*35 Decision will be entered under Rule 50.
Petitioner was engaged in the fabrication and erection of structural steel. As a result of furnishing and erecting a structural steel frame for an athletic club building, it had a balance in an account receivable of $ 243,938.30. Upon default by the owner, a mechanic's lien was established. Upon foreclosure sale petitioner purchased the property for $ 517,259.89, including its account receivable. It sold a one-half interest therein for $ 300,000. The co-owners organized a corporation to complete and operate the building for profit, each receiving one-half of its shares. To protect its investment, petitioner advanced $ 635,152.80, mostly cash and a very small amount of labor and materials for needed repairs, for which the petitioner later received second mortgage bonds. The operation of the building having failed financially, the corporation was reorganized under section 77-B of the Bankruptcy Act. Petitioner in 1937 claimed a loss deduction of its net investment of $ 217,259.19, which was disallowed, and also a deduction of its additional investment or advances in the amount of $ 635,152.80, but was allowed only $ 81,607.66 in settlement. *36 The above transaction was the only one of its kind during the entire history of petitioner. Held, that the entire amount of $ 81,607.66 is a deduction of a class abnormal for petitioner under section 711 (b) (1) (J) (i) of the Internal Revenue Code.
*938 The respondent determined a deficiency of $ 685.29 in the petitioner's excess profits tax for the year 1941.
The single issue is whether the sum of $ 81,607.66, allowed as a compromise bad debt deduction in 1937, is not allowable (excludible) in full as a deduction abnormal to the petitioner for the purpose*37 of determining its excess profits credit for the taxable year, under the provisions of section 711 (b) (1) (J) (i) of the Internal Revenue Code, or in the amount of $ 67,133.69 under section 711 (b) (1) (J) (ii), as determined by respondent.
*939 FINDINGS OF FACT.
Most of the facts were stipulated. In so far as they are material to the issue, they are as follows:
The petitioner is a Missouri corporation, with its principal office in Kansas City, Missouri, and its plant in Kansas City, Kansas. It was organized in 1907 for the purpose of engaging in the business of steel fabrication and erection, and has continuously engaged in such business ever since.
The petitioner's return for the calendar year 1941 relating to its income and excess profits tax liability, and also the petitioner's returns for the base period upon which the excess profits credit based on income was computed, were all filed with the collector of internal revenue for the sixth district of Missouri. A consent agreement was executed by and between the Commissioner and the petitioner on January 4, 1945, fixing the period of limitation for the taxable year under review as June 30, 1946.
By reason of the furnishing*38 and erecting by it of a structural steel frame for a nineteen-story athletic club building in Kansas City, Missouri, an account receivable accrued to petitioner in the amount of $ 243,938.30. Default by the property owner resulted in the establishment and adjudication of petitioner's mechanic's lien in the amount of its unpaid account receivable balance of $ 243,938.30.
The petitioner, by reason of its unpaid mechanic's lien, purchased the building at the mechanic's lien foreclosure sale, the result being that petitioner acquired the property at a net cost to it of $ 517,259.89, including the amount of its original account receivable balance of $ 243,938.30. Thereafter, petitioner sold a half interest in the property for $ 300,000, with the net result that its half interest in the property was acquired by it at a net cost of $ 217,259.89.
The petitioner and its co-owner thereupon organized Continental Building Co. and transferred the title to the property to such corporation, the petitioner receiving one-half of its stock. The building was then completed at a cost of more than two million dollars, of which amount $ 1,600,000 was obtained by a bond issue secured by a deed of trust*39 upon the property. The operation of the building by Continental Building Co. was a failure, and culminated on June 21, 1937, in its reorganization under section 77-B of the Bankruptcy Act.
In the years following the acquisition of its Continental Building Co. stock and prior to that company's reorganization under section 77-B and prior to petitioner's base period, the petitioner, for the purpose of protecting its investment, made necessary advances in cash, labor, and materials to Continental Building Co. and substantial amounts of interest accrued on the cash advances and were permitted *940 to remain unpaid, resulting in an aggregate unpaid amount of $ 635,152.80, consisting of the following items:
| Cash advances for the retirement of bonds and other corporate | |
| purposes | $ 437,500.00 |
| Other cash advances to meet operating costs | 45,000.00 |
| Open account balance for furnishing labor and materials for | |
| much needed repairs and improvements | 5,296.21 |
| Accrued interest on cash advances | 47,356.59 |
| Total | 635,152.80 |
The petitioner received second mortgage bonds from Continental Building Co. in the amount of $ 635,152.80 on account of the above unpaid advances and other *40 items. Upon the organization of the new company, Continental Building Corporation, under section 77-B, the petitioner received certificates for class B stock in the new corporation in consideration of its assent to the plan of reorganization and its surrender of the second mortgage bonds in the amount of $ 635,152.80.
