*1222 1. Petitioner held to be an association taxable as a corporation. Trust No. 5833, Security-First Nat. Bank of Los Angeles v. Welch, 54 Fed.(2d) 323, followed.
2. The petitioner trust was organized pursuant to a declaration of trust in 1923 for the purpose of developing and selling a real estate subdivision. The original owner of the land held a first mortgage for the unpaid purchase price and the trustee was given authority to encumber the land further for improvements. Lots were sold for a small down payment of from 20 to 30 per cent of the purchase price and the balance in deferred payments under a sales contract. Title to the lot was transferred to the purchaser upon completion of the deferred payments. Held, upon the evidence, that the sales contracts did not have a fair market value in excess of 50 per cent of their face at the time of the sales.
3. Under the sales contracts the purchasers of lots agreed to pay the city and county taxes on such lots. The trustee collected from the lot purchaser an amount which it commingled with other funds of the trust and from which it paid city and county taxes upon the entire property. The Commissioner*1223 has allowed the deduction for taxes of the amount so paid by the trustee. The amount collected from lot purchasers should be included in the gross income of the petitioner.
4. A distribution of 50 per cent of the profits after certain other distributions pursuant to the trust agreement held not to be compensation for extraordinary services deductible as ordinary and necessary business expense.
*1251 This is a proceeding for the redetermination of deficiencies in income tax for 1928 and 1929 of $8,427.85 and $6,256.17, respectively.
The issues raised by the pleadings relate to (a) the taxability of the petitioner as an association; (b) the fair market value of certain real estate sales contracts; (c) the income realized from amounts received from purchasers of lots, out of which the petitioner paid city and county taxes; (d) the deductibility of amounts alleged to have been paid as compensation for services rendered.
FINDINGS OF FACT.
The petitioner is a trust created and*1224 existing under and by virtue of the laws of the State of California; the Security-First National Bank of Los Angeles is the duly appointed, qualified and acting trustee; its principal place of business is at Fifth and Spring Streets, Los Angeles.
In January, 1923, Belle C. Thom, hereinafter referred to as the trustor, contracted to sell to Allen Jones a tract of land, designated as Bellehurst, located in Glendale, Los Angeles County, California, for a consideration of $600,000, of which $50,000 was to be paid upon execution of the deed to the property. Jones thereafter transferred his interest in this contract to the beneficiaries of the petitioner, which was organized for the purpose of developing, subdividing and selling the Bellehurst property pursuant to a declaration of trust executed on March 4, 1923. The trustor conveyed the Bellehurst property to the Security Trust & Savings Bank (now Security-First National Bank of Los Angeles), hereinafter referred to as the trustee. The declaration of trust recited that the consideration for *1252 the conveyance of the Bellehurst property had been paid to the trustor -
* * * by the following persons in the amounts respectively*1225 set opposite their names, which persons are hereinafter called "Beneficiaries," as follows, to-wit:
| W. Leimert | $10,000.00 |
| H. H. Cotton | 7,500.00 |
| Chas. H. Toll | 2,500.00 |
| John T. Cooper | 7,500.00 |
| R. K. Snow | 2,500.00 |
| W. M. Lenz | 2,500.00 |
| E. P. Thom | 5,000.00 |
| C. G. Andrews | 2,500.00 |
| Chas. D. Bates | 5,000.00 |
| A. Borland | 5,000.00 |
and further that -
* * * the sum of Fifty Thousand ($50,000.00) Dollars additional will be deposited with the Trustee within sixty (60) days after the date hereof as an improvement fund, in accordance with the terms and conditions hereinafter contained; that the conveyance to the Trustee has been made, and the title so conveyed will be held by it in trust for the following uses and trusts in relation thereto: [Only those portions material to our determination are quoted].
I.It is understood and agreed by all of the parties hereto that the beneficial interest in this trust, all of which is owned by the foregoing beneficiaries, shall be divided into units of the denomination of Five Hundred ($500.00) Dollars and that each of the beneficiaries shall be deemed to hold one (1) of said units for each Five Hundred ($500.00) Dollars*1226 that he has contributed and paid, according to the foregoing list, and for each Five Hundred ($500.00) Dollars that he contributes hereafter.
