*1722 1. Petitioner sustained a loss of $16,606.33 in 1923 in exchange and cancellation of bonds of Beaumont & Great Northern Railroad Company for securities received by him from reorganization managers of the Missouri, Kansas & Texas Railway Company.
2. Petitioner sustained a loss of $2,392.72 in 1924, which was not a "capital loss" chargeable against "capital gains" of that year. The "net loss" if any, resulting therefrom is a proper deduction on petitioner's return for 1925.
*1343 The Commissioner determined deficiencies of $4,578.04 and $154 in petitioner's income taxes for 1923 and 1925, respectively. Petitioner alleges that the Commissioner erred (a) in disallowing loss sustained upon bonds exchanged for cash and other securities of a determinable value; (b) in treating as income the bonds and stocks so received; and (c) in not accepting the returns filed by the taxpayer as correctly showing his true net income.
FINDINGS OF FACT.
Petitioner is an individual residing in Houston, Tex. The notice of deficiency was mailed February 24, 1928.
In 1921 petitioner*1723 owned $45,000 par value of Beaumont & Great Northern Railroad Company first mortgage 5 per cent gold bonds, *1344 which were acquired for legal and other services under a contract dated October 8, 1912, with the Missouri, Kansas & Texas Railroad Company. These first mortgage 5 per cent gold bonds of the Beaumont & Great Northern Railroad Company (hereinafter sometimes referred to as the Beaumont Company) were guaranteed as to principal and interest under contract with the by endorsement on the bonds by the Missouri, Kansas & Texas Railroad Company (hereinafter sometimes referred to as the Missouri Company). The total amount of such bonds was $883,000, of which petitioner's $45,000 was a part. Of the remainder, $794,000 was owned by one William Carlisle and members of his family, and $44,000 was scattered among holders of small amounts. At the time petitioner acquired said bonds, the financial position of the Missouri Company was good. It was earning its interest charges, and an amount in excess of interest; and its guarantee of the Beaumont bonds made them good marketable paper. The guarantor itself took an option to acquire such bonds within two years at $102. On March 1, 1913, these*1724 bonds had a value not less than par.
Because of the Missouri Company's inability to refinance maturing obligations on account of the financial crisis due to the World War, the railway corporation went into a receivership; but it continued to pay the interest on the Beaumont bonds until 1923, when it failed in such payments, and as a result of such failure a settlement was made by the owners of the bonds with the reorganization managers for the Missouri, Kansas & Texas Railroad Company. The Beaumont Company had contributed a valuable volume of traffic to the Missouri Company's system, but during the period of the Missouri Company's receivership such traffic was greatly reduced. Lumber was the principal commodity originating on the Beaumont Company's property, and by 1923 the timber was practically cut out. Because of this condition, the reorganization managers decided not to include the property of the Beaumont & Great Northern Railroad Company in their plan for reorganization and no provisions were originally made or contemplated for refunding its bonds which had been guaranteed as to principal and interest by the Missouri Company. Upon learning of the plan of reorganization*1725 proposed, petitioner and Carlisle protested the intended omission. Petitioner and Carlisle's attorney, Edward A. Haid, proceeded to New York and for seven days, from January 19 to 25, were in active conference with J. & W. Seligman & Company and Hallgarten & Company, the reorganization managers, and their counsel and attorneys, or with each other.
Petitioner and Carlisle's representative were finally successful in their negotiations for the recognition of their bonds; but as a condition *1345 precedent to any settlement whatever the reorganization managers insisted as a sine qua non that the holders of the bonds of the Beaumont Company should assume the ownership of the property as well as release the Missouri Company from all liability under its guaranty of the principal and interest of the Beaumont Company's bonds. The reorganization managers would have nothing to do with the property. As the best settlement he could obtain, petitioner agreed for himself and the others in interest to acquire all the bonds in question, cancel them and satisfy the lien of the mortgage, and himself to take over and operate the property in the hope that at some time in the future he*1726 might be able to make it valuable, although at the time of the negotiations with the reorganization managers it was regarded by all parties as a liability rather than an asset. The operating loss for the year ended December 31, 1922, was $97,275.17.
