1951 U.S. Tax Ct. LEXIS 66">*66 Decision will be entered under Rule 50.
1. Petitioner made a down payment in 1945 on a contract to buy land. He did not carry out the contract, and claimed an ordinary loss in 1945 of the amount of the deposit. Respondent allowed the loss as a short term capital loss. Held, petitioner has failed to prove error in respondent's determination.
2. Petitioner deducted in his 1945 and 1946 returns advances made in each year to a corporation of which he was president and a substantial stockholder. The corporation was in bad financial condition and operating at a loss. Held, the amounts advanced in 1945 are deductible as bad debts, but the amounts advanced in 1946 were in the nature of capital contributions and are not deductible.
17 T.C. 620">*621 The respondent determined deficiencies in income tax for the years 1945 and 1946 of $ 2,599.69 and $ 3,009.22.
Two questions are presented: First, whether petitioner was entitled to deduct the full amount of $ 2,075 which he claimed as the loss of a down payment for a piece of real estate in 1945 which he "forfeited" for failure to carry out his contract of purchase; and, second, whether petitioner was entitled to deductions of $ 4,524.27 in 1945 and $ 12,590 in 1946, representing loans or advances made to a corporation of which petitioner was an officer and stockholder and which he claims became worthless debts in those years.
A third issue involving a claimed deduction of $ 50 in 1946 as interest paid was abandoned by petitioner.
FINDINGS OF FACT.
Part of the facts have been stipulated and are found as set out in the stipulations.
Petitioner is a resident of Philadelphia, Pennsylvania. He filed his returns for 1945 and 1946 with the collector for the first district of Philadelphia.
On May 17, 1945, petitioner entered into a written agreement with Pennsylvania Trust and Missionary Society pursuant to which he agreed to1951 U.S. Tax Ct. LEXIS 66">*68 purchase a certain lot in Philadelphia. The total purchase price was $ 24,000, payable by a cash deposit of $ 2,000 at the signing of the agreement and $ 22,000 cash at settlement, settlement to be made on or before July 18, 1945. The agreement further provided that should the purchaser fail
to make Settlement as herein provided, the sum or sums paid on account are to be retained by the Sellers, either on account of the Purchase Price, or as Compensation for the damages and expenses * * * as the Sellers shall elect and in the latter case this Contract shall become null and void and Cancellation shall automatically take place.
Petitioner paid his $ 2,000 deposit and also expended $ 75 in connection with this transaction. Settlement was not made by or on the specified date. This default was brought to petitioner's attention by counsel for the vendor by letter dated August 6, 1945, in which counsel stated that they would be obliged to file a bill for specific 17 T.C. 620">*622 performance unless petitioner by return mail advised of his intention to make final settlement. The vendor retained the $ 2,000 deposited by petitioner and none of that payment or the $ 75 expenditure has ever been1951 U.S. Tax Ct. LEXIS 66">*69 returned to petitioner or claimed by him.
In his income tax return for 1945 petitioner deducted as an ordinary loss the full amount of $ 2,075. In his notice of deficiency respondent treated the loss as a short term capital loss and limited the deduction to $ 1,000.
This transaction was entered into by petitioner for profit. It was not entered into in connection with petitioner's trade or business.
Petitioner was president of the Stanley Engineering Corporation (hereinafter called the corporation), during 1945 and 1946. He devoted all his working time to the conduct of the corporation's business and owned 20 per cent of its common and 15.6 per cent of its preferred stock. The corporation was engaged, among other things, in the manufacture of antennae, radar equipment, A-bomb agitators, tricycles, and sound motion picture projectors. Petitioner had charge of incoming employees, opened and closed the plant, conferred with foremen, picked up supplies, and, in short, whenever there was anything to do he was there to do it.
During the last six months of 1945 petitioner made advances to the corporation for the purposes of meeting payrolls and paying for materials and meeting miscellaneous1951 U.S. Tax Ct. LEXIS 66">*70 expenses in the total amount of $ 4,524.27. At various times all during 1946 similar advances for similar purposes were made totalling $ 12,288.56. Petitioner did not receive any bond, debenture, note, or other evidence of indebtedness and has not been repaid any of the money he advanced.