In its 1937 income tax return the petitioner claimed a deduction of $ 217,259.89, which deduction was disallowed by the Commissioner on examination. The loss item of $ 81,607.66 involved herein was allowed by the Commissioner as a compromise deduction from petitioner's 1937 income in lieu of the loss aggregating $ 635,152.80, representing money, labor, and materials furnished by petitioner to protect its investment of $ 217,259.89. In allowing such deduction, the Commissioner's "Explanation of Adjustments" dated December 31, 1941, states:
(a) It has been mutually agreed and conceded for settlement purposes that $ 81,607.66 of the indebtedness due from the Continental Building Company to the taxpayer is allowable as a deduction in computing taxable net income.
The bad debts allowed as deductions to the petitioner for the base period years are as follows:
| Bad debt losses | |||
| Bad debt losses | connected with | ||
| Year | Total | connected with | advances to |
| accounts | protect | ||
| receivable | accounts | ||
| receivable | |||
| 1936 | $ 26,643.09 | $ 26,643.09 | |
| 1937 | 81,803.70 | 196.04 | $ 81,607.66 |
| 1938 | 2,145.44 | 2,145.44 | |
| 1939 |
*41 The record discloses the following additional facts:
On February 28, 1945, the petitioner sent to the collector of internal revenue by registered mail a letter transmitting two claims for refund relating to its income, declared value excess profits, and excess profits taxes for 1941. The claims for refund each state that the time *941 within which the claim for refund may be filed expires "on June 30, 1946 (Waiver on file)." The petitioner filed its income tax return for 1941 with the collector on March 14, 1942.
The petitioner's advances made prior to April 30, 1931, to Continental Building Co. aggregating $ 635,152.80 were made in an attempt to establish that company as a going concern so as to derive profit from the operation of the building and ultimately to recoup its investment or minimize its loss. The deduction of $ 81,607.66 is the only allowance ever made by the respondent of the total amount of investment and advances made by the petitioner to Continental Building Co.
During petitioner's entire history, it made no other investment in real estate or any other property or advances incident thereto for the purpose of protecting an investment or account receivable, except*42 as heretofore set forth. It has never made cash advances to any business or other activity of any customer from which it was attempting to recover an account receivable.
The Commissioner, in computing the excess profits net aggregate income for the base period years, denied the disallowance of the amount of $ 81,607.66 in 1937 as an abnormal deduction, but disallowed the item in 1937 to the extent of $ 67,133.69, with the explanation as follows:
The bad debts deducted and allowed in computing normal tax net income for 1937 may be disallowed only to the extent that the total deduction of this class exceeds 125% of the average deduction of such class for the preceding four years as provided in section 711 (b)(1)(J)(ii) of the Internal Revenue Code and that the loss on account of the notes and account of the Continental Building Company does not constitute a separate abnormal disallowable item for purposes of computing excess profits net income for the base period year 1937.
OPINION.
The sole question in controversy is whether or not the entire amount of $ 81,607.66 is a class of deduction abnormal for the taxpayer under the provisions of section 711 (b)(1)(J)(i) of the Internal Revenue*43 Code. 1
*44 *942 It is argued by respondent that the original debt and all additions thereto resulted directly from materials and services furnished by petitioner in its usual course of business; that it was an uncollected trade account originally and remained such until petitioner claimed its loss; that there was nothing abnormal about the original trade account established by petitioner for the erection of an athletic club building; and that any additional loss through advances is properly classifiable as collection expenses to be added thereto.