As the result of these conferences and negotiations, a series of agreements was entered into, as follows:
An agreement, known as the Beaumont agreement, was made under date of January 23, 1922, between petitioner and the reorganization managers, providing for the transfer to petitioner, under certain contingencies, of the entire capital stock of the Beaumont Company, amounting at par to $50,000, and certain equipment for the operation of its lines of railroad. Upon the same day an agreement, known as the settlement agreement, was made with the reorganization managers by petitioner and Edward A. Haid, as a committee acting for and in behalf of holders of the thirty-year first mortgage 5 per cent gold bonds of the Beaumont Company, by which settlement agreement, and by the Beaumont agreement, provision was made for the cancellation of the above mentioned then existing issue of first mortgage bonds, aggregating in principal amount $883,000, *1727 and also to effectuate the release or cancellation of the mortgage securing said bonds.
A further agreement, known as the Sabine agreement, was made under date of March 21, 1922, between petitioner and the reorganization managers for the transfer to petitioner, under certain other contingencies, of the lines of railroad and other property formerly owned by the Trinity & Sabine Railroad Company; and a fourth agreement, known as the supplemental agreement, was made under date of January 8, 1923, between petitioner and the reorganization managers, which supplemental agreement modified to some extent not material here the provisions of the Beaumont agreement and the Sabine agreement; to both of which agreements petitioner and the reorganization managers only were parties. The operating loss on the Trinity and Sabine properties for the year ended December *1346 31, 1922, was $77,923.08; and the combined loss from the operation of these properties was $175,198.25 for the same year.
Under and by virtue of these agreements, the $794,000 first mortgage bonds of the Beaumont Company owned by the Carlisle interests were delivered to petitioner without consideration from him, and*1728 petitioner acquired the remaining $44,000 bonds scattered among holders of small amounts; all of which, together with petitioner's $45,000 of the bonds, totaling the amount of $883,000, were delivered to the reorganization managers, who erased the guaranty of principal and interest by the Missouri, Kansas & Texas Railroad Company, and returned the bonds to petitioner who surrendered them to the Beaumont Company and forthwith caused the Beaumont Company to take such corporate action as was required to satisfy and cancel the lien of the first mortgage, dated July 1, 1909.
In accordance with the Sabine agreement dated March 21, 1922, petitioner acquired at public sale on foreclosure the line of railroad between Trinity and Colmesneil, in Texas. There was an issue of $1,340,000 of old bonds against this property, upon which no interest had ever been paid. These bonds petitioner surrendered to the Beaumont Company in accordance with the requirements of the reorganization managers who, under the supplemental agreement dated January 8, 1923, lent him $100,000 for five years, on his personal note secured as appears below, for the acquisition of the line between Trinity and Colmesneil. *1729 Petitioner agreed to seek the authority of the Interstate Commerce Commission to convey the railroad property between Trinity and Colmesneil to the Beaumont Company. Such authority was secured, and the name of the Beaumont & Great Northern Railroad Company was changed to Waco, Beaumont, Trinity & Sabine Railway Company (hereinafter referred to as the Waco Company), which corporation was authorized by the Commission to readjust its financial structure and to issue to petitioner $1,113,000 of capital stock and $1,110,000 of thirty-year 6 per cent first mortgage bonds in lieu of the capitalization previously outstanding against the two properties. Under the Sabine and the supplemental agreements, petitioner gave to the reorganization managers $330,000 par value of these new bonds as collateral security for his five-year personal note above mentioned, with the proviso, however, that the remaining $780,000 of the bonds authorized should not be issued until the loan to him, so secured, was repaid to the reorganization managers. That loan has not been repaid, nor have the bonds, except those pledged as above to secure the loan, been issued. Other than the $100,000 advanced by the reorganization*1730 managers to petitioner on the Waco bonds under the supplemental agreement, he has never been able to borrow money on the collateral *1347 of any of the securities of the Waco Company. Bankers told him that they would not accept either the stock or bonds of that corporation as collateral security.
