*153 Decision will be entered under Rule 50.
The Dennis Group purchased the Camp Wolters land (then under lease to the United States) along with restoration rights applicable to that land. It also concluded a "contract" with the United States to purchase the Camp Wolters buildings and improvements in return for $ 412,500 in cash and release of the restoration rights. The group then formed petitioner, conveyed the land to petitioner for $ 151,336.88 in land notes, and assigned the "contract" and restoration rights to petitioner for $ 1,424 in cash and $ 411,080.20 in building notes. Petitioner paid the United States the $ 412,500, released the restoration rights, and expended an unidentified $ 2,350 to acquire the Camp Wolters buildings and improvements. Petitioner claims a cost basis of $ 827,354.20 for those buildings and improvements. Held:
1. The transfer of the building notes and $ 1,424 cash for the "contract" and restoration rights was a section 112 (b) (5)-112 (c) (1) exchange. The Dennis Group's basis for those assets was $ 50,000 and petitioner's basis therefor (under section 113 (a) (8)) was $ 51,424. Petitioner's basis for the Camp Wolters buildings and improvements*154 was that $ 51,424, plus the $ 412,500 paid in cash and the unidentified $ 2,350 -- a total of $ 466,274.
2. Useful depreciable life for Camp Wolters improvements (other than the buildings) was as determined by respondent. All of the Camp Wolters buildings, except those actually rented, were held for sale; therefore depreciation deductions are allowable, based on 10-year useful life, only on those buildings actually rented. Petitioner failed to properly raise the issue of respondent's disallowance of capital gains treatment for some of the buildings sold.
3. Interest paid on the building and land notes is properly deductible.
*737 Respondent determined deficiencies in income taxes for the taxable years ended March 31, 1948, and March 31, 1949, of $ 95,851.70 and $ 31,240.17, respectively.
*738 Respondent made adjustments for the year ended March 31, 1948, as follows: 1
| ADJUSTMENTS TO NET INCOME | ||
| Net income as disclosed by return | $ 353,692.58 | |
| Unallowable deductions and additional income: | ||
| (a) Cost of buildings sold decreased | $ 161,535.00 | |
| (b) Cost of equipment sold | 8,090.13 | |
| (c) Cost of electrical equipment | 13,912.12 | |
| (d) Legal expense | 2,500.00 | |
| (e) Depreciation | 41,293.55 | 227,330.80 |
| Net income adjusted | $ 581,023.38 |
| EXPLANATION OF ADJUSTMENTS | |
| (a) Cost of buildings sold, per your return | $ 335,617.00 |
| Cost of buildings sold, as determined | 174,082.00 |
| Decrease of cost | $ 161,535.00 |
| (b) Cost of equipment sold, per your return | $ 33,393.54 |
| Cost of equipment sold, as determined | 25,303.41 |
| Cost disallowed | $ 8,090.13 |
| (c) Cost of electrical equipment sold, per your return | $ 28,000.00 |
| Cost of electrical equipment sold, as determined | 14,087.88 |
| Adjustment | $ 13,912.12 |
| (d) Organization expenses, representing $ 1,250.00, paid to each, W. O. Gross | |
| and G. M. Ritchie for legal expenses, are held unallowable, $ 2,500.00. | |
| (e) Depreciation claimed in your return had been determined excessive by | |
| $ 41,293.55. * * * |
*156 Respondent also disallowed capital gains treatment in the computation of tax on income derived from petitioner's sale of any of its buildings. Except for the disallowance and for adjustment (d), petitioner assigns error to the foregoing.
For the year ended March 31, 1949, respondent made adjustments as follows:
| ADJUSTMENTS TO NET INCOME | ||
| Net income as disclosed by return | $ 108,965.62 | |
| Unallowable deductions and additional income: | ||
| (a) Cost of buildings sold | $ 44,635.97 | |
| (b) Gross profit land and buildings sales | 5,037.37 | |
| (c) Depreciation | 25,436.30 | 75,109.64 |
| Net income adjusted | $ 184,075.26 |
| EXPLANATION OF ADJUSTMENTS | |
| (a) Net cost basis of buildings sold, per your return | $ 101,225.25 |
| As determined | 56,589.28 |
| Adjustment | $ 44,635.97 |
| (b) Gross profit on land and buildings sales has been determined understated | |
| * * *, $ 5,037.37. | |
| (c) Depreciation has been determined overstated in your return | |
| * * *, $ 25,436.30. |
*157 Respondent also disallowed capital gains treatment in the computation of tax on income derived from petitioner's sale of any of its buildings. Except for that disallowance, petitioner assigns error to the foregoing.
By amended answer filed at the hearing, respondent asserted that the deficiencies for the 1948 and 1949 fiscal years should be increased by $ 1,258.75 and $ 5,684.16, respectively, giving as his reasons therefor the following:
(a) Respondent alleges that he erred in allowing as a deduction in the income tax return of the petitioner for the year ended March 31, 1948, interest claimed on land notes in the amount of $ 3,312.49.
(b) Respondent alleges that he erred in allowing as a deduction in the income tax return of petitioner for the year ended March 31, 1949, interest claimed on building notes in the amount of $ 14,958.31.
Petitioner filed an appropriate reply denying respondent's allegations.
FINDINGS OF FACT.
Petitioner is a corporation chartered under the laws of Texas and located at Mineral Wells, Texas. The tax returns for the periods in question were filed with the collector for the second district of Texas.
