1962 U.S. Tax Ct. LEXIS 81">*81 Decision will be entered under Rule 50.
In 1954, S corporation was formed for the purpose of developing and constructing a shopping center. S purchased a tract of land and obtained commercial zoning for such land, hired an architect to prepare plans for the shopping center, found tenants to sign leases for the planned buildings, and unsuccessfully attempted to obtain permanent mortgage financing for the project. In 1956, before physical construction of the shopping center had begun and before S had realized any taxable income from the shopping center, S agreed to sell its entire interest in the shopping center to K. of C. corporation and S adopted a plan of complete liquidation. Upon completion of construction of the shopping center in 1957, K. of C. paid S the agreed consideration and S distributed its assets to its shareholders. Held, (1) S is a collapsible corporation as defined in section 341(b), I.R.C. 1954, and is thereby not entitled to nonrecognition of its gain on the sale of the shopping center under the provisions of section 337 (a) and (c), I.R.C. 1954; (2) the gain S realized on the sale of the shopping center is taxable as long-term capital gain.
38 T.C. 844">*845 The Commissioner determined a deficiency in petitioner's income tax for the fiscal period July 1 to September 25, 1957, in the amount of $ 87,717.68. At issue is the applicability of the nonrecognition provisions of section 337(a) of the 1954 Code to petitioner's sale of certain corporate property pursuant to a plan of complete liquidation. The Commissioner has determined that the nonrecognition provisions do not apply based on the limitation in section 337(c) excluding collapsible corporations as defined in section 341(b). If the Commissioner is upheld in this regard, a further question is whether the gain realized by petitioner on the sale of the assets involved constitutes ordinary income or long-term capital gain.
FINDINGS OF FACT.
The facts stipulated by the parties are incorporated herein by this reference.
1962 U.S. Tax Ct. LEXIS 81">*84 Petitioner, a Pennsylvania corporation now in liquidation, with its principal office at Grant Avenue and Blue Grass Road, Philadelphia, Pennsylvania, filed its corporate income tax return for the period July 1, 1957, to September 25, 1957, with the district director of internal revenue, Philadelphia, Pennsylvania.
Early in 1954 a group of persons headed by Michael Lubin owned a one-half interest in 7 acres of unimproved real estate at the corner of State and Sproul Roads, Springfield Township, Delaware County, Pennsylvania. This land, hereinafter referred to as the Lubin tract, was commercially zoned and on it Lubin and his associates planned to develop a shopping center. The Lubin group and a man named Powell, who owned the other one-half interest in the land, had purchased the Lubin tract in 1952 for a total price of $ 187,500.
Penn Fruit Company, Inc., a corporation operating a chain of grocery supermarkets in the Philadelphia area, was interested in obtaining a store in the area of State and Sproul Roads, and early in 1954 its officers approached Lubin to explore the possibility of negotiating for a lease on a store to be erected on the Lubin tract. Because of restrictions 1962 U.S. Tax Ct. LEXIS 81">*85 imposed by other leases already negotiated, Lubin was unable to lease a store to Penn Fruit on the Lubin tract.
However, at that time Lubin had an option to acquire 14 1/2 acres of ground, then zoned for residential use, adjoining the Lubin tract 38 T.C. 844">*846 on both sides. Lubin suggested that Penn Fruit might acquire a store on this adjoining ground if it would join with him and his associates in purchasing this ground, in having the zoning changed, and thereafter in developing it.
Hanna Realty Company, a Pennsylvania corporation wholly owned by five individuals who also own or control approximately 40 percent of the stock of Penn Fruit Company, is and since the late 1930's has been used as a real estate affiliate of Penn Fruit Company. These five individuals were the principal stockholders of Penn Fruit Company prior to the time it became a "public company" in about 1952 or 1953, and they thereafter continued to dominate its affairs. Hanna Realty purchases ground required by Penn Fruit either for the erection of supermarkets, the extension of existing facilities, or for protection against competition, and additionally builds supermarkets and leases them to Penn Fruit. During the1962 U.S. Tax Ct. LEXIS 81">*86 years 1955 and 1956, Hanna Realty owned and leased 12 stores occupied by Penn Fruit. From time to time Hanna Realty sold land which it had acquired for Penn Fruit when such land no longer served Penn Fruit's purposes and, in some instances, when Hanna Realty was unable to finance certain stores for Penn Fruit and found it necessary to sell the land to a financial institution or insurance company which in turn leased it back to Penn Fruit.
Petitioner was formed by Hanna Realty and Lubin and his associates for the specific purpose of purchasing and developing the 14 1/2-acre land parcel contiguous to the Lubin tract. Petitioner was incorporated under Pennsylvania law on June 23, 1954. Its authorized purposes, as stated in its articles of incorporation, were as follows:
To buy, sell, exchange, lease and otherwise acquire, hold, own, maintain, manage, develop, improve, alter, mortgage, let, rent, convey, deal in and otherwise turn to account real estate of every class and description.
To build, construct, purchase or otherwise acquire, repair, maintain, operate, manage, sell, convey and otherwise turn to account homes, office buildings, apartment houses, buildings, structures and real1962 U.S. Tax Ct. LEXIS 81">*87 estate of every class and description.
The shareholders of petitioner were as follows:
| Number | Percent of | |
| of shares | ownership | |
| Hanna Realty Company | 318 3/4 | 42.5 |
| David Cohen (legal counsel for Hanna Realty Company) | 63 3/4 | 8.5 |
| Lewis Posner, representing an investors' syndicate | 367 1/2 | 49.0 |
The actual owners of the 367 1/2 shares held in the name of Lewis Posner were as follows:
| Percentage of 367 1/2 | |
| Sproul shares | |
| Lewis Posner | 13 |
| Michael Lubin | 35 |
| E. Fred Kemner | 13 |
| Elsie and Edward Goldsborough | 13 |
| Hilda and Myer Harsfield | 13 |
| Lillian I. Laveson | 13 |
38 T.C. 844">*847 The objective of the Hanna Realty Company and its counsel, David Cohen, in organizing and participating in petitioner's activities was to obtain a Penn Fruit store in the State and Sproul Roads area. The purpose of the Lubin group was to develop a shopping center in conjunction with the adjoining 7-acre tract in which it already had an interest.