The facts of record do not support the respondent's theory. It is true that sometime prior to 1931 the petitioner had an account receivable with a balance therein of $ 243,938.30 owing to it for the erection of a structural steel frame for an athletic club building. However, upon default by the owner of the property, the petitioner purchased the property at the mechanic's lien foreclosure sale at a net cost to it of $ 517,259.89, including the amount due it of $ 243,938.30. In substance and effect, petitioner's trade account receivable of $ 243,938.30 was paid and the proceeds, together with an additional amount of $ 273,321.59, were invested*45 in the property. Obviously, had petitioner attempted to claim a deduction at the time of the payment of the additional amount of $ 273,321.59 as an expense of collecting its accounts receivable, the claims would have been disallowed on the ground that the amount, together with the amount of the account receivable, represented the cost of the property purchased.
Petitioner sold a one-half interest in the property for $ 300,000. The cost of the whole property having been $ 517,259.89, the cost to petitioner of its remaining one-half interest was $ 217,259.89. The co-owners of the property formed a corporation, transferred the property to it, and each received one-half of the corporation's shares. Thereafter petitioner made advances to the corporation. That a very small portion of such advances consisted of labor and materials for much needed repairs and improvements in the building is not important. The advances were made by petitioner to protect its investment and it was so stipulated.
From the record it appears that petitioner claimed a loss deduction in 1937 of both the amounts of $ 217,259.89 and $ 635,152.80, but, as stated in respondent's brief, the respondent "disallowed*46 the $ 217,259.89 common stock investment on account of worthlessness in prior years." As to the later advances represented by second mortgage bonds, respondent "in settlement allowed a deduction of $ 81,671.66." Apparently at that time the respondent did not treat petitioner's loss *943 as an entirety, i. e., as one arising out of a trade account, together with additional amounts properly classifiable as collection expense to be added thereto, as he now argues it should be treated.
During its entire history petitioner neither made any similar investment in realty or other property, or advances for its protection, nor did it ever make any advances for the protection of a trade account receivable. It was not engaged in the business of operating an athletic club building or of advancing funds for such operation. It was engaged in the business of steel fabrication and erection. Its investment and advancements, and resultant loss, were unusual and of a class by themselves.
The situation herein is analogous to that presented in Green Bay Lumber Co., 3 T. C. 824, wherein it is stated:
* * * We are of the opinion, however, that Congress did not intend*47 to limit classification of deductions for the purposes of subsection (J) to the "statutory deduction categories" of section 23. This is not to say we disapprove or find to be unsound the requirement of the regulation that "reference must be made to the deductions of the entire class rather than to any particular deductible items therein." We merely hold that bad debts do not all have to fall into a single class -- a view, incidentally, specifically recognized by section 23 (k), I.R.C., which classifies bad debts into those coming within the "general rule," securities becoming worthless, nonbusiness debts, and securities of affiliated corporations. The question therefore becomes largely one of fact, i. e., whether the $ 8,000 item is of a different class from the other bad debts which were claimed and allowed.
Since the character of the deduction of $ 81,607.66 allowed in 1937 is wholly unlike other bad debt deductions taken by petitioner and allowed in the base period years, and since it arose under its own peculiar conditions and circumstances, the petitioner is entitled, in determining the excess profits net aggregate income for the base period years, to the disallowance of the*48 entire amount of $ 81,607.66 in 1937 as a deduction of a class abnormal for the taxpayer under section 711 (b) (1) (J) (i).
Oaklawn Jockey Club, 8 T.C. 1128">8 T. C. 1128, and Arrow-Hart & Hegeman Electric Co., 7 T. C. 1350, cited by respondent, are distinguishable on the facts and not controlling herein.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 711. EXCESS PROFITS NET INCOME.
* * * *
(b) Taxable Years in Base Period. --
(1) General Rule and Adjustments. -- The excess profits net income for any taxable year subject to the Revenue Act of 1936 shall be the normal-tax net income, as defined in section 13 (a) of such Act; and for any other taxable year beginning after December 31, 1937, and before January 1, 1940, shall be the special-class net income, as defined in section 14 (a) of the applicable revenue law. In either case the following adjustments shall be made * * *
* * * *
(J) Abnormal Deductions. -- Under regulations prescribed by the Commissioner, with the Approval of the Secretary, for the determination, for the purposes of this subparagraph, of the classification of deductions --
(i) Deductions of any class shall not be allowed if deductions of such class were abnormal for the taxpayer, and
(ii) If the class of deductions was normal for the taxpayer, but the deductions of such class were in excess of 125 per centum of the average amount of deductions of such class for the four previous taxable years, they shall be disallowed in an amount equal to such excess.↩