*3955 The petitioner is entitled to a deduction on account of debts ascertained to be worthless and charged off during the taxable year.
*1126 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1924, in the amount of $1,411.71. The deficiency arises from the action of the respondent in disallowing as a deduction the amount of a debt alleged by the petitioner to have become worthless and to have been charged off during the taxable year.
FINDINGS OF FACT.
The petitioner, a resident of California, inherited in 1921, a ranch containing 320 acres of land in Imperial Valley, California. The property when acquired was worth at least $20,000. In November, 1923, the petitioner sold the property to Weast at an agreed price of $20,500. The agreement was that the purchaser would assume a mortgage of $7,500 against the property, pay the petitioner $8,000 in cash and give him an unsecured note for $5,000, making up the total amount of $20,500.
Weast had no assets of any value prior*3956 to the time of the purchase and in order to finance the transaction he proposed to procure a loan of $16,000 from the Indiana State Life Insurance Co. secured by a first mortgage on the property, and in addition thereto a loan of $5,000 from a local bank secured by a junior mortgage.
Weast gave petitioner his unsecured note for $5,000, dated November 14, 1923, and payable on or before three years after date, in accordance with the original agreement. An attempt was made by Weast to secure the loans of $16,000 and $5,000, respectively, to be secured by the property, but he was unable to procure more than $10,000 from the insurance company on the first mortgage. This loan was based on an appraisal of the ranch at that time of $20,000. Weast then placed a second mortgage in favor of the Thorn-Hill Investment Co. for $1,000 in payment of commissions. He placed a third mortgage in favor of a local bank for $5,000.
Due to Weast's inability to finance the purchase of the ranch in the manner originally planned, he found himself unable to pay petitioner the $8,000 in cash and paid him $2,500 in cash and gave him another unsecured note for $5,000 dated February 23, 1924, and payable*3957 three years after date, so that the petitioner received the purchase price as follows: $2,500 in cash, the assumption of a first mortgage which was a lien against the property in the amount of $7,500, and the two promissor notes for $5,000 each, making a total of $20,000 instead of $20,500. Weast, out of the money he borrowed, paid approximately $2,200 in taxes, $1,600 on account of a chattel mortgage not connected with this transaction that he was required to pay off, and the interest on the $7,500 mortgage up to date in addition to the principal thereof. He also paid out a portion *1127 of the money in improving the place and undertaking to reclaim a part of the land.
During the summer of 1924, Weast's health failed and he was required to leave the ranch on account of the extreme heat and underwent treatment at San Diego. Weast told the petitioner of his condition in 1924 and told him that he would not be able to pay the notes.
At the end of 1924, Weast had placed other obligations on the ranch so that on December 31, 1924, there were liens against the ranch in excess of $24,000. Weast also owed in excess of $500 in addition to the amount that he owed Thompson.
*3958 The ranch in 1923 was in fairly good condition and the soil was tillable. In 1924, however, there were only about 60 acres of the 320 acres that produced anything. Approximately 40 acres went back to salt land. This had previously been fairly good land. Weast undertook to reclaim the land from salt but was unsuccessful. He used a portion of the money that he borrowed for this purpose. He undertook to sell the land in 1924 but did not receive an offer of any kind.
The petitioner resided in Los Angeles and was engaged in the manufacture of irrigation equipment and lawn sprinklers. Prior to the sale of the property in question, Weast had been first a lessee of the property and later was employed by the petitioner on a salary basis. The petitioner had paid out considerable money over a period of years and was dissatisfied with the result of the operation of the ranch. He was very desirous of disposing of it on any reasonable basis. It was thought by the petitioner and Weast that it might be sold in small tracts but this could not be accomplished. In the latter part of 1923 the market for farm products which were raised and which were capable of being raised on this ranch*3959 was very much depressed. Farmers in the vicinity had begun to move away and in 1924 conditions grew worse and the farming of land in the vicinity was being abandoned. The petitioner knew the financial condition of Weast and, coming to the conclusion that no recovery could be had from him on account of the market conditions, the large amount of encumbrances against the property constituting all the assets to which he could look for recovery, charged off the two notes for $5,000 each in 1924 and claimed a deduction therefor in his income-tax return for that year. This deduction was disallowed by the respondent.
OPINION.
TRAMMELL: We are convinced by the evidence that the notes in question were ascertained to be worthless and charged off during the taxable year.
*1128 The respondent contends that the deduction is not allowable for the reason that the notes were worthless at the time they were received and consequently could not be deducted in 1924. He also contends that since there is no evidence to show that the amount of the notes was included in or carried in income account, it could not be deducted.
We will discuss the latter contention first. It is true that*3960 there is no evidence to show that the notes were ever included in income. The fact is, however, that they did not constitute income. The cost of the ranch, for the purpose of determining gain or loss, was its value at the time received by inheritance, which was $20,000. Its sales price was the same. This resulted in no gain or loss. A taxpayer is not required to include in gross income anything except gains, profits and income. Section 213 of the Revenue Act of 1921. No gains, profits or income were derived from this transaction from sales or dealings in property as provided in the above section of the Act defining gross income. A taxpayer, however, is entitled to deduct a loss on account of a debt ascertained to worthless, if the debt arises from a capital outlay involving no income. The entire purchase price of the ranch was capital since it did not exceed the cost thereof. A portion of the property owned by the petitioner was converted into the notes and these notes became worthless and upon either system of accounting, cash or accrual, the petitioner is entitled to the deduction.
We may answer the respondent's first contention, that is, that the notes were worthless*3961 when received and therefore a deduction is not allowable when they were charged off, by the statement that in our opinion the notes could not have been considered worthless when made. The petitioner had confidence in the maker of the notes. There was some equity in the purchaser over and above the liens against the property, which equity could have been subjected to the payment or part payment of the notes due to the petitioner. This situation, however, did not exist at the end of 1924 because other liens had been placed upon the property. When the sale was made in 1923 the ranch was being operated and was in cultivation, crops were being raised and the land was in fairly good condition. If prices of farm products had remained as they were when Weast purchased the property, such property would have produced a substantial income, or if Weast had been able to sell the property in small tracts as he had contemplated, doubtless the notes would have been paid in full, but these circumstances did not occur. On the other hand, a large portion of the land became unsuited for cultivation during 1924 on account of the salt condition which became manifest. Market conditions continued to*3962 grow worse instead of better and before the end of the year there was no market for such property in the vicinity *1129 where this property was situated. The fact that the maker of the notes did not have property or assets out of which the notes could have been collected when he made them, is not sufficient reason for holding that they were worthless when given and that their worthlessness could not be subsequently ascertained. A person may have credit to such an extent that he could borrow money upon his promissory note without having any other assets than his good name and character and yet circumstances may subsequently occur which would warrant the payee of the note in ascertaining that it was worthless and charging it off. Here the petitioner undoubtedly had great faith and confidence in the maker of the notes when they were given, but in view of all the facts and circumstances which occurred, he reached the conclusion that the notes were worthless before the end of 1924. Under these circumstances he had the right to a deduction on account of their worthlessness, although they were not due until a later time.
Reviewed by the Board.
Judgment will be entered on*3963 15 days' notice, under Rule 50.
GREEN dissents.