On June 30, 1954, petitioner entered into an agreement to acquire the 14 1/2-acre tract of land which was contiguous to the Lubin tract at State and Sproul Roads. Settlement under this agreement was held on October 6, 1954. Title to the 14 1/2-acre tract1962 U.S. Tax Ct. LEXIS 81">*88 was held in the name of Murray A. Pierson as a strawparty until January 16, 1956, when title was formally transferred into the name of petitioner. The total cost of the land was $ 179,190.39.
During the year 1955, petitioner through its representatives exerted continuous efforts to have the land rezoned as a shopping center district. The land was so rezoned by the Springfield Township Commissioners on December 28, 1955, on the condition that a shopping center be developed on the land within 18 months or the land would automatically revert to a residential district.
In the latter part of 1955, when it appeared that the land would be rezoned for shopping center use, petitioner began looking for tenants. Hanna Realty was particularly interested in finding a good department store tenant which it believed was essential to "anchor" the development. Also toward the end of 1955, petitioner made preliminary attempts to obtain permanent financing for the shopping center project.
Among the department stores approached as potential tenants was E. J. Korvette, Inc., with whom discussions were held over a 4-month period beginning in August or September 1955. An oral agreement between petitioner1962 U.S. Tax Ct. LEXIS 81">*89 and Korvette was reached early in January 1956.
On January 9, 1956, petitioner obtained a commitment from Penn Fruit for lease of a supermarket to be constructed on the property by petitioner. Under the terms of this commitment, as later amended, the lease was to run for an initial term of 25 years at a basic net rental of $ 42,000 per year, with the lessee given the option to renew for four additional 5-year terms at a basic rental of $ 18,900 per year during any renewal period.
On March 26, 1956, a lease was signed by Korvette for a department store to be constructed on the property by petitioner. This lease was to run for an initial term of 21 years at an annual basic rental of $ 210,000 per year (subsequently adjusted to $ 203,000 per year), and the lessee was given the option to renew for three additional periods of 5 years each at a stipulated reduced rental. The lease was subject to cancellation if petitioner did not obtain financing for the construction 38 T.C. 844">*848 of the Korvette building within 90 days after the plans and specifications were approved.
During the spring and summer of 1956, petitioner conducted negotiations with Howard D. Johnson Company for a lease for a1962 U.S. Tax Ct. LEXIS 81">*90 Howard Johnson restaurant to be constructed in the shopping center. These negotiations were protracted because of the illness of Howard Johnson. On September 29, 1956, petitioner and Howard D. Johnson Company executed a lease for a restaurant to be constructed on the property. The lease was for an initial term of 20 years with a minimum annual rental of $ 13,500, plus a percentage of gross sales in excess of $ 270,000, and the lessee was granted an option to extend the lease for two additional 5-year terms at the same rental.
Sometime prior to May 14, 1956, petitioner hired George Neff, an architect, to prepare plans for the shopping center, and negotiations were begun with the Township authorities relative to the shopping center agreement, building permits, and performance and maintenance bonds. On May 14, 1956, petitioner's board of directors authorized the employment of Sidney Elkman as general contractor to construct the shopping center.
After obtaining the oral commitment for a lease from Korvette in January 1956, petitioner opened specific discussions with mortgage brokers and mortgage institutional lenders for the purpose of obtaining a permanent mortgage to finance the1962 U.S. Tax Ct. LEXIS 81">*91 construction of the shopping center. Concentrated efforts to this end continued through the spring of 1956. A number of the major institutional lenders and many minor ones were approached. However, petitioner was unsuccessful in obtaining a commitment for a permanent mortgage.
Among the mortgage brokers approached by petitioner was Raymond Armstrong, who was a mortgage broker and a mortgage loan correspondent for Massachusetts Mutual Life Insurance Company. Discussions were begun with Armstrong late in February or early in March 1956. Massachusetts Mutual rejected the loan request on June 13, 1956, because Korvette's credit was not strong enough at that time for its lease to qualify as acceptable collateral to support the loan. Armstrong also unsuccessfully applied in petitioner's behalf to the Teachers Insurance and Annuity Association and the National Life Insurance Company of Vermont.
Other mortgage institutions approached by petitioner included Northwestern Mutual Life Insurance Company, Aetna Life Insurance Company, Jefferson Standard Life Insurance Company, New England Benefit Life Insurance Company, and Pilot Life Insurance Company. All rejected the requested loan.
George1962 U.S. Tax Ct. LEXIS 81">*92 Scurria, in 1956 manager of Penn Fruit's real estate department, took an active part in the leasing and financing of petitioner's proposed shopping center. In his efforts to obtain financing, 38 T.C. 844">*849 Scurria consulted among others Donald Deppen and Charles H. Hayes, officers in Ivor B. Clark, Inc., a mortgage brokerage firm in New York City which petitioner engaged on or about April 1, 1956. Scurria's original instructions to the Clark firm were to obtain permanent mortgage financing based upon the Korvette, Penn Fruit, and Howard Johnson leases. The Clark firm's efforts in this direction, like those of other agencies consulted, were unsuccessful.