II.IT IS UNDERSTOOD AND AGREED that in all dealings between the Trustee and the Beneficiaries, and in the establishment of the price at which the property above described is to be sold by the Trustee, of the terms of sales, of the manner, method and time of disposition of the proceeds of such sales, of the restrictions, covenants, conditions and reservations under and upon which said property or any part thereof shall be sold, of the form of contract and deed to be executed in case of any and all sales, of the manner, method, extent and cost of improvement of said property, and also in the disposition of the proceeds of sales of real estate, and in the execution of this trust, the said Trustee shall, subject of course to the terms of said contract, be bound by the written direction of any two of a Board of three of said Beneficiaries hereinafter called the "Board of Syndicate Managers", which shall be filed with the said Trustee, and such written direction shall be full and complete authority to the Trustee to do any and all of said acts*1227 or things, and shall bind each and every beneficiary hereof.
THAT said Board of Syndicate Managers shall consist, at the outset, of H. H. Cotton, John T. Cooper and W. H. Leimert and until the Trustee receives a notice in writing, signed by beneficiaries holding at least three-fourths (3/4ths) of the entire number of said units of beneficial interest, it shall act upon the written direction of any two of said named persons, but from and after the receipt by it of such notice in writing, notifying it of a change in the personnel of said Board of Syndicate Managers, it shall act only upon *1253 the written direction of any two of the persons comprising said Board of Syndicate Managers as changed by such written notice.
* * *
V.The Trustee will sell or convey such title to any part or all of the above described real estate, not including said water and water rights, as it has received by reason of any conveyance made to it as the Trustee hereunder, at such prices and upon such terms and under such conditions and restrictions as the said Board of Syndicate Managers may direct, provided, however, that the Board of Syndicate Managers may from time to time designate some*1228 person, or persons, as an agent or agents, for the purpose of directing the Trustee to make conveyance or sales, but in such event, the said Board of Syndicate Managers shall first fix the prices, restrictions, and covenants under, for and upon which said property is to be sold, by written direction to the Trustee, and said Agent shall have authority only to direct a conveyance for such price or prices in excess thereof, and provided always that the Trustee shall not part with the title to any lot, parcel or portion of said real estate for a price less than the release prices therefor fixed as follows:
The release price per acre shall be Four Thousand ($4,000.00) Dollars, and upon subdivision of the property into lots the total release price of all of the lots shall aggregate Four Thousand ($4,000.00) Dollars per acre for that portion of the property subdivided, and the Trustor, or her successors in interest, shall from time to time agree with said Board of Syndicate Managers on a schedule of release prices to cover the property as subdivided, and such schedule shall be followed by the Trustee in the conveyance of said property.
VI.In each and every case where any part of*1229 the trust estate is sold, either for cash or upon contract, the payments thereon shall be applied by the Trustee to the purchase price of the particular real estate described in such deed or contract, and whenever as to the particular property so described the Trustee shall have received the sum of money designated as the purchase price thereof then the Trustee shall thereupon convey the said property to the person entitled thereto.
VII.If any portion of said property, whether the same be subdivided or not, is sold for all cash, then the Trustee shall pay to the Trustor the release price of such particular property so sold, as shown by the schedule of release prices which is at that time in effect. If any portion of the said real estate, whether subdivided or not, is sold upon credit, or upon any terms by which a portion of the purchase price is deferred, then the Trustee shall pay to the beneficiaries the first twenty-five per cent (25%) of the sales price, provided that by so doing the balance remaining unpaid is not less than the release price of such property, and shall pay the remaining portion of said purchase price, fifty per cent (50%) thereof, to the Trustor, until*1230 the Trustor has received the full release price of such parcel so sold, and the remainder thereof to the Beneficiaries, provided always, however, that the Trustee shall be paid its compensation as hereinafter fixed, if it so desires, before any other distribution of the proceeds of said sales is made, and provided always that no portion of said real estate may be conveyed for a price which will not allow to the *1254 Trustor on such division of payments as above provided the total release price of such portion of the trust estate so sold. After the Beneficiaries have received the sum of One Hundred Thousand Dollars ($100,000.00), which amount has been agreed by them to be paid in to the Trustee under the terms hereof, plus an additional sum of One Hundred Thousand Dollars ($100,000.00), then the balance of such moneys distributed by the Trustee shall be distributed as follows: fifty per cent (50%) thereof to the Beneficiaries and fifty per cent (50%) thereof to E. P. Thom, said E. P. Thom to take said sum in addition to whatever sums he may receive as one of the above named beneficiaries, it being understood that amounts expended upon the order of the Beneficiaries for commissions, *1231 improvements, taxes expenses of operation of trust and similar matters, shall not be deemed to be payments to the Beneficiaries under the terms hereof.