Prior to the outbreak of World War II, as a step *158 in the preparedness program then being initiated by the United States, the United States Army became interested in acquiring possession of several thousand acres of land in Palo Pinto County, Texas, in the vicinity of the city of Mineral Wells, Texas, to be used as an induction and training center. It was not desired to purchase such lands, but rather to lease them. The lands in question were owned by a number of different landowners. The War Department wanted to deal with only one lessor and refused to lease the lands piecemeal. In order to obtain the economic benefits of having a large Army camp located nearby, the city of Mineral Wells, sometimes called the city herein, undertook to secure assignable leases to all of the acreage designated by the War Department and to sublease all such lands to the United States under one master lease.
Accordingly, the city proceeded to acquire leases on the desired acreage, under which the city became primarily liable for all of the *740 burdens imposed on the lessee under such leases. Each lease, among other things, contained the following provisions:
4. The City shall have the right to assign this lease to the United States of America*159 (hereinafter called Government,) and to sublet the demised premises for a similar purpose, but will not permit the use of said premises by anyone other than the Government.
* * * *
7. The City shall have the right, during the existence of this lease, to permit the Government to make alterations, clear brush, fell trees, attach fixtures, and erect additions, structures, or signs, in or upon the premises hereby leased, which fixtures, additions, or structures so placed in or upon or attached to the said premises shall be and remain the property of the Government and may be removed therefrom by the Government prior to the termination of this lease, and the City shall require the Government, before the expiration of this lease or the expiration of any renewal thereof, to restore the premises to the same condition as that existing at the time of entering upon the same under this lease, reasonable and ordinary wear and tear and damages by the elements or by circumstances over which the Government has no control, excepted. [Emphasis added.]
8. As a part of the consideration herefor, the City is given the option, at any time during the term of this lease or of any renewal thereof, *160 to purchase the lands and premises above described at the price of * * *.
When the required acreage had been assembled by the city under a number of individual leases, all of said acreage was subleased by it to the United States under a single master lease to take effect November 1, 1940, which, among other things, contained the following provisions:
8. The Government shall have the right, during the existence of this lease, to make alterations, attach fixtures, and erect additions, structures, or signs, in or upon the premises hereby leased (provided such alterations, additions, structures, or signs shall not be detrimental to or inconsistent with the rights granted to other tenants on the property or in the building in which said premises are located); which fixtures, additions, or structures so placed in or upon or attached to the said premises shall be and remain the property of the Government and may be removed therefrom by the Government prior to the termination of this lease, and the Government, if required by the Lessor, shall, before the expiration of this lease or renewal thereof, restore the premises to the same condition as that existing at the time of entering upon *161 the same under this lease, reasonable and ordinary wear and tear and damages by the elements or by circumstances over which the Government has no control, excepted: Provided, however, that if the Lessor requires such restoration, the Lessor shall give written notice thereof to the Government sixty days before the termination of the lease.
Provided further that any restoration shall be based on and confined to the structures, fixtures, and appurtenances covered by the condition survey. Provided further that in the event of termination of this lease, the Government shall be allowed four months from and after July 1 of any year in which to remove or otherwise dispose of the improvements, both above ground and underground, that have been placed thereon by the Government. [Emphasis added.]
Under the foregoing lease, the United States took possession of the Camp Wolters premises and built an extensive and expensive induction *741 and training center thereon, consisting of many barracks, power plant, hospital facilities, etc. The Government further laid extensive concrete paving, installed water and gas pipelines, used portions of the premises for a firing range, and otherwise so*162 altered the premises that it would have cost a large sum of money to restore the premises to anything like their original condition as required by the lease.
Early in 1946, it became apparent that the Government intended to deactivate Camp Wolters and was contemplating dismantling and disposing of the improvements owned and located on the Camp Wolters premises. At this point, the mayor of Mineral Wells, a lawyer, became concerned about the potentially large liability of the city under the restoration clause of the leases to which it was a party, in the event the United States either was dilatory about settling with the underlying landowners (grantors in the original leases wherein the city of Mineral Wells was lessee), or was unable to come to satisfactory terms with such landowners concerning the restoration of their premises to the original condition, or did not adequately compensate them for failure to effect such restoration. The mayor was also concerned over the financial setback that the city probably would suffer when Camp Wolters was deactivated. He discussed the possible ways of solving these twin difficulties with H. E. Dennis, a director of the Mineral Wells Chamber *163 of Commerce and chairman of its Industrial Committee. A plan was formulated by Dennis to prevent the demolition of the Camp Wolters improvements and conserve them for industrial use through the purchase of the Camp Wolters land and facilities by private citizens interested in the welfare of the city.
The essence of the plan was as follows: Dennis agreed to attempt to interest several individuals in putting up the money to purchase the Camp Wolters lands, provided that the city would assign to him and any other individuals he might be able to interest in the venture, the city's option rights to purchase the leased premises from the several original lessors. It was contemplated that, if and when Dennis and his associates acquired the Camp Wolters lands and the restoration rights incident thereto, they would have preferential rights to acquire the Camp Wolters buildings and improvements and be in a position to save them from demolition and use them as a means of attracting light industries to the Mineral Wells Camp Wolters area. As consideration for the assignment of the city's option-to-purchase rights, Dennis and his associates agreed, for their part, to save the city harmless from*164 any and all restoration claims that might be asserted against it by the original landowners.