Under date of April 2, 1956, Charles H. Hayes of the Clark firm wrote to the national office of the Knights of Columbus, stating that from time to time his office has "attractive mortgage loan offerings as well as desirable sale and leaseback investments" and asking the Knights of Columbus what its requirements might be for such investments. When Hayes wrote this letter, he hoped to interest the Knights of Columbus in petitioner's property if a favorable reply was received. Hayes received a reply from the Knights of Columbus dated1962 U.S. Tax Ct. LEXIS 81">*93 April 4, 1956, and sometime thereafter and prior to May 10, 1956, the Knights of Columbus expressed an interest to Hayes in purchasing all or part of petitioner's shopping center project. The Clark firm communicated this interest to petitioner, and on May 10, 1956, Scurria in petitioner's behalf sent Donald H. Deppen of the Clark firm a telegram specifically authorizing him to represent petitioner in negotiating a sale to the Knights of Columbus of the Korvette store only for $ 2,300,000. This telegram was the first specific authorization by petitioner to the Clark firm or anyone else to offer any portion of the petitioner's property for sale.
The Clark firm around this time prepared a brochure offering an "investment purchase with leaseback to Sproul Realty Company" of the Korvette store for a price of $ 2,300,000. Charles H. Hayes handcarried a copy of this brochure to the offices of the Knights of Columbus on May 11, 1956. At about the same time the Clark firm sent out copies of the same brochure to a number of institutions, including the Mutual Benefit Life Insurance Company, Northwestern Mutual Life Insurance Company, John Hancock Mutual Life Insurance Company, Prudential1962 U.S. Tax Ct. LEXIS 81">*94 Insurance Company of America, General Life Company of America, New York Life Insurance Company, Equitable Life Insurance Company, Chase Manhattan Bank, Metropolitan Life Insurance Company, Penn Mutual Life Insurance Company, Connecticut Mutual Life Insurance Company, Connecticut General Life Insurance Company, and Feist & Feist.
Subsequent to May 10, 1956, petitioner's representatives conducted negotiations with the Knights of Columbus which continued through June and July 1956. During these talks the Knights of Columbus indicated it would prefer to include the Penn Fruit store and the Howard Johnson restaurant with the Korvette store in any purchase arrangement.
38 T.C. 844">*850 On July 26, 1956, Ivor B. Clark, Inc., submitted to petitioner a tentative offer from the Knights of Columbus to purchase the shopping center upon completion of construction of the buildings required under the Penn Fruit and Korvette leases and under a lease to be obtained from Howard Johnson. The terms of this offer were formally submitted to petitioner in a letter from the Knights of Columbus, dated August 10, 1956, offering petitioner $ 2,750,000 for the completed shopping center.
Notwithstanding the sale negotiations1962 U.S. Tax Ct. LEXIS 81">*95 being carried on with the Knights of Columbus during the late spring and summer of 1956, petitioner continued its efforts during the same period to obtain permanent mortgage financing. The Lubin group was opposed to selling either the Korvette building or any other part of the shopping center, and Lubin tried to avert the possibility of a sale up to the last moment. Lubin and his associates were interested in the income-producing aspects of the shopping center project and wanted to hold it as an investment together with the 7-acre Lubin tract adjoining petitioner's property. During the summer of 1956, Lubin personally contacted several institutional lenders, including Prudential Life Insurance Company of America and Massachusetts Mutual Life Insurance Company, in a final unsuccessful effort to obtain mortgage financing. He also contacted the Provident Tradesmens Bank and Trust Company of Philadelphia, which had tentatively agreed to provide petitioner with temporary construction financing, in an effort to induce the bank to grant petitioner a 3-year temporary loan to enable the shopping center project to go forward and give petitioner additional time to work out a permanent mortgage. 1962 U.S. Tax Ct. LEXIS 81">*96 The bank refused Lubin's request for such temporary loan because it did not normally invest in mortgages of this type and, in addition, it was not satisfied at that time with the credit of Korvette as collateral in a transaction of that character.
Late in June 1956, with petitioner's authorization, Raymond Armstrong made a final attempt to secure permanent financing for the shopping center by applying to the mortgage brokerage office of Brooks, Harvey & Co. of New York City. Brooks, Harvey & Co. on June 29, 1956, turned down the application, stating that it had done so "after an analysis of the credits represented by the tenants of the * * * shopping center."
On August 10, 1956, petitioner and the Springfield Township Commissioners executed an agreement relative to the construction of the Springfield Township Shopping Center in accordance with the Township's use and building regulations.
Hanna Realty Company and its counsel, David Cohen, were fearful that Penn Fruit's interests would be harmed if petitioner did not accept the purchase offer of the Knights of Columbus. Another 38 T.C. 844">*851 supermarket chain, Food Fair, was then developing a separate shopping center about 1 mile from1962 U.S. Tax Ct. LEXIS 81">*97 petitioner's location, and Penn Fruit's officials were concerned that any delay in building petitioner's stores would result in the area being preempted and in the possibility of losing some of the shopping center's tenants such as Korvette. In order to overcome the opposition of the Lubin group in regard to acceptance of the purchase offer of the Knights of Columbus and to induce the group to agree to the sale, Hanna Realty and Cohen offered to give the Lubin group most of the gain that petitioner was expected to derive from the transaction. Based on this offer, a written agreement was signed by all of petitioner's shareholders on September 19, 1956.
Under the agreement of September 19, 1956, Lewis Posner, acting for the Lubin group, agreed to approve the proposed sale to the Knights of Columbus and to vote in favor of a plan of liquidation and dissolution of petitioner, and Hanna Realty and Cohen agreed that Posner would receive $ 230,000 as his (i.e., the Lubin group's) share of the liquidation distribution upon receipt by petitioner from the Knights of Columbus of the $ 390,000 which was to be paid to petitioner under the proposed sales agreement.
