*1156 1. Petitioner for a good many years has been a real estate dealer and trader and developer. Several years prior to the taxable years in question he acquired in a trade a one-half interest in a building situated in Atlanta, Georgia. He acquired his interest in the building primarily for sale in the course of his business and not to hold as an investment. The building was leased for a good rental when acquired and petitioner thought it would be readily salable. Later the lessee became insolvent and the building was left vacant and petitioner was unable to sell it. In 1936 the owner of the first mortgage foreclosed his lien and petitioner lost his one-half interest in the building. Held, that petitioner held his one-half interest in this building "primarily for sale to customers in the ordinary course of his trade or business" within the meaning of section 117(b), Revenue Act of 1936, and it was not a capital asset and his loss is deductible in full as an ordinary loss.
2. In the years 1937 and 1938 petitioner made payments on the second and third mortgages against the above property, which he had assumed and agreed to pay when he traded for the property. Petitioner kept*1157 his books and filed his income tax returns on the cash basis. Held, that petitioner is entitled to take his losses incurred by these payments in the years that the payments were made, even though he had lost the property under foreclosure in 1936. Harry H. Diamond,43 B.T.A. 809">43 B.T.A. 809, distinguished.
*204 The respondent determined deficiencies in income tax for the calendar years 1936 and 1937, Docket No. 103558, in the respective amounts of $3,092.33 and $115.12, and for the calendar year 1938, Docket No. 105830, in the amount of $318.79.
*205 In determining the deficiency for 1936 the Commissioner made several adjustments in petitioner's income tax return for that year, the principal one being the disallowance of $34,351.86 representing part of a foreclosure loss claimed by petitioner on his return. The Commissioner explained his disallowance of that loss in the following language:
(a) The loss sustained by the partnership of Black and Gould on the sale during the year 1936 of property known as the Black-Gould Building*1158 through foreclosure proceedings instituted by the holder of the first mortgage is held to be a capital loss to the partnership of Black and Gould subject to the statutory limitation of $2,000.00. * * *
Petitioner, by an appropriate assignment of error, contests this action of the Commissioner. He does not contest the other adjustments made by the Commissioner.
The deficiency for 1937 is due to several adjustments made by the Commissioner, all having to do with a claimed loss connected with the Black-Gould Building, the correctness of which the petitioner contests in the following assignment of error:
(b) In determining the taxable net income of the Petitioner for the year 1937, the Commissioner erroneously disallowed a deduction of $7,115.57 representing expenses resulting from foreclosure proceedings.
The deficiency for 1938 is due to two adjustments made by the Commissioner in petitioner's income, the principal one of which was the disallowance of an item which he designated "(b) Expense-Black-Gould Building $15,992.44." The Commissioner described this adjustment in his deficiency notice as follows:
(b) The amount deducted in your amended income tax return for the year*1159 1938 as expenses of the Black Gould Building, which represents principal payments on mortgages in favor of Emory University and Emanuel Kaufman in the amount of $15,992.44, has been disallowed for the reason it is held not to represent a proper deduction.
Petitioner, by an appropriate assignment of error, contests this action of the Commissioner.
FINDINGS OF FACT.
The petitioner is an individual and resides in Atlanta, Georgia. He is a real estate dealer, trader, and developer, having originally engaged in the real estate business as a partner with his father, E. P. Black, about 43 years ago. E. P. Black has been dead about 30 years.
For all the taxable years involved in these proceedings petitioner reported his income on the cash receipts and disbursements basis.
Petitioner bought, developed, and traded in real estate for sale at a profit. He did not buy real estate to hold as an investment. His plan of operation was to buy property and develop it, and rent it if *206 necessary while awaiting sale so as to show an income and then sell it when he could. A subdivision of approximately 90 acres, known as Boulevard Park, in Atlanta, Georgia, was developed by*1160 him through a corporation. He also developed a subdivision known as Argonne Drive, consisting of about 80 acres. He dealt principally in residential property but also bought and sold business property.
Some properties which petitioner built or acquired were not readily sold and in some cases these properties were rented until sold. During the taxable years before us he had four properties of this nature, which had been acquired during the years 1923, 1925, and 1933. These properties are and have been continuously for sale. They have been rented intermittently.