Pursuant to this understanding, the option rights were assigned by the city in a resolution dated April 17, 1946, to Ernest Mims, as nominee for Dennis and any others he might interest in the venture. *742 On June 18, 1946, the city officials passed a resolution relating to the purchase of the buildings and improvements on Camp Wolters, which provided in part as follows:
WHEREAS, certain valuable improvements have been constructed on the leased lands by the Government and negotiations are now in progress for the sale of such improvements and the City desires to authorize Mr. Ernest Mims, a citizen of Mineral Wells, Texas, to represent the City in such negotiations. NOW, THEREFORE, be it resolved by the Board of Commissioners of the City of Mineral Wells, Texas, that Mr. ERNEST MIMS is hereby authorized and empowered to negotiate with representatives of the United States for the transfer of improvements that have been constructed on lands covered by Lease No. W. 58-qm-540 to himself, or his nominee, in lieu of restoration, upon such terms as may be agreed upon by him and the representative*165 of the United States, provided that no obligation is incurred by the City and provided further that there is procured from the owner or owners of the tract of land covered by said lease a full and complete release to the City and the Government of any and all damages resulting from the use of such lands by the Government and a release from the payment of future RENTALS, and the City hereby ratifies the actions of Mr. Ernest Mims that may be taken in this connection.
Dennis succeeded in inducing some 18 or 19 other individuals to each put up the sum of $ 10,000 in cash and join him in his attempt to purchase the Camp Wolters land and improvements. (Later additional persons were permitted to participate in the venture and the number of participants, including Dennis, eventually numbered 89 from whom approximately $ 356,000 was raised. They will hereinafter be referred to as the Dennis Group.) With a portion of the funds thus raised, Ernest Mims, acting as agent for the Dennis Group, exercised the options to buy some 3,000 or more acres of land on which the principal improvements made by the Government at Camp Wolters were located, for an aggregate consideration of approximately $ *166 151,000 (the total of the prices set in the options). In each instance, deeds were taken in the name of Mims. Each deed included the following provision relating to the landowners' restoration claims:
Including in this conveyance all claims or demands which I * * * [grantor] * * * may have or be entitled to against the United States Government or the City of Mineral Wells by reason of the construction and maintenance of army facilities on the property here conveyed, for damages, restoration or otherwise.
Of the approximately $ 151,000 paid, $ 50,000 was paid for the transfer of the restoration rights, which sum constituted the Dennis Group's basis for those rights.
Through Mims, the group also concluded an agreement (referred to by them as a contract) on March 21, 1947, with the United States, represented in the transaction by General Henry Hutchins, then Colonel Hutchins of the United States Army Corps of Engineers. The contract gave them the right to acquire all of the physical assets *743 owned by the United States and located on or affixed to the Camp Wolters premises for an agreed consideration of $ 412,500 in cash plus the relinquishment to the United States of all *167 restoration claims then held in Mims' name.
All of the Dennis Group's assets, rights, and privileges were held in common, each member's share thereof being in proportion to the member's cash contribution to the $ 356,000 fund raised from the group.
Petitioner corporation was chartered on April 3, 1947, with authorized capital stock consisting of 1,424 shares of common stock of the face or par value of $ 10 per share, all of which was subscribed for and fully paid in in cash ($ 14,240) by the Dennis Group. At the same time, there was paid into the treasury of the corporation by the Dennis Group, as paid-in surplus, the further sum of approximately $ 190,000 in cash, so that petitioner corporation, when first organized, began business with a cash capital of $ 204,240. This $ 204,240 was the balance remaining of the $ 356,000 contributed by the 89 members of the Dennis Group after approximately $ 151,000 thereof was paid for the land and the restoration rights bought by their agent, Mims.
On April 7, 1947, the Camp Wolters lands (but no restoration rights) were conveyed to petitioner by Mims, as nominee for the Dennis Group, in consideration of a series of 89 nonnegotiable unsecured*168 installment notes (hereinafter referred to as land notes) totaling $ 151,336.88. On the same day, namely April 7, 1947, Mims, as nominee for the Dennis Group, also executed an assignment to petitioner of (a) the contract for the purchase of the Camp Wolters improvements and (b) the restoration rights above referred to. As consideration for the assignment, petitioner paid nominee Mims $ 1,424 in cash and executed a series of 89 nonnegotiable unsecured installment notes (hereinafter referred to as building notes) in the total face amount of $ 411,080.20. The gain realized by the Dennis Group on the transaction was at least equal to the $ 1,424 paid to Mims. The assignment reads, in pertinent part, as follows:
WHEREAS, on or about the 21st day of March, 1947, the undersigned, Ernest M. Mims, made and entered into a contract with the Government of the U. S. acting through the duly authorized officers of the Corps of Engineers U. S. Army for the purchase of certain buildings, improvements, fixtures, attachments and personal property located on and within the Camp Wolters Military Reservation; in connection with which agreement the said Ernest M. Mims agreed to pay the sum of $ 412,500.00*169 in cash to said Government and also agreed to waive all claims for restoration or other damages considered to be due him as the owner of the fee title to the lands upon which said military reservation was situated; said preliminary contract being evidenced by telegram dated March 18, 1947, to the undersigned from the Division Engineer, Southwestern Division Corps *744 of Engineers, Dallas, Texas, and by proposal letter of the undersigned to said Division Engineer dated March 20, 1947, and by letter from said Division Engineer to the undersigned dated March 21st, 1947, reference being made to said instruments for full description.
WHEREAS, Camp Wolters Enterprises, Inc., a Texas Corporation, is desirous of acquiring the aforementioned contract and the contract rights of the said Ernest M. Mims with reference to said purchase.