The financial condition of the corporation during 1945 and 1946 was bad. Its cash position during the years 1945 and 1946 was as follows:
| 1945 | 1946 | |
| Opening cash balance | $ 35,926.68 | $ 10,696.95 |
| Cash receipts | 362,452.54 | 308,852.92 |
| Total | 398,379.22 | 319,549.87 |
| Cash disbursements | 388,682.27 | 320,634.98 |
| Closing cash balance | 10,696.95 | - 1,085.11 |
| $ 398,379.22 | $ 319,549.87 |
At the end of 1945 the corporation's balance sheet showed the following:
| Assets | |
| Total current assets | $ 75,937.11 |
| Fixed assets | 99,321.50 |
| Prepaid expenses | 2,980.40 |
| Total assets | $ 178,239.01 |
| Liabilities and Capital | |
| Current liabilities | $ 120,821.83 |
| Mortgage payable | 50,800.00 |
| Note payable | 5,000.00 |
| Total liabilities | $ 176,621.83 |
| Capital stock | 46,000.00 |
| Earned surplus (deficit) | 44,382.82 |
| Total capital | $ 1,617.18 |
17 T.C. 620">*623 At the end of 1946 the balance sheet1951 U.S. Tax Ct. LEXIS 66">*71 showed:
| Assets | |
| Total current assets | $ 18,318.45 |
| Fixed assets (net book) | 95,629.80 |
| Miscellaneous assets | 40,431.60 |
| Prepaid expenses | 2,611.86 |
| Total assets | $ 156,991.71 |
| Liabilities, Capital and Deficit | |
| Current liabilities | $ 194,785.71 |
| Long-term liabilities | 84,900.00 |
| Total liabilities | $ 279,685.71 |
| Capital stock | 51,000.00 |
| Deficit | 173,694.00 |
| ($ 122,694.00) |
The capital deficit figures above were subject to adjustment for operating loss carry-backs and do not include claims asserted by the United States totalling $ 441,692.30 for corporate income and excess profits taxes and contract renegotiation, the disposition of which claims is not shown by the record.
A debtor's petition for reorganization dated and acknowledged December 30, 1946, was filed by the corporation in the District Court of the United States for the Eastern District of Pennsylvania under chapter X of the Bankruptcy Act. The petition asked that the corporation be reorganized and that the stockholders be permitted some interest in the reorganized corporation. The petition was signed on behalf of the corporation by the petitioner here. Among other things the petition alleged:
The1951 U.S. Tax Ct. LEXIS 66">*72 assets of the Debtor are of substantial value. However, under present conditions, it is unable to pay its creditors in full and a forced sale will result in diminution of the value of the assets and consequent loss to creditors and others having claims against the Debtor.
Trustees were appointed. They carried on the corporation's business until March 21, 1947, at which time they recommended that the corporation be adjudged a bankrupt. A bankruptcy adjudication was entered April 9, 1947. The corporation's real and personal property was sold for $ 106,754.91 on May 7, 1947. Final distribution of the assets was ordered on December 10, 1948. Petitioner received nothing under any distribution of assets of the corporation in the reorganization proceeding.
Petitioner's advances to the corporation in the amount of $ 4,524.27 in 1945 were made with the expectation they would be repaid and became worthless in that year. The advances of $ 12,288.56 in 1946 were worthless when made and were in the nature of capital contributions to the corporation.
In his income tax return for 1945 petitioner deducted $ 4,524.27 from the salary of $ 11,700 paid him by the corporation as "deductible business1951 U.S. Tax Ct. LEXIS 66">*73 and travel expenses," and in his 1946 return deducted the sum of $ 12,590 as having been "paid into Stanley Corp. now liquidated." Both deductions were disallowed by respondent.