Sometime prior to 1924, the petitioner and his brother-in-law, E. M. Gould, acquired a farm of 3,000 acres in Webster County, Georgia, for the purpose of planting thereon small pecan trees, subdividing it, and selling it as small pecan orchards. After planting about 100 acres, it was realized that the pecan trees were not going to develop as rapidly as expected. Gould did not want to wait for the trees to grow and insisted that petitioner trade the property. They wanted to get their money out of the farm, and to do so it was thought necessary to trade upward, that is, add some money and trade for something in the*1161 city that would sell. In 1924 petitioner traded the farm in part payment for a building located at West Peachtree and Pine Streets, Atlanta, Georgia, known as the Franklin Building. The consideration for the building was $200,000, which was paid and agreed to be paid as follows:
| Cash | $35,000 |
| The farm of 3,000 acres | 50,000 |
| A first mortgage assumed by petitioner and Gould | 65,000 |
| A second mortgage | 35,000 |
| A third mortgage | 15,000 |
At the time petitioner and Gould acquired the Franklin Building it was leased by the Franklin Motor Car Co. of Atlanta at approximately $7,000 per year. They thought this lease would make the building readily salable and they could get their money out of it. In this they were disappointed. The lessee became insolvent and the lease was terminated two or three years after the purchase of the property and before a sale was accomplished. Thereafter the building became vacant and petitioner had to pay out considerable sums of money in taxes, insurance, and interest in trying to hold it until it could be sold. Finally petitioner could not pay out any more money to hold the property and was notified of foreclosure proceedings. The first*1162 mortgage on the Franklin Building was foreclosed and the property was sold in 1936. Due to the foreclosure petitioner sustained a loss in 1936 in the amount of $35,351.86, computed as follows:
| One-half interest in farm valued at $50,000 | $25,000.00 |
| One-half reduction of third mortgage | 3,500.00 |
| Cash investment in property | 17,500.00 |
| Total | 46,000.00 |
| Less one-half depreciation previously claimed | 10,648.14 |
| Loss in 1936 | 35,351.86 |
*207 In 1937 petitioner paid in connection with the second and third mortgages on the Franklin Building, which he had assumed, the sum of $6,325, insurance on the building $635.57, and interest on loans $155; a total of $7,115.57.
In 1938 petitioner paid $15,867.44 on the second and third mortgages and $125 interest; making a total of $15,992.44.
In his income tax return for 1936 the petitioner claimed an ordinary loss of $35,351.86 due to the foreclosure of the first mortgage on the Franklin Building. The respondent determined that the loss occasioned by the foreclosure was a capital loss the deduction for which was limited to $2,000. Since petitioner owned only a one-half interest in the building, the respondent allowed*1163 only $1,000 as loss sustained due to the foreclosure.
In his income tax return for 1937 petitioner claimed a deduction for payments of $7,115.57 made in connection with the Franklin Building, which were disallowed by the respondent. The respondent allowed, however, $3,325 of this amount as a bad debt, and allowed $507.33 as insurance paid on the Black-Gould Building.
In his income tax return for 1938 petitioner claimed $15,867.44 as a deduction for payments made in connection with the second and third mortgages on the Franklin Building. The respondent disallowed this deduction.
Petitioner's one-half interest in the Franklin Building was held by petitioner for sale to customers in the ordinary course of his business as real estate dealer, trader, and developer from the time he acquired it in 1924 until it was sold on foreclosure of the first mortgage in 1936.
OPINION.
BLACK: Two questions are presented for decision by the issues raised in the pleadings: (1) Whether the loss sustained by petitioner upon the foreclosure of the first mortgage and sale of the Franklin Building in 1936 was an ordinary business loss deductible in full, or whether it was a capital loss and*1164 limited in the amount deductible as determined by the respondent; (2) whether amounts expended in 1937 and 1938 in connection with the second and third mortgages on the Franklin Building, which were assumed by petitioner, were losses deductible in those years.
*208 In his deficiency notices the respondent held that the amounts in question were not proper deductions. In his brief the respondent seems to defend his disallowance of these 1937 and 1938 deductions upon the ground that they were parts of the same loss which occurred in 1936 and that, inasmuch as the 1936 loss was a capital loss, the entire loss, including that which was incurred in 1937 and 1938, is limited by section 117(d).
