire transaction relating to the garage property was a transaction entered into for profit. Therefore, if the respondent's contention that the petitioner is required to include in his gross income $1,233.34 from the operation of the garage is correct, he likewise is entitled to deduct from his gross income as a loss one-fourth of the $13,000 paid under the agreement of April 23, 1934, or $3,250. Whether the $13,000 be regarded as an ordinary and necessary expense of the operation of the garage under the principle of *963 , or as a loss, the result is the same. In either event, the deduction, exclusive of the admitted loss of $38,440.21, is $2,016.66.
This brings us to the final question as to whether the petitioner is entitled to deduct from gross income the full amount of the admitted loss of $38,440.21 upon his investment in the garage property or whether his deduction is limited, under the capital net loss provisions of the statute, to only $2,000 of that amount.
Section 23:e) of the Revenue Act of 1934 provides that in computing net income individuals may deduct losses incurred during the taxable year. Subdivision :j) of the same section provides that losses from the extent provided in section 117:d). That section provides in material part as follows: shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges.
There can be no question that the petitioner's investment of $38,440.21 in the mortgaged property was a capital asset within the meaning of the taxing statute. He had held his interest in the property for more than two years. The petitioner contends, however, that *958 he did not*964 think that he did.
Many of the decisions of the Board and the courts bearing upon this point have been reviewed in . In our opinion therein we said:
Had the purchaser surrendered his interest in the land or reconveyed it to the vendor in exchange for a cancellation of the debt, the transaction would have been regarded as a sale or exchange of capital assets. ; . * * *
Cf. , and .
There may be some question as to whether the transaction between the tenants in common and the Philadelphia Saving Fund Society under the agreement of April 23, 1934Was a "sale" within the meaning of the statute. See Commissioner v. Freihofer :C.C.A., 3d Cir.), , affirming . We are nevertheless of the opinion that the transaction constituted an exchange within the purview of the above cited cases. The tenants in common relinquished their rights in the garage property in*965 return for specific benefits which were to accrue to them. In our opinion the limitation upon the deduction of capital losses contained in section 117:d) of the Revenue Act of 1934 applies.
In the determination of the deficiency the respondent allowed the petitioner a deduction of only one-fourth of the total loss of $2,000 upon the ground that the petitioner was a member of a partnership.
The evidence clearly shows, however, that the petitioner and his associates were not partners but were tenants in common of the garage property. The deduction of capital net losses is available to every taxpayer, other than a corporation, subject to the statutory limitations. :See sec. 117, Revenue Act of 1934.) The miximum deduction of $2,000 on the loss from the sale or exchange of capital assets is available to every taxpayer in his individual income tax return. The petitioner here is entitled to the deduction of the full amount of $2,000 of his capital loss.
Reviewed by the Board.
Judgment will be entered under Rule 50.
MELLOTT, dissenting: The conclusion of the majority that the petitioner exchanged a capital asset and thereby sustained a capital loss*966 seems to me to be erroneous.
The agreement set out in the majority opinion indicates that the owner of the property gave up :1) $13,000; :2) their cause of action against the mortgagee; :3) possession of the property; and :4) caused their tenants to release their cause of action against the mortgagee. *959 They received :1) a release from liability for delinquent taxes; :2) a release from liability for all interest due on the bond which they had executed; and :3) conditional cancellation of the bond without personal liability for the payment of the principal.
The majority hold that a loss occurred in the year 1934. If this conclusion is correct, then I think it is an ordinary loss rather than one from a sale or exchange of a capital asset. It was sustained when the owners ascertained that the property not only was not worth the amount of the mortgage indebtedness but actually constituted a liability to them. Cf. DeLoss v. Blair, 28 Fed.:2d) 803; certiorari denied, ; .
The capital asset was the real property; but it was neither sold nor exchanged. The*967 foreclosure proceeding cut off and extinguished the equity of redemption of the owners; but this did not occur until 1935. If the loss had been claimed in that year it would probably be allowable as an ordinary loss under the rationale of Commissioner v. Freihofer, 102 Fed.:2d) 787, affirming ; and . That question, however, is not before us.
I am of the opinion that the Commissioner correctly computed petitioner's gain from the operation of the garage to be $1,233.34. The $13,000 paid to the mortgagee, however, was not an ordinary and necessary expense of carrying on a trade or business. It was paid as part of the consideration for canceling the bond. It, therefore, merely increased the owners' loss on the property.
BLACK and DISNEY agree with this dissent.