On September 21, 1956, petitioner1962 U.S. Tax Ct. LEXIS 81">*98 and the Knights of Columbus entered into an agreement for the sale of the Springfield Township Shopping Center site. The sales price was $ 390,000, subject to certain conditions which among others included:
(a) The Knights of Columbus agreed to reimburse petitioner for the costs incurred in improving the site with buildings to be occupied by Penn Fruit, Korvette, and Howard Johnson; the total amount of such costs, including the $ 390,000 for the land, to be limited to $ 2,750,000.
(b) After settlement petitioner agreed to proceed on its own responsibility and risk with the erection of the buildings and the improvements on the shopping center site.
(c) Petitioner agreed in essence to assign as landlord the various leases with Penn Fruit, Korvette, and Howard Johnson to the Knights of Columbus.
(d) The Knights of Columbus agreed to pay petitioner $ 390,000 (less $ 10 to be paid at settlement) on the reimbursement date and then only after all other items of cost to be paid or reimbursed by the Knights of Columbus had been paid or reimbursed.
(e) Petitioner agreed that the project of contructing the buildings and improvements on the shopping center site would be fully completed within1962 U.S. Tax Ct. LEXIS 81">*99 15 months from the date of the sales agreement, subject to extension due to causes beyond the petitioner's control and occurring without petitioner's fault.
38 T.C. 844">*852 On September 27, 1956, petitioner's board of directors adopted certain resolutions which, among other things, approved the sales agreement to the Knights of Columbus of September 21, 1956, and adopted a plan for the complete liquidation and dissolution of petitioner.
On October 25, 1956, petitioner obtained a written commitment for a construction mortgage loan up to $ 2,360,000 from the Provident Tradesmens Bank and Trust Company of Philadelphia. Michael Lubin negotiated the construction loan for petitioner. He first approached the bank about the loan in the late spring of 1956. At that time petitioner had no commitment for a "permanent take-out," and the bank would not grant the construction loan until a "firm take-out" had been obtained. After the Knights of Columbus agreed to purchase the property, the bank granted petitioner the requested construction loan on the strength of the sales agreement. As collateral for the loan, petitioner assigned to the bank the sales agreement and the surety bond under that agreement1962 U.S. Tax Ct. LEXIS 81">*100 and gave the bank a first mortgage on the property in the amount of $ 2,750,000 which was immediately recorded.
Contracts covering the construction of the three buildings were awarded to Sidney Elkman on October 30, 1956. By a later amendment, dated April 12, 1957, the Howard Johnson restaurant building was withdrawn from the Elkman contract and awarded to John Crockett, Inc.
Pursuant to the terms of the sales agreement, the land for the shopping center was conveyed by petitioner to the Knights of Columbus on November 1, 1956, prior to the commencement of construction. No part of the consideration was paid to petitioner at that time.
The construction of the improvements on the shopping center site was supervised and checked by the bank's inspectors. Moneys were paid by the bank to the contractors on vouchers from petitioner in reliance upon the bank's inspectors and the architect's certification. The bank did not look to petitioner or its employees to perform any duties in this regard.
On the reimbursement date which was fixed at September 6, 1957, after construction had been completed, the Knights of Columbus sent the bank a check for $ 2,750,000, of which $ 2,360,000 was used1962 U.S. Tax Ct. LEXIS 81">*101 by the bank to satisfy the construction mortgage and a demand note owing to the bank, and the remaining $ 390,000 was transmitted by the bank to petitioner.
Petitioner filed a certificate of election to dissolve with the Commonwealth of Pennsylvania on August 9, 1957.
38 T.C. 844">*853 Following the receipt by petitioner of the $ 390,000 that it received for its interest in the shopping center, $ 230,000 was distributed in 1957 to the members of the Lubin group (whose stock in petitioner was held in the name of Lewis Posner) as follows:
| Lewis Posner | $ 30,000 |
| Michael Lubin | 80,000 |
| E. Fred Kemner | 30,000 |
| Elsie and Edward Goldsborough | 30,000 |
| Hilda and Myer Harsfield | 30,000 |
| Lillian I. Laveson | 30,000 |
Hanna Realty Company received a liquidation distribution from petitioner in the amount of $ 40,265.07, and David Cohen received a liquidation distribution in the amount of $ 10,000. 1
1962 U.S. Tax Ct. LEXIS 81">*102 Prior to the sale of the shopping center to the Knights of Columbus, petitioner had realized no taxable income. During the years 1954 through 1957, the only activities in which petitioner engaged pertained to the shopping center located at State and Sproul Roads, Springfield Township, Delaware County, Pennsylvania.
Michael Lubin and his associates ultimately constructed stores on the 7-acre Lubin tract adjacent to the land which petitioner sold to the Knights of Columbus. The Lubin group still owns its interest in the 7-acre shopping center and derives rental income from it.
Michael Lubin's principal business activity during the taxable years 1955 through 1958 was as a real estate broker. During these same years, the major portion of Lubin's taxable income resulted from the sale of real estate. Lubin was involved in a considerable number of partnerships in these years, and the income from all such partnerships was derived from the sale of real estate.
In their joint income tax returns for the years 1955 through 1958, three of the other members of the Lubin group included the following information: (a) Lewis Posner -- occupation, attorney; in addition to income from the practice1962 U.S. Tax Ct. LEXIS 81">*103 of law, income reported from rental property, sales of property (including income from some of the real estate partnerships listed on Lubin's returns), and mortgage and loan interest; (b) E. Fred Kemner -- occupation, realtor; income reported from own real estate business as well as from some of the same real estate partnerships listed on Lubin's returns; (c) Lillian I. Laveson -- occupation of husband, attorney; income also reported from certain partnerships, some of which were the same real estate partnerships listed on Lubin's returns.