NOW, THEREFORE, I, Ernest M. Mims, of Palo Pinto County, Texas, in consideration of the sum of Ten ($ 10.00) Dollars to me in hand paid by said Corporation, and other considerations as hereinafter set out do hereby sell, transfer, assign and set over to the said Camp Wolters Enterprises, Inc., a Corporation, the above mentioned contract and all of my claims*170 and rights thereunder; and I hereby authorize the said Corporation to proceed either in the name of said Corporation or in my name to final consummation of said purchase and to acquire title either in my name or in the name of the Corporation from the U. S. Government the title to said properties; and it is hereby understood and agreed that in the event the representatives of the United States Government require that the bill of sale or other form of conveyance executed by them be made to me in my name, that I will take such title for the benefit of the Corporation and will forthwith execute such instrument or instruments as may be necessary or appropriate to vest record title to any asset or assets so conveyed to me in the Corporation.
In consideration of this assignment of my contract rights, the Corporation agrees to pay me the sum of $ 1424.00 in cash and to execute and deliver to me, or to my nominees, its nonnegotiable, unsecured promissory notes in the number and principal amounts as follows: 26 notes in the principal sum of $ 11,547.56 each; 6 notes in the principal sum of $ 5,774.28 each; 7 notes in the principal sum of $ 2,886.79 each; 6 notes in the principal sum of $ 2,309.19*171 each; 1 note in the principal sum of $ 1732.01; 18 notes in the principal sum of $ 1154.37; 9 notes in the principal sum of $ 1154.38 each; 16 notes in the principal sum of $ 578.20 2 each; all of said notes dated April 7, 1947, payable to the undersigned, or his nominees, in five equal annual installments, the first installment due five years after date and additional installments six, seven, eight and nine years after date respectively, and bearing interest at the rate of four (4%) per cent per annum after maturity only, the interest payable annually, and all past due principal and interest to bear interest at the rate of six (6%) percent per annum. Said notes shall contain the usual provision for accelerated maturity and attorneys fees and the privilege of payment of any amount of principal at any time after date; and shall contain the further provision that each is one of a series of 89 notes of the same date and that no payment can be required on any one note except on a pro-rata basis out of property or funds of the Corporation available for payment on the entire series of notes.
As further consideration the said Corporation agrees that it will comply with the terms of the*172 contract first above referred to sand [sic] will pay to the U. S. Government the sum of $ 412,500.00 in cash upon execution of the assignment and sales contract by the Government by which the title to the buildings and other properties above described pass to the Corporation, or to me, which shall be for its benefit, and the Corporation assumes the obligation of the undersigned to pay said sum of money to the Government for such transfer and delivery of the properties.
*745 Each of the aforementioned 89 land notes and 89 building notes bore interest at the rate of 4 per cent per annum and included the following provisions:
The principal of this note is payable in five equal annual installments, the first due and payable five years after date, and a like installment six, seven, eight and nine years after date, respectively; the maker having the privilege of paying all or any part hereof at any time after date. It is understood*173 that this note is one of a series of 89 notes this day executed by the corporation; and no payment hereon shall be required except on a pro-rata basis out of property or funds available for payment on the entire series of notes.
* * * *
It is understood and agreed that the undersigned Corporation will probably hereafter become indebted to the Republic National Bank of Dallas, or other parties; such loans to be secured by liens on physical properties of the corporation; and no payment shall be made on this note unless and until the corporation has completely liquidated said loans, and any renewals, extensions, or refinancing thereof.
At petitioner's first stockholders' meeting, which was held on July 18, 1947, each of the 89 members of the Dennis Group was given a part of the following, such part determined on the basis of the member's pro rata cash contribution to the $ 356,000 raised by the Dennis Group:
(a) The 1,424 shares of common stock issued by petitioner.
(b) The $ 1,424 in cash paid by petitioner to Mims (as nominee for the Dennis Group) for the assignment of the "contract" with the United States and the restoration rights.
(c) The 89 serial building notes (totaling $ 411,080.20) *174 issued as additional consideration for the "contract" and restoration rights.
(d) The 89 serial land notes (totaling $ 151,336.88). Each of the 89 notes in the two series was dated April 8, 1947, and made out to a member of the Dennis Group in an amount determined by applying the same percentage to the total face value of the series as the percentage of that member's contribution to the aforementioned $ 356,000. During the 1948 fiscal year petitioner paid, and took a deduction on its return for, $ 3,312.49 in interest on the land notes; during the 1949 fiscal year it paid, and took a deduction for, $ 14,958.31 in interest on the building notes. By June 1948, the petitioner had fully redeemed the series of building notes.
In connection with the purchase of the buildings from the Government, petitioner borrowed from the Republic National Bank in Dallas, Texas, $ 325,000. The formal application for the loan was made on April 14, 1947. The initial discussion between the bank and the individuals representing petitioner was held 2 or 3 weeks before the date of the application to the bank for the loan. The *746 application stated the purpose for which petitioner, Camp Wolters *175 Enterprises, Inc., was formed in the following language:
Camp Wolters Enterprises, Inc., of Mineral Wells, Texas, a Texas corporation, with a paid in capital and surplus of $ 356,000, was formed for the express purpose of acquiring Camp Wolters with a view of establishing new industries in Mineral Wells, Texas, in the buildings at Camp Wolters suitable for such purposes, and for the wrecking and sale and salvage of those properties purchased. The corporation has ninety-two stockholders, twenty directors and an executive committee of nine.
The transfer of the physical improvements located at Camp Wolters took the form of a "Supplemental Agreement for Cancellation of Lease, and Transfer of Improvements" executed April 15, 1947. Under this agreement Mims was substituted for the city of Mineral Wells as lessor, and the Government relinquished, transferred, and delivered to Mims title to the improvements in consideration of the payment to the Government of the sum of $ 412,500 in cash (part of which was the money borrowed from the Republic National Bank) and waiver of all restoration rights. The city of Mineral Wells was required to join in the execution of the agreement because it was*176 the original lessor under the original leasing agreement.