The applicable sections of the Revenue Act of 1936 are set out in the margin. 1 The provisions of the 1938 Act are the same as the 1936 Act in these respects.
*1165 The petitioner contends that the Franklin Building was purchased and held for sale at a profit in the ordinary course of his business as a trader or dealer in real estate and the loss sustained by the foreclosure of the first mortgage and sale of the property is deductible under section 23 of the Revenue Act of 1936. He further contends that the payments made by him in 1937 and 1938 in satisfaction of the second and third mortgages on the property, which he had assumed, constitute losses deductible in the years in which they were paid.
The First Issue.
As has already been stated, in his income tax return for 1936, petitioner claimed a loss on the foreclosure of the first mortgage on the Franklin Building in the sum of $35,351.86. The amount of his loss is not in dispute. In the computation of the deficiency for 1936, the respondent treated the loss in question as a capital loss and allowed a reduction of $1,000 as the amount of capital loss allowable to petitioner on his one-half interest in the property. It is settled that a mortgage foreclosure and sale results in a "sale or exchange" within the provisions of section 117 of the taxing statute, *1166 .
The issue turns on whether the Franklin Building was acquired and held for sale to customers in the ordinary course of petitioner's *209 business, or whether it was acquired and held as an investment. The facts in the record, we think, support petitioner's contention that it was acquired and held for sale in the ordinary course of his business to customers, and we have so found as a fact from the evidence presented.
The facts show that petitioner was engaged in the business of buying and selling real estate for profit and had been engaged in this business in Atlanta for many years. His transactions included the buying and selling of buildings, and the buying, subdividing, and developing of large tracts of land for sale. Sometime prior to 1924 petitioner and his brother-in-law, Gould, bought about 3,000 acres of land in Webster County, Georgia, for the purpose of planting it in pecan trees and subdividing it into small tracts to be sold to customers for small pecan orchards. After planting about 100 acres in pecan trees it became evident that it was going to be a long and doubtful process. Petitioner and Gould wanted*1167 to get their money out of the property, but there was not a ready sale for farm land and it was decided to trade it for other property which could be more readily sold.
In 1924 petitioner traded the pecan farm as part consideration for the Franklin Building in Atlanta. The Franklin Building was leased to an automobile agency at approximately $7,000 per year and seemed to offer a likely prospect for petitioner and Gould to get their money out of the pecan farm venture. They thought that a building of that kind well leased would be readily salable, but before it could be sold the lessee became insolvent and the lease was canceled, leaving the building vacant and more difficult to sell at a favorable price. Thereafter, petitioner was compelled to pay out large sums of money to hold it. Finally, in 1936, he could no longer make the payments and the building was sold at a foreclosure sale, occasioning the loss here in question.
The respondent does not rest his argument solely on the fact that the Franklin Building was held by petitioner for twelve years before it was sold at foreclosure sale. He concedes that petitioner was engaged in the real estate business and that the property*1168 here involved constituted "property held by the taxpayer" during a part of the calendar year 1936. He argues, however, that the property in question was not held by petitioner primarily for sale to customers in the ordinary course of his trade or business. The respondent apparently would limit petitioner's customers to customers for residential property because he dealt principally in that type of property. That construction it seems to us is too narrow. It is obvious from the record that the Franklin Building was acquired by petitioner and Gould for the purpose of selling it and was continuously held for sale from the time it was purchased until it was lost on foreclosure sale.
*210 Where, as here, one is regularly engaged in the business of buying and selling real estate, as was petitioner, any person who can be found to buy such property is a customer, as that term is ordinarily understood, and where such property is held for sale under such circumstances it must be deemed to be held for sale to customers within the meaning of the statute. *1169 .
The case here is readily distinguished on its facts from , cited and relied upon by the respondent. In the Thompson case, the taxpayer was not engaged in the business of buying and selling real estate for profit, and that fact we strongly emphasized in our opinion, but it acquired real estate in payment of accounts receivable for lumber and other materials which it furnished. The corporation's holding of the real estate was merely incidental to its business. In the instant case the property in question was held by the petitioner primarily for sale to customers in the ordinary course of his trade or business, as shown by the evidence upon which our findings of fact are based. See ; . It follows that the loss sustained was an ordinary loss, all of which is deductible from income in the taxable year, and is not a capital loss limited by section 117 of the statute.