During 1955 and 1956, over a 12- to 18- month period, the interest rate on permanent mortgage money based on prime credit risks rose 38 T.C. 844">*854 from approximately 4.5 percent to 5.5 percent. In these same years the prime interest rate on borrowed money rose from 3 1/4 percent to 3 1/2 percent in 1955, from 3 1/2 percent to 3 3/4 percent in April 1956, and from 3 3/4 percent to 4 percent in August 1956. Mortgage money was very tight during this period, and frequently it was not possible to find a private investor to take large long-term mortgages.
Petitioner, on its tax return for the period beginning July 1, 1957, and ending September 25, 1957, 1962 U.S. Tax Ct. LEXIS 81">*104 computed the gain it realized from the sale of the Springfield Township shopping center site to the Knights of Columbus but claimed that such gain was not recognizable under the provisions of section 337(a) of the Internal Revenue Code of 1954. The gain was computed as follows:
| Land -- Sold Nov. 1, 1956 | $ 390,000.00 | |
| Less -- Cost, 1954 | $ 179,190.39 | |
| Expenses of sale | 8,291.50 | 187,481.89 |
| Long-term capital gain | 202,518.11 |
The same return reported that petitioner's total cost of construction of the shopping center had exceeded its reimbursement from the Knights of Columbus by $ 2,776.32. In a statement attached to the deficiency notice sent to petitioner, the Commissioner determined that petitioner realized a net gain of $ 199,741.79 "upon the sale of land and buildings" and that such gain "is taxable as ordinary income." The petition filed by petitioner alleges that the Commissioner erred in determining that any gain was recognizable under the provisions of section 337 of the 1954 Code and, in the alternative, in taxing gain from the sale of its assets as ordinary income rather than as long-term capital gain.
Petitioner was availed of principally for the 1962 U.S. Tax Ct. LEXIS 81">*105 construction of property with a view to the liquidation of the corporation, sale of the property, and a distribution to petitioner's shareholders before the realization by petitioner of a substantial part of the taxable income to be derived from such property.
At the time of the sale of the shopping center to the Knights of Columbus, petitioner did not hold such property primarily for sale to customers in the ordinary course of its trade or business.
OPINION.
Under section 337(a) of the 1954 Code, a corporation which adopts a plan of complete liquidation and distributes all of its assets within a 12-month period thereafter recognizes no gain or loss from the sale or exchange of its property during such 12-month 38 T.C. 844">*855 liquidating period. 2 However, section 337(c)(1)(A) states that these provisions shall not apply to any sale or exchange "made by a collapsible corporation (as defined in section 341(b))." Pertinent excerpts from section 341(b) appear in the margin. 3 At issue herein is the correctness of the Commissioner's determination that petitioner is a collapsible corporation and is, therefore, taxable on the gain it realized in 1957 from the sale of its chief asset, a shopping1962 U.S. Tax Ct. LEXIS 81">*106 center, pursuant to a plan of liquidation. If petitioner is held to be a collapsible corporation, a second issue is whether the gain which is then recognizable on the sale of the shopping center is taxable as ordinary income, as determined by the Commissioner, or as long-term capital gain, as claimed by the petitioner.
1962 U.S. Tax Ct. LEXIS 81">*107 1. As set forth more fully in our findings, petitioner was formed in 1954 for the principal purpose of developing and constructing a shopping center in Springfield Township, Delaware County, Pennsylvania. Between the time of its organization and the spring of 1956, petitioner purchased a 14 1/2-acre tract of land for the shopping center, succeeded in having the zoning changed on such land from residential to commercial, hired an architect to prepare plans for the center, began negotiations with the Township with respect to 38 T.C. 844">*856 building permits and performance and maintenance bonds, obtained two tenants for the shopping center and was in the process of negotiating with a third, and had unsuccessfully attempted to obtain permanent mortgage financing for the necessary construction and improvements. Without more such preliminary activities on the part of a corporation have been held to constitute "construction" within the definition of a collapsible corporation. J. D. Abbott, 28 T.C. 795">28 T.C. 795, 28 T.C. 795">805, affirmed 258 F.2d 537 (C.A. 3); Leland D. Payne, 30 T.C. 1044">30 T.C. 1044, 30 T.C. 1044">1058-1059, affirmed 268 F.2d 6171962 U.S. Tax Ct. LEXIS 81">*108 (C.A. 5); Ellsworth J. Sterner, 32 T.C. 1144">32 T.C. 1144, 32 T.C. 1144">1149; Jack Farber, 36 T.C. 1142">36 T.C. 1142, 36 T.C. 1142">1156, on appeal (C.A. 2). Before the actual physical construction of the shopping center had begun and prior to the realization by petitioner of any income from the project, in September, 1956, petitioner agreed to sell the entire shopping center to the Knights of Columbus under a sales agreement that provided petitioner would assume the responsibility for the construction of the buildings and other improvements and the Knights of Columbus would reimburse petitioner for the costs of such construction and improvements up to a stipulated maximum amount. That sales agreement was entered into only after petitioner had exhausted all efforts to obtain mortgage financing to complete the project on its own behalf; it had not previously considered a sale and undertook to sell the shopping center only as a last resort when it became apparent that it would not be able to construct the project for itself. Petitioner agreed to accept $ 390,000 as consideration for the shopping center site, and petitioner's shareholders decided upon approving the sales 1962 U.S. Tax Ct. LEXIS 81">*109 agreement to adopt a plan of complete liquidation. Following completion of the physical construction of the shopping center in September of 1957, petitioner was paid in full for its interest therein, and thereafter petitioner proceeded to distribute its assets to its shareholders in liquidation.