On its books and records, petitioner entered as the cost to it of the Camp Wolters lands the sum of $ 151,340.80, 3 and recorded as the cost to it of the buildings and improvements acquired from the Government the sum of $ 827,354.20, which it apportioned ratably over such assets. This $ 827,354.20 includes $ 412,500 paid in cash to the Government, the $ 1,424 paid to nominee Mims, the $ 411,080.20 issue of building notes and an unidentified $ 2,350 not here in issue. In the notice of deficiency from which this appeal was taken, respondent reduced the aggregate basis for the buildings and improvements by $ 411,080.20 (the amount of the building notes) to $ 416,274. There is no controversy between the parties as to the manner in which the total consideration paid for the buildings and improvements is to be apportioned as between specific assets. The dispute between them is confined solely to the contention of petitioner on the one hand that such aggregate basis totals $ 827,354.20, and the contention of the respondent on the other hand, that such aggregate basis does not exceed the sum of $ 416,274.
*177 Petitioner's amended return for the fiscal year ended March 31, 1948, shows the following sources of gross income: *747
| Gross Income: | |||
| Building sales | $ 675,335.50 | ||
| Less cost of buildings sold | 339,139.50 | ||
| Gross profit buildings sales | $ 336,196.00 | ||
| Equipment sales | 142,257.72 | ||
| Less cost of sales -- fencing | $ 1,500.00 | ||
| Other equipment | 26,791.12 | ||
| Steam distribution system | 22,000.00 | 50,291.12 | |
| Gross profit equipment sales | 91,966.60 | ||
| Sale of electrical equipment | 90,000.00 | ||
| Cost of electrical equipment sold | 28,000.00 | 62,000.00 | |
| Sale of 114.05 acres of land | 5,963.40 | ||
| Less cost of same | 7,991.75 | (2,028.35) | |
| Rental income | 9,915.31 | ||
| Gas income | 89.48 | ||
| Water income | 122.00 | ||
| Sewerage | 68.00 | ||
| Lead salvage sales | 3,313.90 | ||
| Damage to land | 400.00 | ||
| Miscellaneous income | 1,385.22 | ||
| Gross income | $ 503,428.16 |
Petitioner's return for the fiscal year ended March 31, 1949, shows the following sources of gross income:
| Gross Income: | |||
| Building sales | $ 234,475.00 | ||
| Deduct cost of buildings sold | $ 112,472.50 | ||
| Less depreciation prior year | 11,247.25 | 101,225.25 | |
| Gross profit building sales | $ 133,249.75 | ||
| Land and building sales | 84,800.00 | ||
| Deduct cost of buildings sold | 22,325.00 | ||
| Less depreciation prior years | 2,232.50 | ||
| 20,092.50 | |||
| Add cost of land sold -- 76.14 a | 5,118.00 | 25,210.50 | |
| Gross profit land and bldgs. sold | 59,589.50 | ||
| Less deferred income on installment | |||
| sales (Schedule C) | 38,831.75 | 20,757.75 | |
| Equipment sales | 22,906.00 | ||
| Rental income | 19,466.00 | ||
| Gas income | 2,016.83 | ||
| Water income | 376.50 | ||
| Sewerage income | 176.50 | ||
| Miscellaneous income | 7,651.29 | ||
| Income from sale of clay | 1,200.21 | ||
| Gross income | $ 207,800.83 |
*178 *748 Petitioner held the improved areas of Camp Wolters until 1951, when condemnation proceedings were instituted and it was taken over by the United States Air Force. During the period petitioner held the property it rented about 35 to 40 per cent of the square footage of the buildings. Of approximately 200 barracks buildings, petitioner sold about 130 or 140 and rented 60 or 70. A number of other buildings were also sold, some as a fire prevention measure. The buildings acquired from Camp Wolters, except those actually rented by the petitioner at one time or another, were held by petitioner for sale.
The Government began organizing and building the Camp Wolters Training Camp in 1940. Petitioner purchased the used property in 1947. The remaining useful life of the Camp Wolters buildings from and after the date acquired by petitioner was 10 years. The remaining useful life of all other depreciable Camp Wolters improvements and equipment from and after the date acquired by petitioner was as determined by respondent in his deficiency notice. Petitioner has introduced no evidence to the contrary.
OPINION.
1. The major issue involves determining the correct basis of the buildings*179 and improvements acquired from the Government by the petitioner. Respondent argues that their basis is composed only of the following:
| Cash paid to the Government under the "contract" of purchase | $ 412,500 |
| Paid the Dennis Group's nominee (Mims) for assignment of the | |
| purchase "contract" and restoration rights | 1,424 |
| An unidentified and uncontested sum | 2,350 |
| $ 416,274 |
Petitioner, on the other hand, contends that included in that basis is an additional $ 411,080.20 given the Dennis Group (through Mims) in building notes as further consideration for the assignment of the contract and restoration rights and that the correct total basis is, therefore, $ 827,354.20.
The Government had leased land for Camp Wolters with a clause requiring it to restore the land to its prior condition. It would have cost the Government an undetermined sum to have restored that land. The Dennis Group, composed of 89 members and acting through nominee Mims, first acquired the leased land along with the restoration rights from the original owners for approximately $ 151,000. On March 21, 1947, again acting through Mims, they concluded a contract with the Government under which they were to*180 acquire the Camp Wolters buildings and improvements, constructed by the Government, *749 in return for $ 412,500 in cash and the release of all restoration rights. The interest of each member of the group in the assets, rights, and privileges of the group was in proportion to that member's cash contribution to the group fund. Petitioner was chartered on April 3, 1947, with 1,424 shares of fully paid common stock, plus paid-in capital surplus -- the money for both the stock and surplus coming from the group fund. All of petitioner's stock was issued to members of the Dennis Group in proportion to each member's cash contribution to the aforementioned fund. On April 7, 1947, Mims (acting for the Dennis Group) conveyed the Camp Wolters land to petitioner and assigned the contract for the buildings and improvements, plus the restoration rights, to petitioner. In return therefor petitioner gave the following consideration:
A. For the land:
89 nonnegotiable, unsecured installment notes (land notes) in the total face amount of $ 151,336.88 -- each note made out to a member of the Dennis group in proportion to that member's contribution to the group fund.