17 T.C. 620">*624 OPINION.
On the first issue, petitioner assigns error in respondent's determination that the loss of $ 2,075 claimed as a deduction on his return for 1945 was a capital loss, deduction of which was limited by section 117 (d) of the Internal Revenue Code to $ 1,000, and not an ordinary loss deductible in full. The parties agree that the transaction was entered into for profit, that there was a loss in 1945, and that it amounted to $ 2,075. They also agree that the contract was a purchase contract binding on petitioner rather than a mere option to purchase and that under the contract petitioner received immediately an equitable title to the land. Since it was not an option, the parties do not argue the applicability of section 117 (g) (2) of the Code, relating to the treatment of gains and losses attributable to the failure to exercise privileges or options to buy or sell. The issue is narrowed to the question whether respondent erred in determining that there was a "sale or exchange" of petitioner's1951 U.S. Tax Ct. LEXIS 66">*74 equitable interest.
Petitioner's argument is that by not carrying out the contract on his part he forfeited the down payment, that there was no sale or exchange involved in the forfeiture, and there was no other party to that forfeiture. Petitioner cites no cases on this point.
In Cape May Real Estate Co. v. Henderson, 231 Pa. 82">231 Pa. 82, 79 A. 982, it is stated that the general rule in Pennsylvania is that a purchaser in a contract to buy land cannot take advantage of his own wrong or set up his own default to work a forfeiture of his contract unless the contract so provides, and that upon the purchaser's default, the seller may elect either to assert and enforce the forfeiture or to insist upon performance of the contract. That case is cited with approval in Freeman v. Lawton, 353 Pa. 613">353 Pa. 613, 46 A.2d 205, in which it is stated that mere default in payment of installments does not of itself constitute cancellation, though furnishing cause therefor, and that to effect cancellation of a land contract the express or implied assent of the vendor is necessary. The contract here gave the sellers1951 U.S. Tax Ct. LEXIS 66">*75 the right to elect between forfeiture and suit for performance. It did not give the purchaser any election in this respect.
The Board of Tax Appeals (now this Court) has held that where the buyer has defaulted on a contract to purchase land and thereafter the parties have reached a settlement, the buyer giving a quitclaim deed to the property and the seller releasing the buyer of further liability on the original contract, the later transaction is a "sale or exchange" within the meaning of section 117 of the Code, and the buyer has sustained a capital loss. Betty Rogers, 37 B. T. A. 897, affd. 103 F.2d 790; Harold R. Smith, 39 B. T. A. 892; C. L. Gransden & Co., 39 B. T. A. 985, affd. 117 F.2d 80.
17 T.C. 620">*625 On the other hand, in C. G. Ganopuls, 39 B. T. A. 1120, it was held that no sale or exchange occurred where, after the buyer's default, the seller mailed him a notice of forfeiture declaring the contract forfeited and notifying him to deliver up the premises. Respondent has not acquiesced in that decision1951 U.S. Tax Ct. LEXIS 66">*76 and now argues that it is in effect disapproved in view of later decisions of the Supreme Court in Helvering v. Hammel, 311 U.S. 504">311 U.S. 504; Helvering v. Nebraska Bridge Supply & Lumber Co., 312 U.S. 666">312 U.S. 666; and by other decisions, such as Commissioner v. Paulson, 123 F.2d 255, and George Hewitt Myers, 3 T.C. 1044.
We think it unnecessary to consider the application of the Ganopuls case here, for petitioner has failed to prove that there was no sale or exchange in the termination of this contract. He entered into the contract, paid the deposit and $ 75 for expenses in connection with it, and failed or refused to make settlement on the day fixed therefor. He did not recover the amounts paid out. He received a letter threatening suit for specific performance. This is all we are told. Since respondent saw fit to allow the loss as to 1945, we may surmise that the transaction was terminated and the amounts were lost in that year. But we do not know whether the vendor declared the deposit forfeited; effected an agreement with petitioner to cancel the 1951 U.S. Tax Ct. LEXIS 66">*77 contract and release petitioner of further liability; or took some other action. Any such circumstances would be important in determining whether a "sale or exchange" occurred or petitioner's rights in the property were extinguished by action of the vendor as provided in the contract. Petitioner has not expressly negatived the existence of a subsequent agreement which would confirm the respondent's action. We may not assume that nothing more occurred. In this state of the record we must sustain the respondent's determination that a capital loss resulted from the transaction.