Does petitioner in these circumstances come within the statutory definition of a collapsible corporation? In accordance with the regulations 4 issued under section 337 of the 1954 Code, this question must be decided on the basis of what would have happened if petitioner had liquidated the corporation by distributing its interest in the shopping center directly to its shareholders instead of selling that interest to the Knights of Columbus and distributing the resulting cash to its shareholders thereafter. The regulations provide that if petitioner would have been collapsible had it distributed its property in kind 38 T.C. 844">*857 to its shareholders, then it remains collapsible for purposes of applying the provisions of section 337 when it sells or exchanges its property pursuant to a plan of liquidation. We think that insofar as they are pertinent herein, the regulations represent a reasonable1962 U.S. Tax Ct. LEXIS 81">*110 and proper interpretation of what Congress intended when it excepted collapsible corporations from the operation of the nonrecognition provisions of section 337. 5
1962 U.S. Tax Ct. LEXIS 81">*111 Upon consideration of the facts in accordance with the cited regulations, we conclude that petitioner comes within the definition of a collapsible corporation. We have already indicated that we think petitioner was availed of principally for the construction of property as the term "construction" is used in the statutory definition. And we think the requisite "view" was also present. If petitioner had distributed its entire interest in the shopping center to its shareholders and then the shareholders had sold the project to the Knights of Columbus, there would have occurred both a distribution to petitioner's shareholders before the realization by petitioner of a substantial part of the taxable income to be derived from the shopping center and the realization by petitioner's shareholders of gain attributable to the shopping center. Thereby, the two essential elements of the statutory "view" would have been filled. Because petitioner would have come squarely within the definition of a collapsible corporation if it had liquidated immediately prior to the sale of the shopping center rather than immediately after, we hold pursuant to the applicable regulations that petitioner must1962 U.S. Tax Ct. LEXIS 81">*112 be considered a collapsible corporation for purposes of the exception contained in section 337(c), and that, therefore, it is not entitled to nonrecognition of its gain on the sale of the shopping center under section 337(a).
Petitioner's principal contention in opposition to being classified as a collapsible corporation is that its shareholders did not use the corporate form to convert ordinary income into capital gain, that the sale of the shopping center would have resulted in capital gain to its shareholders even if the corporate entity had not been used, and that the statute was never intended to include such a transaction within the definition of a collapsible corporation, citing United States v. Ivey, 294 F.2d 799 (C.A. 5), rehearing denied 303 F.2d 109, and Honaker, Drlg., Inc. v. Koehler, 190 F. Supp. 287">190 F. Supp. 287 (D. Kans.). A similar argument was recently rejected in Braunstein v. Commissioner, 38 T.C. 844">*858 305 F.2d 949 (C.A. 2), affirming 36 T.C. 22">36 T.C. 22, on the basis that the statute contains no such limitation on the applicability1962 U.S. Tax Ct. LEXIS 81">*113 of the collapsible corporation provisions, that the pertinent legislative history indicates that these provisions were intended to apply to some cases in which the property if sold by the shareholders would have produced capital gain, and, finally, that the addition of subsection (e) to section 341 by amendment in 1958 6 would have been unnecessary if the limitation on the applicability of the statute urged by petitioner is correct. We are in accord with the reasoning of the Court of Appeals for the Second Circuit in this regard. 1962 U.S. Tax Ct. LEXIS 81">*114 7 Therefore, notwithstanding that hereinafter we hold that petitioner realized long-term capital gain from the sale of the shopping center and not ordinary income, we think that the collapsible corporation provisions are applicable to petitioner.
1962 U.S. Tax Ct. LEXIS 81">*115 In a separate argument petitioner attempts to avoid being treated as a collapsible corporation on the basis of the so-called "postconstruction motive" cases. Cf. Jacobson v. Commissioner, 281 F.2d 703 (C.A. 3), reversing 32 T.C. 893">32 T.C. 893; Maxwell Temkin, 35 T.C. 906">35 T.C. 906; Charles J. Riley, 35 T.C. 848">35 T.C. 848, appeal dismissed (C.A. 1). Assuming that its preliminary site-purchasing, zoning, leasing, and mortgage-seeking activities constituted "construction" under the statute, as we have decided above, petitioner argues that the decision to sell the shopping center was not made until after all such activities had been completed and that, therefore, the proscribed "view" did not arise or exist at any time during such "construction." We see no merit in 38 T.C. 844">*859 this attempt to isolate preliminary construction activities from actual physical construction. From its inception the "construction" undertaken by petitioner was not merely the rezoning of the shopping center site and the leasing of the intended buildings but included the actual physical construction of the shopping center1962 U.S. Tax Ct. LEXIS 81">*116 and all the land improvements involved therein. Although petitioner agreed on September 21, 1956, to sell its interest in the project prior to the start of physical construction of the shopping center, the sales agreement provided that petitioner was responsible for completing such physical construction and that it would not receive the stipulated consideration for the site until such physical construction had been completed. Petitioner was in fact paid in September 1957, when the construction of the shopping center was completed. Thus, it is clear that petitioner's decision to sell the shopping center and liquidate the corporation was made almost a full year prior to the completion of the construction of the shopping center. In these circumstances, there existed the requisite "view" to a distribution to petitioner's shareholders before the completion of construction, and the Jacobson, Temkin, and Riley cases are therefore inapplicable. Sec. 1.341-2(a) (2) and (3), Income Tax Regs.; cf. 32 T.C. 1144">Ellsworth J. Sterner, supra at 1148; 36 T.C. 1142">Jack Farber, supra at 1155-1158.
For the sake of completeness we should add that 1962 U.S. Tax Ct. LEXIS 81">*117 for purposes of decision it makes no difference that petitioner's actions in selling the shopping center and liquidating may have been motivated, in whole or in part, by its failure to obtain permanent mortgage financing for the project. Assuming that this was the sole reason for making a distribution to the shareholders, the definition contained in section 341(b) is still applicable to petitioner. Cf. 32 T.C. 1144">Ellsworth J. Sterner, supra at 1148.