B. For the "contract" *181 and restoration rights:$ 1,424 in cash.
89 nonnegotiable, unsecured installment notes (building notes) in the total face amount of $ 411,080.20 -- each note made out to a member of the Dennis group in proportion to that member's contribution to the group fund.
Petitioner subsequently paid $ 412,500 to the Government for the Camp Wolters buildings and improvements, and released the restoration rights.There is no doubt that the $ 412,500 cash payment to the Government is to be included in petitioner's basis for the buildings and improvements. Also the $ 1,424 and $ 2,350 heretofore mentioned are to be included. Respondent has included these amounts in his determination of the deficiencies. This leaves us to consider whether the basis should be increased by the $ 411,080.20 in building notes given by petitioner to the Dennis Group (through Mims) in consideration for the contract and restoration rights. Petitioner alleges that these notes should be included as a part of its cost in acquiring the buildings and improvements and, therefore, should be included in the basis of the latter.
We think petitioner cannot be sustained in its contention as to cost basis for reasons*182 which follow.
We are of the opinion that the exchange of the contract and restoration rights in return for $ 1,424 and the building notes was one which fell within the provisions of sections 112 (b) (5) and 112 (c) (1) of the Code and, consequently, that the petitioner's basis for the contract and restoration rights must be determined under section *750 113 (a) (8). 4 We first note that both before and after the exchange the Dennis Group owned all of petitioner's stock, Peck & Peck, 42 B. T. A. 651, and that the building notes received by each member of the Dennis Group were in proportion to that member's interest in the contract and restoration rights. Consequently, both the control and proportionate interest tests of sections 112 (b) (5) and 112 (h) are met. It is, however, necessary to consider whether the building notes qualify as "securities" within the meaning of section 112 (b) (5). The stock of petitioner was issued for cash paid in by the Mims Group and is, therefore, not involved in the question we are now considering.
*183 The identical phrase "stock or securities" is used in other subsections of section 112 and has been subject to considerable litigation on the question of which debt obligations qualify as "securities." The line is drawn somewhere between long-term bonds and short-term notes. Short-term notes are not "securities." Pinellas Ice & Cold Storage Co. *751 v. Commissioner, 287 U.S. 462">287 U.S. 462 (3 1/2-month notes); Commissioner v. Sisto Financial Corporation, 139 F. 2d 253, reversing 47 B. T. A. 425 (demand notes); Neville Coke & Chemical Co., 3 T.C. 113">3 T. C. 113, affd. 148 F. 2d 599 (3-, 4-, and 5-year notes); Pacific Public Service Co., 4 T. C. 742 (demand notes); Wellington Fund, Inc., 4 T. C. 185 (12-month notes). On the other hand, long-term bonds have been held to be "securities." Helvering v. Watts, 296 U.S. 387">296 U.S. 387 (mortgage bonds); Daniel H. Burnham, 33 B. T. A. 147, affd. 86 F. 2d 776 (10-year*184 unsecured notes); Commissioner v. Freund, 98 F. 2d 201, affirming B. T. A. Memorandum Opinion (6-year bonds); Globe-News Publishing Co., 3 T. C. 1199 (25-year scrip).
While none of the foregoing cases involved section 112 (b) (5) transactions we take it that the words "stock or securities" have the same meaning when used in section 112 (b) (5) as they do when used in section 112 (b) (3) and 112 (b) (4). We have been cited to no authority which holds to the contrary and we know of none.
The test as to whether notes are securities is not a mechanical determination of the time period of the note. Though time is an important factor, the controlling consideration is an over-all evaluation of the nature of the debt, degree of participation and continuing interest in the business, the extent of proprietary interest compared with the similarity of the note to a cash payment, the purpose of the advances, etc. It is not necessary for the debt obligation to be the equivalent of stock since section 112 (b) (5) specifically includes both "stock" and "securities."
In Wellington Fund, Inc., supra,*185 we said at p. 189:
The question of the meaning of the term "securities," as used in various revenue statutes, has been considered by the courts in a number of cases. The rule appears to be settled that where such an act does not define the term, it denotes an obligation of a character giving the creditor some assured participation in the business of the debtor, or, in other words, an investment in the business, and that the term does not include evidences of indebtedness for short term loans representing temporary advances for current corporate needs. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462">287 U.S. 462; Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937; certiorari denied 288 U.S. 599">288 U.S. 599; L. & E. Stirn, Inc. v. Commissioner, 107 Fed. (2d) 390; Commissioner v. Sisto Financial Corporation, 139 Fed. (2d) 253.
In our recent decision in Neville Coke & Chemical Co., 3 T.C. 113">3 T. C. 113, we held that a creditor holding three, four, and five-year notes of a corporation, evidencing advances*186 made to meet current liabilities, was not, because of that fact, a holder of securities of the corporation, since such notes could not be considered investments in the business and thus did not constitute securities within the purview of section 112 (b) (3) of the Revenue Act of 1936.