Upon the erasure by the reorganization managers for the Missouri, Kansas & Texas Railroad Company of the endorsement of guaranty of the latter company from all the first mortgage bonds of the Beaumont Company and the delivery to petitioner of such bonds, with the endorsement so erased, together with the entire capital stock of the Beaumont Company (par value, $50,000), the reorganization managers, in consummation of the Beaumont agreement and the settlement agreement, delivered to petitioner for the account of all those in interest:
| Bonds of the West Lumber Company | $426,700 |
| Shares of preferred stock, Series A, of the reorganized company (M., K. & T.) | 2,000 |
| Shares of the common stock of the reorganized company - no par value | 2,000 |
Of these securities, petitioner was entitled to receive, and did receive, his pro rata of 45/883; the agreed fair market value of*1731 which at the time of consummation in 1923 was as follows:
| West Lumber Company bonds | $17,648.35 |
| Cash - principal and interest on West Lumber Company bonds matured | 4,491.83 |
| Preferred and common shares of the reorganized M., K. & T. stock | 6,253.49 |
| Total | 28,393.67 |
From about 1915 to 1923, petitioner was engaged in the oil subiness, buying and selling leases, drilling wells, etc., in the Humble, Blue Ridge, and Welch oil fields in Texas or Louisiana, and in "wildcat" speculative leases in many different areas. Such operations covered properties of several thousand acres. Until petitioner reentered the railroad business as president of the Waco, Beaumont, Trinity & Sabine Railway Company in 1923, as the result of the foregoing agreements with the reorganization managers of the Missouri Company, he was regularly engaged only in the oil business. After that occurrence he did not have either the time or the money to carry on both businesses simulataneously; so he immediately began to liquidate his oil interests as rapidly as possible. At the date of the hearing in November, 1930, he had not yet sold all of his oil properties, but he had sold most of them soon after*1732 1923, and his only connection with the oil business after 1923 was the liquidation of his interests in it.
Petitioner's return for 1924 reports a loss from the sale of real estate in that year of $25,596.15, and a resulting net loss of $12,417.83, computed as follows:
| Income | Loss | |
| W.B.T. & S. Ry. Co. - legal services | $6,242.57 | |
| Rents and royalties | 12,037.58 | |
| Sale of real estate - loss | $25,596.15 | |
| Profit on crops sold - net | 208.66 | |
| Loss | 7,107.34 | |
| Allowable deductions not contested | 5,310.49 | |
| Total loss for year | 12,417.83 |
*1348 This loss of $12,417.83 was claimed as a deduction from income for 1925, but it was disallowed.
OPINION.
LOVE: In regard to the first issue, respondent contends that petitioner is claiming a loss in 1923 on securities all of which he still owns, and that the alleged loss is not deductible in that year for the reason that no such loss is deductible until it is established by sale or other disposition of the securities; and also that since there was no capital outlay for the guaranty of the bonds of the Beaumont & Great Northern Railroad Company, the total amount received for the release of the guaranty, viz. *1733 , $28,393.67, was received as taxable income. In regard to the second issue concerning the deduction on petitioner's 1925 return of the net loss of $12,417.83 shown on his return for 1924, respondent contends that the loss in 1924 was not sustained in the course of a business regularly carried on by petitioner; and, also, that no capital gains having been reported or found on the 1924 return, it follows, under the provision of the statute, that the net loss appearing on that return is not an allowable deduction in 1925.