The Bellehurst property was well located for development and the rapid growth of the city of Glendale indicated that the subdivision was marketed at a good time. The improvements were started shortly after the execution of the trust agreement, and the sales campaign was launched in the spring of 1923. The sales were rapid and approximately 80 per cent of the property was sold in 1923, although only 50 per cent of the contemplated improvements were made in that year. The lots were sold under an "Agreement for the Sale of Real Estate," which was the usual form of sales contract (hereinafter referred to as the sales contract) then in use in selling subdivisions of property in Southern California. The terms of the sales were usually 20 to 30 per cent cash, although some sales were made with a smaller down payment, and deferred monthly payments of 1 per cent of the gross selling price, plus 7 per cent interest per annum and taxes. The buyer was given possession of the property at the time of the sale, but he acquired title thereto*1232 only upon the execution of his payments and full compliance with the terms of the sales contract. These contracts further provides, inter alia:
Should default be made in payment of any of said installments of principal or interest, when the same become due, or in the repayment on demand, of any amount herein agreed to be repaid, then the whole unpaid balance of said purchase price and all advancements theretofore made, with the interest thereon, shall become immediately due and payable at the option of Seller, which may thereupon, at its option enforce its rights hereunder, either by forfeiture of all rights under this Agreement and all interest in the lands described herein and the appurtenances as hereinafter provided; or by a proceeding in equity or action at law for specific performance with damages, or for foreclosure hereof with damages, or for the recovery of the purchase price with interest. And no court of law or equity shall relieve Buyer upon failure to comply strictly and literally with the terms of this Agreement.
In case of the election by Seller to enforce its right of forfeiture hereunder, all rights and interest hereby created, or then existing in favor*1233 of Buyer, or anyone claiming under Buyer, shall utterly cease and determine, and the right of possession and all equitable and legal interests in the premises hereby contracted, with all the improvements, and other appurtenances, shall revert to and revest in Seller, and without any right of Buyer, either at law or in equity, or *1255 reclamation, or recovery of, or compensation for moneys paid, or services performed, or improvements placed upon said land. And the money paid, and improvements erected shall be forfeited to and be retained by Seller as liquidated damages for such default and not as a penalty, and Seller shall have the right immediately upon any default in the performance on the part of Buyer to enter upon the lands and take possession with or without process of law.
And it is further agreed that no tender or offer of performance by Seller shall be necessary as a condition precedent to its right to exercise any privilege, option or right hereunder, and that the same may be exercised upon any default of Buyer without such or any tender or offer of performance and without notice of any kind to Buyer.
* * *
It is further agreed that this Agreement shall*1234 not be recorded, and in the event that it is recorded this Agreement and all rights, interests and estates of Buyer shall, at the election of Seller, become absolutely null and void, with the same effect as if a default had occurred hereunder.
* * *
It is further agreed that Seller may at any time at its option, execute and deliver to Buyer a deed conveying said premises in accordance with the terms of this Agreement, subject to the matters, herein set forth, and Buyer agrees, upon receipt thereof, to record the same and execute and deliver to Seller a promissory note, or notes, for the balance of the purchase price then remaining unpaid, payable to Seller in the amounts, at the time, and with the interest above specified, and execute and deliver, at the option of Seller, either a Trust Deed or Mortgage upon said property, which shall be a valid lien securing the payment thereof.
Although 80 per cent of the Bellehurst property was sold in 1923, the improvements thereon were slow at first, and only a few houses were erected in 1923. The building did not get under way until 1926 and 1927 and at the time of the hearing, in 1932, only 62 per cent of the lots had been improved. *1235 It was not the usual practice for the buyer to build on his lot until the release price had been paid.