In the Globe-News Publishing Co., supra, we said at pp. 1204-1205, the following:
In further support of its claim that the issuance of the scrip must be recognized as the payment of a taxable dividend, the petitioner argues that the scrip *752 did not constitute securities, and for that reason section 112 (b) (3), supra, is not applicable. In making this argument, it classifies the scrip as "only an unsecured note and obligation to pay." The contention is, we think, without merit. Securities may take the form of shares of stock, bonds, or notes. Commissioner v. Neustadt's Trust, 131 Fed. (2d) 528 (20-year debenture bonds); Commissioner v. Kolb, 100 Fed. (2d) 920 (10-year debenture); South Atlantic Steamship Line, supra (25-year debenture bonds); Humphryes Manufacturing Co., 45 B. T. A. 114*187 (stock); Knapp-Monarch Co., supra (stock); Burnham v. Commissioner, 86 Fed. (2d) 776 (notes); Skenandoa Rayon Corporation v. Commissioner, supra (stock); Clarence J. Schoo, 47 B. T. A. 459 (25-year debenture); Karl B. Segall, 38 B. T. A. 43 (debenture notes).
The scrip in the instant case was payable on or before 25 years from the date of issuance, at the option of the petitioner. It called for interest at 4 percent annually, which was cumulative and payable on any subsequent interest payment date, as petitioner's directors might determine. Failure to pay the interest when due did not affect or accelerate the maturity date of the scrip. The scrip was transferable only on the dividend book of the petitioner and was subordinate to the payment of principal and interest due or to become due on the outstanding bonds of the company and to the sinking fund provided for the payment of such bonds. Such being the character of the scrip, the scrip certificates issued evidenced such a continuing interest in the affairs of the petitioner as to constitute them securities within the meaning*188 of section 112 (b) (3), supra. See and compare Pinellas Ice & Cold Storage Co. v. Commissioner287 U.S. 462">287 U.S. 462.
In the instant case, the petitioner issued 89 nonnegotiable unsecured installment notes in exchange for the assignment of the contract and restoration rights on April 7, 1947, four days after petitioner was incorporated. The contract and restoration rights constituted permanent contributions to petitioner's business, not merely temporary advances of rights to be used for current needs. These interest bearing notes became due in five equal annual installments between the fifth and ninth years after issuance. Petitioner had the privilege of paying the notes off before the due date, subject to two general provisions: (1) Any payments on the notes had to be on a pro rata basis for the entire series of 89 notes. (2) Petitioner borrowed $ 325,000 from the Republic National Bank and no payment whatsoever was to be made on the notes until the $ 325,000 loan and any renewals, extensions, or refinancing had been completely liquidated. In other words, the latter requirement imposed a condition precedent to the due date of the notes. In the*189 event petitioner had been unsuccessful and unable to pay off the prior loan, the holders of the 89 notes had no right to demand the installment payments on the due dates. It seems clear that the noteholders were assuming a substantial risk of petitioner's enterprise, and on the date of issuance were inextricably and indefinitely tied up with the success of the venture, in some respects similar to stockholders. As a matter of fact, all 89 notes were redeemed within 2 years, but we must examine the notes as of the date of issuance. Having considered all the facts, we conclude that the 89 notes constituted "securities" under *753 section 112 (b) (5) and that, consequently, the transaction falls within the provisions of that and the other aforementioned sections.
Our next question concerns the transferors' (Dennis Group) basis for the contract and restoration rights. This depends upon the transferors' cost of those items. Sec. 113 (a), I. R. C. There is no evidence in the record that any cost was incurred by the Dennis Group in concluding the contract with the Government. See T. H. Symington & Son, Inc., 35 B. T. A. 711, 743.
As for the restoration*190 rights, the transferors (through Mims) obtained those rights along with the Camp Wolters land by exercising the options assigned by the city of Mineral Wells. The option prices, aggregating about $ 151,000, were determined prior to any alterations of the land by the Government, and, consequently, at a time when the restoration rights had no determinable value. However, when the options were exercised, the condition of the land had been altered considerably by the Government, and the restoration rights, undoubtedly, had some substance.
Petitioner issued its notes for $ 411,080.20 to its stockholders in consideration of the transfer to it of the contract and the restoration rights. The restoration rights may have been, as petitioner argues, worth a considerable portion of this $ 411,080.20, but we do not have to determine their value at the time petitioner acquired them. Under our holding to the effect that section 112 (b) (5) is applicable, our task is to determine what these restoration rights cost the group from whom petitioner acquired them. We have determined that cost to be $ 50,000. While the evidence bearing upon this cost is not as satisfactory as it might be, we think*191 it is sufficient to support our finding of $ 50,000. Cf. Andrew P. Solt, 19 T.C. 183">19 T. C. 183.
We need not attempt to determine the precise gain the transferors realized as a result of exchanging the contract and restoration rights for the $ 1,424 and the $ 411,080.20 in building notes. Suffice it to say that we think it was at least equal to the $ 1,424, which is recognized gain under the provisions of sections 112 (b) (5) and 112 (c) (1) of the Code. Under section 113 (a) (8), therefore, the petitioner's basis for the contract and restoration rights is equal to the transferors' $ 50,000 basis in the rights plus the $ 1,424 recognized gain -- or $ 51,424.
To acquire the Camp Wolters buildings and improvements, petitioner, as aforementioned, (a) paid the Government $ 412,500 in cash, (b) expended an undisputed $ 2,350, and (c) exercised a contract and released restoration rights having a basis in its hands of $ 51,424. Under these circumstances it seems clear to us that petitioner's basis for the buildings and improvements was $ 466,274. This $ 466,274 is composed of the $ 416,274 which the Commissioner has allowed in his *754 determination of the *192 deficiencies, plus $ 50,000, the cost to the Mims Group of the restoration rights.