Discussing the issues in their order, we are of the opinion that petitioner has fully and clearly sustained his allegations of loss on his $45,000 par value of first mortgage 5 per cent gold bonds of the Beaumont & Great Northern Railroad Company. We do not understand respondent's contentions that petitioner is claiming a loss "on securities all of which he still owns," and that "to overcome the fact that no loss has been established by sale or other disposition of the bonds, petitioner argues their worthlessness at the time of their receipt," which contention, says the respondent, "is not sustained by the evidence in the record." It certainly is not sustained, *1734 nor does petitioner argue or contend for any such thing. On the contrary, petitioner strenuously asserts, and it is not denied, that he received these bonds in 1912 as compensation for legal and other services; that the bonds so received were guaranteed as to principal and interest by the Missouri, Kansas & Texas Railroad Company, which guaranty *1349 was not rescinded until 1923; and that the bonds so guaranteed were worth their par value of $45,000 at the time of their receipt and at March 1, 1913; and we have so found. Furthermore, petitioner does not "still own" all of these securities, nor any of them. The evidence in the record is clear that under the Beaumont agreement and the settlement agreement, the entire issue of $883,000 of these bonds (of which petitioner's $45,000 was a part) was delivered to the reorganization managers who erased the guaranty of the railroad company and returned them to petitioner, who forthwith brought about their cancellation and retirement, and the satisfaction of the first mortgage lien underlying the issue. We do not know whether or not petitioner retained what had once been "the bonds" - the evidences of the debt when that debt existed, *1735 though we doubt it; but if he did, such "evidences" then had no more value than any other worthless pieces of paper. Petitioner and respondent agree that in the settlement petitioner received as his share thereof, in cash and securities of the West Lumber Company and the reorganized Missouri, Kansas & Texas Railroad Company, his 45/883 of their fair market value at the time of consummation in 1923, which was $28,393.67.
We find it difficult to follow the thread of respondent's argument in regard to this issue.
Section 202 of the Revenue Act of 1921, which is applicable here, provides that the basis for ascertaining the gain derived or the loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired before March 1, 1913, shall be the cost of such property, with certain limitations which are here immaterial, which in this case we have found to be the same as its March 1, 1913, value, viz., $45,000.
Respondent and petitioner agree that the fair market value of petitioner's pro rata of the securities received from the reorganization managers under the Beaumont agreement and the settlement agreement was $28,393.67. It is clear then that petitioner's*1736 loss on that closed transaction was $16,606.33.
It is true that petitioner about that time took over from the reorganization managers the entire capital stock of the Beaumont and Great Northern, amounting in face value to $50,000, and thus acquired absolute control of that property; and that he also took over another small railroad property running from Trinity to Colmesneil, for the acquisition of which he borrowed $100,000 from the reorganization managers on his personal five-year note; and respondent alleges further that petitioner immediately paid out $75,000 for new equipment (which we do not find sustained by the record); that he was "congratulated" on the settlement obtained; that he had succeeded in getting the property at no cost to himself; *1350 that it was "an excellent settlement" in the opinion of Carlisle's attorney; and that petitioner was "personally anxious" to obtain these properties and operate them.
But we do not see what these contentions have to do with the issue before us. It was only at the insistence of the reorganization managers, as a condition precedent to any further negotiations in connection with the bonds, that petitioner finally consented*1737 to take over the Beaumont Company's property. In so doing he was certainly getting nothing of value at that time, but rather he was assuming a known liability. That was the opinion also of the reorganization managers, whose counsel, when petitioner expressed doubt as to the wisdom of his course, replied that they were far more anxious to get rid of the property than petitioner was to take it. The "congratulations" to which respondent refers were addressed, as a matter of fact, not to petitioner, but to Haid, Carlisle's attorney, and even so, though Carlisle fared better than petitioner, since no part of the burden of the Beaumont property was assumed by him, it seems to us that they were not free from a suspicion of irony, for in response to Haid's remark that another lamb had been shorn in Wall Street, one of the attorneys for the reorganization managers replied: "Haid, you have gotten a great deal more than I think you are entitled to and I congratulate you." In other words, something had been saved from the wreck. But the taking over by petitioner of the Beaumont property and the later acquisition by him of the Sabine property was a separate transaction from the cancellation*1738 and retirement of the Beaumont bonds in consideration of the receipt of certain bonds of the West Lumber Company, and preferred and common stock of the reorganized Missouri, Kansas & Texas Railroad Company, which is the issue that we have immediately before us.