2. Having decided that petitioner is a collapsible corporation and that the sale of the shopping center is thereby excepted from the nonrecognition provisions of section 337 of the 1954 Code, we turn next to the question of the character of the gain realized by petitioner as a result of such sale. The provisions of section 341 relating to collapsible corporations are of no assistance on this question, for they deal only with the treatment of gain to shareholders of collapsible corporations and not with gain realized by the corporation itself. The Commissioner has determined that petitioner's net gain on the sale is taxable to it as ordinary income. Petitioner contends that such gain is properly taxable as long-term1962 U.S. Tax Ct. LEXIS 81">*118 capital gain. We agree with petitioner on this issue.
Based on all of the evidence of record, we have made the ultimate finding that at the time petitioner sold the shopping center to the Knights of Columbus petitioner did not hold the shopping center primarily 38 T.C. 844">*860 for sale to customers in the ordinary course of its trade or business. 8 Without attempting to recite all of the evidence upon which this finding is based, we do note that petitioner does not appear to have considered sale of the shopping center until April or May of 1956, after it had unsuccessfully attempted to obtain permanent mortgage financing for the project; that the purchase offer from the Knights of Columbus came unsolicited through the offices of Ivor B. Clark, Inc., which had been authorized by petitioner to seek permanent mortgage financing and which therefore required separate authorization from petitioner for the sales negotiations with the Knights of Columbus; that petitioner continued its efforts to seek mortgage financing during the summer of 1956 while it negotiated a possible sale to the Knights of Columbus; and that petitioner's final decision to sell the shopping center was coupled with a decision1962 U.S. Tax Ct. LEXIS 81">*119 to liquidate the corporation.
The Commissioner emphasizes two aspects of the record in support of his determination that petitioner's gain constituted ordinary income. First, that some of petitioner's shareholders and, in particular, several members of the Lubin group, were actively engaged in the real estate business during the years 1955 through 1958. We have taken this element of the case into account and have made certain findings in this regard based on stipulated tax returns of the individuals involved. But in the light of the record as a whole, we think the admittedly separate business activities of several of petitioner's individual shareholders have little relevance in the determination of petitioner's purpose in holding the shopping1962 U.S. Tax Ct. LEXIS 81">*120 center property at the time of its sale. 9
The second group of facts underscored by the Commissioner is that at least a portion of petitioner's property, the Korvette store, was offered for sale to a number of third parties before the sale of the entire property to the Knights of Columbus was completed. Our findings show that at about the time the Ivor B. Clark firm presented petitioner with an offer from the Knights of Columbus to purchase the Korvette store1962 U.S. Tax Ct. LEXIS 81">*121 only, the Clark firm had a brochure prepared offering petitioner's Korvette building for sale and sent this brochure to a number of institutions, including banks, insurance companies, and one real estate brokerage firm. It is not clear from the record whether 38 T.C. 844">*861 petitioner ever authorized the preparation and general distribution of this brochure or whether the Clark firm, once it had obtained one purchase offer, decided on such action on its own initiative. Since the Clark firm had to obtain special authorization by telegram from petitioner to represent it in sales negotiations for the Korvette store with the Knights of Columbus, the latter would appear to be a distinct possibility. However, even if we could conclude that petitioner authorized the distribution of this particular sales brochure, this fact would not be enough to tip the scales in favor of ordinary income treatment. Taking into account petitioner's original plans to lease the shopping center itself, its extended efforts to get permanent mortgage financing, its continued efforts along these lines even after the purchase offer from the Knights of Columbus had been received and the brochure sent out, and its 1962 U.S. Tax Ct. LEXIS 81">*122 decision to liquidate once its decision to sell became final, we cannot find that petitioner at any time held the shopping center primarily for sale to customers in the ordinary course of its trade or business.
At the trial and on brief the Commissioner put forward an alternative theory that the price received by petitioner represented funds from a sale plus moneys for services performed, of which at a minimum the latter portion would represent ordinary income in petitioner's hands. The Commissioner points to no evidence of record to show that such was the intent of the parties involved, and we can find none. To be sure, petitioner was not entitled under the sales agreement to any consideration for the shopping center site until it had completed the construction of the shopping center buildings and improvements and had been reimbursed for such construction costs up to a stated maximum amount by the Knights of Columbus. And it may also be assumed that the appreciation in the value of the shopping center site was related to petitioner's past efforts in regard to zoning, hiring architects, obtaining favorable leases, and the like. But there is no indication that either petitioner 1962 U.S. Tax Ct. LEXIS 81">*123 or the Knights of Columbus intended to segregate any portion or percentage of the agreed consideration of $ 390,000, stated as payable "for the Shopping Center Site," for petitioner's efforts in developing the shopping center. And we cannot conclude that any such apportionment was in fact the effect of their agreement. Thus, we must also reject the Commissioner's alternative position. We hold that the Commissioner erred in his determination that petitioner's gain on the sale of the shopping center is taxable as ordinary income and not as long-term capital gain.
Decision will be entered under Rule 50.
Footnotes
1. The amounts of the liquidation distributions were stipulated. The record is silent with regard to how the corporation used that portion of the $ 390,000 which was not so distributed.↩
2. SEC. 337. GAIN OR LOSS ON SALES OR EXCHANGES IN CONNECTION WITH CERTAIN LIQUIDATIONS.
(a) General Rule. -- If --
(1) a corporation adopts a plan of complete liquidation on or after June 22, 1954, and
(2) within the 12-month period beginning on the date of the adoption of such plan, all of the assets of the corporation are distributed in complete liquidation, less assets retained to meet claims,↩
then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period.3. SEC. 341. COLLAPSIBLE CORPORATIONS.