The Second Issue.
After the loss of the Franklin Building through foreclosure sale in 1936, petitioner remained liable on*1170 the second and third mortgage obligations which he had assumed. In 1937 and 1938 he paid out in connection with these liabilities the respective sums of $7,115.57 and $15,992.44, which amounts he claims as a loss sustained on the Franklin Building and deductible from income in the years in which they were paid. Of the amount of $7,115.57 claimed as a deduction for the year 1937, the respondent allowed the sum of $3,325 as a bad debt in connection with the Franklin Building transaction and $507.33 as insurance paid out. There is, however, some confusion in the record about the treatment of the interest claimed in the amount of $155. In the "Explanation of Adjustments" attached to the deficiency letter, the respondent said:
(c) To disallow one-half of interest payment of $310.00 in connection with Black-Gould Building. Since the entire amount was claimed as interest on the original return, the payment made by you for Mr. Gould's part has been disallowed for the reason that it was not claimed as a bad debt.
This indicates that the $155 claimed as representing petitioner's one-half of the interest was allowed. It also indicates that the $155 representing the amount petitioner*1171 paid on Gould's obligation was disallowed and not included in the $3,325 allowed as a bad debt. *211 However, petitioner testified that the $155 allowed was the amount paid for Gould and that the $155 representing his one-half of the interest paid was disallowed. Since both parties seem to accept petitioner's understanding, and there is no reference to the matter in briefs, this is an item which can be properly adjusted under Rule 50.
In a recomputation under Rule 50 it should be noted that $3,832.33 of the $7,115.57 deduction claimed by petitioner for the year 1937 has already been allowed by respondent.
The respondent relies on the Board's decision in , in support of his disallowance of 1937 and 1938 claimed losses, but we do not think that decision supports his contention here. In the Diamond case there was no contention that the property in question was held for sale to customers in the ordinary course of the taxpayer's business. Admittedly, it was a capital asset and the Board found that the payment made after the foreclosure sale was merely a payment on the purchase price of the property which the taxpayer had*1172 obligated himself to make and was a part of the cost to petitioner of the mortgaged property and a part of the total loss sustained by him as a direct result of the foreclosure sale. We think this reasoning is sound, but it is not applicable in the case here under consideration. We have found that the Franklin Building was held by petitioner primarily for sale to his customers in the regular course of his business, and on these facts have held that the capital loss provisions contained in section 117(d) are not applicable.
It naturally follows that the losses occasioned by the payments in 1937 and 1938 must be regarded as of the same character as the loss occasioned by the foreclosure sale in 1936, i.e., ordinary losses and not capital losses. They would therefore be deductible as ordinary losses in the years when paid.
The general rule as set out in sections 41 of the Revenue Acts of 1936 and 1938 is that the net income shall be computed upon the basis of the taxpayer's annual accounting period in accordance with the method of accounting regularly employed in keeping the books of such taxpayer. Sections 43 of the applicable revenue acts provide that:
The deductions and*1173 credits * * * shall be taken for the taxable year in which "paid or accrued" or "paid or incurred", dependent upon the method of accounting upon the basis of which the net income is computed, unless in order to clearly reflect the income the deductions or credits should be taken as of a different period. * * *
The petitioner kept his books and made his income tax returns on the cash receipts and disbursements method. The mere existence of liability of one on the cash basis is not enough to establish loss *212 and there can be no deduction until the debt is paid. ; cf. , ; ; .
We think the above authorities establish that in the instant case petitioner sustained losses in 1937 and 1938 due to payments on the second and third mortgages. These losses were occasioned by the foreclosure sale of property held for sale in the ordinary course of petitioner's business and are of the same character*1174 as the loss sustained at the time of the sale. They were, therefore, ordinary losses, realized and deductible in the years when paid. Cf. .
Decision will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
* * *
(e) LOSSES BY INDIVIDUALS. - In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -
(1) if incurred in trade or business; * * *
SEC. 117. CAPITAL GAINS AND LOSSES.
* * *
(b) DEFINITION OF CAPITAL ASSETS. - For the purposes of this title, "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.
* * *
(d) LIMITATION ON CAPITAL LOSSES. - Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. * * * ↩