2. Respondent (a) disallowed in toto the depreciation deductions on the Camp Wolters buildings and (b) reduced the deductions claimed on the remaining Camp Wolters depreciable property purchased by petitioner. The latter action was predicated on a reduction of petitioner's basis -- with which we have just dealt -- and on increasing the estimated useful lives of such depreciable property. Petitioner failed to produce any evidence rebutting respondent's determination of the useful lives of that property and, consequently, respondent's determination must stand as to the useful life of the equipment.
Respondent's complete disallowance of depreciation deductions on the buildings was based on his finding that petitioner purchased and held those buildings primarily for sale. Section 23 (l) of the Code provides for depreciation deductions for property "used in the trade or business" or "held for the production of income," and Regulations 111, section 29.23 (l)-2, reads, in pertinent part, as follows:
Depreciable property. The necessity for a depreciation allowance arises from the fact that certain *193 property used in the business, or treated under § 29.23 (a)-15 as held by the taxpayer for the production of income, gradually approaches a point where its usefulness is exhausted. The allowance should be confined to property of this nature. * * * It does not apply to inventories or to stock in trade. * * *
The general distinction to be drawn, obviously, is between capital assets used in the trade or business or as an investment for the production of income, and property held for sale. See Gertrude D. Walker, 20 B. T. A. 937, affd. (C. A. 3) 63 F.2d 351">63 F. 2d 351, certiorari denied 289 U.S. 746">289 U.S. 746; but note I. T. 1342, I-1 C. B. 169 (special rule applicable to contractors).
Whether or not buildings are held for sale is a question of fact. The tests to be applied are the continuity, frequency, and substantiality of sales, though other factors are also relevant. Mauldin v. Commissioner, 195 F.2d 714">195 F. 2d 714, affirming 16 T. C. 698; Nathan D. Goldberg, 22 T. C. 533. We think the evidence shows that when petitioner was organized*194 it had a dual purpose: To sell buildings unsuitable for industrial purposes and to rent or sell (depending upon the requirements of the particular transaction) the suitable buildings to industries. The testimony of Dennis as to the petitioner's plans and objectives supports this interpretation.
It remains to be determined which buildings were held by petitioner for investment, or if it was engaged in a "trade or business" for use therein, rather than for sale. The burden of proving this rests upon petitioner. In this connection we note that the only relevant evidence indicates that frequent, substantial, and continuous sales of buildings *755 were made by petitioner. As the following table indicates, a substantial portion of petitioner's gross income was attributable to such sales, whereas a rather negligible portion was attributable to rents:
| Tax return figures of sources | Year ending | Year ending | ||
| of gross income | Mar. 31, 1948 | Per cent | Mar. 31, 1949 | Per cent |
| Building sales | $ 336,196.00 | 66.8 | $ 133,249.75 | 64.1 |
| Rental income | 9,915.31 | 2 | 19,466.00 | 9.4 |
| Total gross income | 503,428.16 | 100 | 207,800.83 | 100 |
On the state of the record we conclude that*195 petitioner has failed to show that any buildings, other than those actually rented, were held for investment or use rather than for sale. Consequently, depreciation deductions are allowable only on those buildings actually rented. Respondent erred in not allowing depreciation on those rented buildings. They were held for investment during the taxable years rather than primarily for sale in petitioner's business.
We have found that the remaining useful life of the buildings, for depreciation purposes, was 10 years on the date acquired by petitioner. The evidence supports this finding.
In its brief the petitioner for the first time challenges respondent's disallowance of capital gains treatment in the computation of income from the sale of some of the aforementioned buildings. We have carefully examined the petition and we find no assignment of error which alleges that the Commissioner erred in not according capital gains treatment to certain sales made by the petitioner during each of the taxable years and as to which it claimed the benefit of the capital gains provisions of the statute in the returns which it filed. Only issues raised by the pleadings can be considered by this*196 Court. Camp Wolters Land Co., 5 T.C. 336">5 T. C. 336.
3. In an amended answer filed at the hearing respondent asserted that deductions taken by petitioner for $ 3,312.49 in interest paid on the land notes during the 1948 fiscal year and for $ 14,958.31 in interest paid on the building notes during the 1949 fiscal year, were improper and that the deficiencies should be increased. No mention was made of this issue in respondent's brief. We have found as a fact that those amounts of interest were actually paid by petitioner and can conceive of no reason why those payments are not properly deductible under section 23 (b) of the Code. Respondent's claim for increased deficiencies on account of these interest deductions is not sustained. We find no ground for it.
Decision will be entered under Rule 50.
Footnotes
1. Petitioner filed both an original and amended return for this fiscal year -- the latter reporting lower net income and tax. Respondent's adjustments are based upon the income and tax reported in the original return.↩
2. These sixteen notes were actually drawn in the principal sum of $ 577.20 each.↩
3. This figure is $ 4 in excess of the total face amount ($ 151,336.88) of the land notes issued as consideration for the conveyance; the difference is probably ascribable to minor transfer costs.↩
4. SEC. 112. RECOGNITION OF GAIN OR LOSS.
(b) Exchanges Solely in Kind. --
* * * *
(5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. * * *
* * * *
(c) Gain from Exchanges Not Solely in Kind.
(1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
* * * *
(h) Definition of Control. -- As used in this section the term "control" means the ownership of stock possessing at least 80 per centum of the total combined voting power of all classes of stock entitled to vote and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --
(A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5) (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), * * *
* * * *
then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