(b) Definitions. --
(1) Collapsible corporation. -- For purposes of this section, the term "collapsible corporation" means a corporation formed or availed of principally for the manufacture, construction, or production of property, for the purchase of property which (in the hands of the corporation) is property described in paragraph (3), or for the holding of stock in a corporation so formed or availed of, with a view to --
(A) the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, before the realization by the corporation manufacturing, constructing, producing, or purchasing the property of a substantial part of the taxable income to be derived from such property, and
(B) the realization by such shareholders of gain attributable to such property.
(2) Production or purchase of property. -- For purposes of paragraph (1), a corporation shall be deemed to have manufactured, constructed, produced, or purchased property, if --
(A) it engaged in the manufacture, construction, or production of such property to any extent,
(B) it holds property having a basis determined, in whole or in part, by reference to the cost of such property in the hands of a person who manufactured, constructed, produced, or purchased the property, or
(C) it holds property having a basis determined, in whole or in part, by reference to the cost of property manufactured, constructed, produced, or purchased by the corporation.
(3) Section 341 assets. -- * * *
(4) Unrealized receivables. -- * * *↩
4. Sec. 1.337-1, Income Tax Regs.: "* * * Sales or exchanges made by a collapsible corporation (as defined in section 341(b)) are excluded from the operation of section 337 by section 337(c). Accordingly, section 337 does not apply to any sale or exchange of property whenever the distribution of such property in partial or complete liquidation to the shareholders in lieu of such sale or exchange would have resulted in the taxation of the gain from such distribution in the manner provided in section 341(a) as to any shareholder or would have resulted in the taxation of the gain in such manner, but for the application of section 341(d)↩."
5. Without the approach taken by the regulations or one comparable thereto, the exception for collapsible corporations in section 337(c) would have little or no meaning. Since any sale or exchange made pursuant to section 337 results in the corporation realizing (but not recognizing) income on its property prior to a distribution to its shareholders, no corporation liquidating under section 337 could ever come within that portion of the collapsible corporation definition requiring a sale or exchange of stock or a distribution to shareholders before the realization by the corporation of a substantial part of the taxable income to be derived from the property. Cf. DeWind & Anthoine, "Collapsible Corporations," 56 Colo. L. Rev. 475, 523-526 (1956); MacLean. "Taxation of Sales of Corporate Assets in the Course of Liquidation," 56 Colo. L. Rev. 641, 666-668↩ (1956).
6. These new provisions are not applicable to the instant case because the terms of the amending statute make them applicable only with respect to taxable years beginning after December 31, 1957, and then only with respect to sales, exchanges, and distributions which occur after the date of enactment, September 2, 1958. Sec. 20(b), Pub. L. 85-866.↩
7. Although the point was never specifically discussed, the same factor appears to have been present in many of the prior cases in which a corporation was used to construct apartment buildings, housing developments, or other structures and the stock of the corporation was sold or a corporate distribution was made prior to the realization of a substantial part of the income to be derived from the project. Cf. Raymond G. Burge, 28 T.C. 246">28 T.C. 246, affirmed 253 F.2d 765 (C.A. 4) (apartment building); Edward Weil, 28 T.C. 809">28 T.C. 809, affirmed per curiam 252 F.2d 805 (C.A. 2) (shopping center); Glickman v. Commissioner, 256 F.2d 108 (C.A. 2), affirming a Memorandum Opinion of this Court (apartment project); Elizabeth M. August, 30 T.C. 969">30 T.C. 969, affirmed 267 F.2d 829 (C.A. 3) (apartment houses); Leland D. Payne, 30 T.C. 1044">30 T.C. 1044, affirmed 268 F.2d 617 (C.A. 5) (rental-housing projects); Max Mintz, 32 T.C. 723">32 T.C. 723, affirmed 284 F.2d 554 (C.A. 2) (apartment house project); C. D. Spangler, 32 T.C. 782">32 T.C. 782, affirmed 278 F.2d 665 (C.A. 4), certiorari denied 264 U.S. 825">264 U.S. 825 (rental-housing projects); Ellsworth J. Sterner, 32 T.C. 1144">32 T.C. 1144 (apartment houses); Jesse Hartman, 34 T.C. 1085">34 T.C. 1085, affirmed per curiam 296 F.2d 726↩ (C.A. 2) (housing projects). The fact that the buildings in these cases may have been capital assets in the hands of the corporations involved and might have been sold by the corporations at a capital gain did not make these corporations any less collapsible under the statute. The important and, indeed, the decisive facts under the statutory definition are that the corporation be availed of principally for construction with a view to a corporate distribution or the sale of its stock prior to the realization by the corporation of a substantial part of the taxable income to be derived from the property and the realization by its shareholders of gain attributable to the property. These facts were present in the cases cited above, and they are equally present here where petitioner's chief asset, a shopping center, was sold pursuant to a plan of liquidation before any income had been realized therefrom.
8. Petitioner's purpose in holding the shopping center property at the time of sale is the only matter which the Commissioner put in issue at the trial and on brief. No dispute has arisen over the requisite 6-month holding period for a capital asset. Sec. 1231(b), I.R.C. 1954↩.
9. Moreover, since there is evidence that the Lubin group had a prior interest in a shopping center adjoining petitioner's and still holds such interest as an investment, the fact that some members of the Lubin group happen to be real estate brokers and others frequently buy and sell real estate assumes even less significance for our inquiry. Also, it is noteworthy that the Lubin group objected to petitioner's sale of the shopping center and approved the sale only after petitioner's remaining shareholders offered it the greater portion of the resulting gain.↩