On the second issue, petitioner insists that he was in the manufacturing business in the taxable years 1945 and 1946; that he advanced $ 4,524.27 to said business in 1945 and $ 12,590 in 1946; that the sums so advanced were never returned to him; and that the advances became worthless in those years. He claims them deductible as business bad debts.
From the facts as we have found them, however, we conclude that the manufacturing business to which the claimed advances were made was not the business of petitioner, but the business of Stanley Engineering Corporation of which petitioner was president and a substantial1951 U.S. Tax Ct. LEXIS 66">*78 stockholder. Recent decisions of this Court in which petitioners who were officers and principal stockholders of corporations have contended that amounts which they put into the corporations by way of loans or advances were deductible as "business" as distinguished from "nonbusiness" bad debts, indicate little sympathy for 17 T.C. 620">*626 petitioner's contention. A. Kingsley Ferguson, 16 T.C. 1248; Jan G. J. Boissevain, 17 T.C. 325. In those cases under facts similar to those here it was decided that petitioners were not engaged in businesses of their own in managing and financing the corporations of which they were officers and substantial stockholders. Accordingly, we cannot subscribe to petitioner's theory that his activities with relation to the corporation constituted his individual business.
Even if we could approve that contention, petitioner is confronted with a further difficulty. Petitioner claims the amounts which he advanced to the corporation to be deductible as "debts which become worthless within the taxable year," section 23 (k), Internal Revenue Code.
Under the facts this would seem to put petitioner in1951 U.S. Tax Ct. LEXIS 66">*79 something of an anomalous situation. It is well settled that debts may not be deducted as bad debts unless they had value when acquired or created. Eckert v. Burnet, 283 U.S. 140">283 U.S. 140. And the burden of proving that the debts were not worthless when created is on petitioner. For the year 1945 we think petitioner has carried that burden. While the corporation was in straitened circumstances in that year its balance sheet was still in the black, and we think petitioner could reasonably have expected to be repaid the money he advanced. By the end of the year, however, the situation had grown darker and the facts as we see them gave petitioner little hope of repayment. Under these circumstances, petitioner properly treated his 1945 advances as having become worthless in that year.
With respect to 1946 we see the picture differently. No one was in better position than petitioner himself to know the condition of the corporation's finances. Its financial troubles were rapidly worsening. Petitioner had himself considered the 1945 advances as worthless at the end of that year and had so treated them in his tax return for that year. Despite his action1951 U.S. Tax Ct. LEXIS 66">*80 in that respect and the additional knowledge he must have gained as time went on he continued to pay money into the corporation in 1946. It seems to us obvious that petitioner had no hope of recovering the amounts advanced in 1946. By the end of 1946 petitioner acknowledged in the debtor's reorganization petition which he filed on behalf of the corporation that the corporation was unable to pay its creditors. Furthermore, in his tax return for 1946 petitioner denominated his advances as "paid into Stanley Corp. now liquidated." From these facts we think the only reasonable conclusion to be drawn is that petitioner was not creating debts by advancing money to the corporation in 1946, but was in fact making a capital contribution to it. Accordingly, we hold that the 1946 advances were not deductible as worthless debts. See Reading Co. v. Commissioner, 132 F.2d 306, 310, affirming a Memorandum Opinion 17 T.C. 620">*627 of the Board of Tax Appeals (now this Court). There it was pointed out that advances under somewhat similar circumstances have been characterized as gifts or contributions of capital, but not debts.
Decision will be entered under Rule1951 U.S. Tax Ct. LEXIS 66">*81 50.