The Beaumont and the settlement agreements were executed January 23, 1922, but it was not until two months later that petitioner executed the Sabine agreement, under which he acquired the line of railroad From Trinity to Colmesneil, as his only hope of making the Beaumont property pay in the future, by amalgamating the two and extending them to Waco, on the west, from Weldon; and southeasterly from Livingston through Beaumont to Port Arthur, connecting with the M. K. & T. at Waco for an interchange of traffic, and tapping the great oil-refining district at and south of Beaumont. And it was not until a year later, January 8, 1923, that the supplemental agreement was entered into which made even remotely possible the translation of petitioner's dreams and visions into partial reality. It is the securities of these amalgamated properties, known as the Waco, Beaumont, Trinity & Sabine Railway Company, that petitioner "still*1739 owns"; and since neither a gain nor a loss in connection *1351 with them is asserted in petitioner's returns for 1923 or 1925, which are the years before us, we are not concerned with them here. Respondent cites us to nothing in support of his contentions and argument, and the facts are so clear, it seems to us, that no citations by us are necessary beyond a statement of the provisions of the law in the case.
In regard to the second issue, we do not believe that it could be contended with success before any tribunal that a man actively and regularly engaged in a business of considerable magnitude for a period of years ceases to be "regularly" engaged in that business during a necessary and reasonable period of liquidation, even though the major portion of his thought, energies, and time, during such period of liquidation, is devoted to a new venture. In , we said:
It is to be noted that in order to constitute a "net loss," it is not necessary that taxpayer should sustain the loss in his principal business or vocation. The word "business" [in section 204 of the Revenue Act of 1921] is qualified by the word "any." The*1740 taxpayer is entitled to this benefit where the loss is incurred in "any trade or business regularly carried on" by him.
Respondent does not deny that in 1924 a loss of $25,596.15 on sales of real estate produced a net loss on petitioner's return for that year of $12,417.83 which petitioner seeks to carry forward to 1925; but he contends that "this issue is quickly disposed of by reference to section 206(a)(2) of the Revenue Act of 1924."
The applicable provisions of that act are as follows:
SEC. 206. (b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year * * *.
SEC. 206. (a) As used in this section the term "net loss" means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:
* * *
(2) In the case of a taxpayer other than a corporation, deductions for capital losses otherwise allowed by law shall be allowed only to the extent of the capital gains.
SEC. 208. (a) For the purposes*1741 of this title -
(1) The term "capital gain" means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921;
(2) The term "capital loss" means deductible loss resulting from the sale or exchange of capital assets;
* * *
(8) The term "capital assets" means property held by the taxpayer for more than two years (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale in the course of his trade or business.
*1352 If, then, the loss claimed by petitioner is a "capital loss," as contended by respondent, it may be allowed only to the extent of the capital gains, since the petitioning taxpayer here is not a corporation.
A copy of petitioner's return for the calendar year 1924 was admitted in evidence. It does not show any capital gains, nor were any proven at the hearing. But Schedule C of that return shows that the loss from sale of real estate was derived as below:
| Kind of property | Date acquired | Amount received | Cost | Loss |
| House property | 1923 | $52,500.00 | $54,892.72 | $2,392.72 |
| I. and G.N. Survey | 1919 | 29,801.30 | 53,004.73 | 23,203.43 |
| 25,596.15 |
*1742 From this it appears that the "house property," having been acquired in 1923 and sold or exchanged in 1924, had not been held by the taxpayer for more than two years, and so does not constitute a capital asset, from the sale or exchange of which alone can a capital loss be sustained. No deficiency has been asserted by the Commissioner for 1924, and the taxes for that year are not under review by us; but the loss in 1924 of $2,392.72 on the "house property" was not a "capital loss" that could be offset only against "capital gains," and provided in section 206(a)(2) of the Revenue Act of 1924. It was a loss sustained in the course of a business regularly carried on by the taxpayer; the amount of the loss to be determined as provided in section 202 of that act, and the net loss, if any, resulting from such sale or other disposition of the property may properly be deducted on petitioner's return for 1925.
The loss sustained on sale of the I. & G.N. survey, having been held for more than two years, was a capital loss, and may not be carried forward to 1925 in the absence of capital gain for 1924.
Petitioner's taxes for 1923 and 1925 will be recomputed in accordance with our*1743 findings and this opinion.
Judgment will be entered under Rule 50.