The total cost of the Bellehurst property to the trust was as follows:
| Land | $600,000.00 |
| Improvements | 444,716.61 |
| Surveyor's and architect's fees | 242.30 |
| Bonds, sewer and light | 1,522.96 |
| Trees, etc | 1,027.78 |
| Total | 1,050,509.65 |
The amounts of the petitioner trust's sales and collections were as follows:
| Year | Sales | Collections |
| 1923 | $1,622,027.38 | $499,284.83 |
| 1924 | 348,632.50 | 376,444.55 |
| 1925 | 52,242.99 | 344,348.71 |
| 1926 | 56,742.05 | 325,854.48 |
| 1927 | 240,642.34 | |
| 1928 | $129,127.94 | |
| 1929 | 107,269.15 | |
| Total | $2,079,644.92 | 2,022,972.00 |
*1256 In determining the deficiencies proposed against the petitioner for the years 1928 and 1929 the Commissioner included in income 50 per cent of the collections in the respective years, namely, $64,563.97 for 1928, and $53,634.58 for 1929.
The sales contracts at the time of their receipt by the petitioner did not have a fair market value of more than 50 per cent of their face.
Under the terms of the sales contracts, the purchasers of lots in the Bellehurst property agreed to pay*1236 all taxes and assessments. The trustee actually paid the taxes and collected amounts for that purpose from the purchasers. During the taxable years before us, the trustee collected and paid for taxes the following amounts:
| Year | Amount collected | Amount paid |
| 1928 | $14,521.97 | $12,877.46 |
| 1929 | 11,644.97 | 9,068.71 |
The trustee commingled these collections with the general funds of the trust. The Commissioner has included the amounts collected in gross income and allowed the deduction of the amounts paid as taxes, in computing the petitioner trust's tax liability for the respective years.
The trust agreement was carried out in accordance with its terms. The board of syndicate managers had charge of its operations. E. P. Thom, by reason of his familiarity with Glendale real estate, was consulted and no important action was taken without his approval; between 1923 and 1928 he devoted about one-half of his time to the Bellehurst development. W. H. Leimert was selling agent for the subdivision and as such received the usual selling commission of 25 per cent of the price of lots sold. This commission was usually paid out of the initial payment received by the*1237 trustee upon the sale of the lot. Leimert kept behind purchasers and saw that the payments of interest and principal were kept up. Bates and Borland (each individually a beneficiary of the trust) were the improvement contractors; they went ahead with the improvements regardless of the funds available for such work, and did much extra work in making the lots attractive. H. H. Cotton and John T. Cooper, together with Leimert, constituted the board of syndicate managers. They were subdividers of broad experience and their services in developing and financing the Bellehurst property were valuable.
In 1928 and 1929 the trustee paid to Thom certain amounts, representing 50 per cent of the profits, in accordance with the provisions of the trust agreement. These amounts were distributed by *1257 him to himself, Leimert, Bates, Borland, Cotton, and Cooper, in accordance with their agreement with respect thereto.
OPINION.
SMITH: The petitioner first alleges that:
(a) The Commissioner has erroneously treated the Petitioner as an association and proposes to tax it as such, whereas the Petitioner is a Trust with no taxable income.
On brief, the petitioner states: "1. The*1238 first issue we submit without argument."
The facts of record do not distinguish this trust from others that the Board and courts have held to be associations taxable as corporations. The Circuit Court of Appeals for the Ninth Circuit held a similar real estate subdivision trust to be an association in Trust No. 5833, . See also ; ; affd., ; ; .
The second and principal issue is raised by the following allegation of error:
(b) The Commissioner has erroneously placed a value of only fifty per cent of face value upon the agreements for payment of balance owing for properties sold by this Petitioner in the years 1923, 1924, 1925 and 1926, whereas said agreements had a fair market value of 85% to 100% of their face value.
Neither party contends that the Bellehurst property was sold and the income therefrom reported on the installment sales basis. *1239 Both are in apparent agreement that lots were sold for cash and deferred payments, the latter covered by the sales contracts, and that the income at the time of the sales and at the time of the collections is determinable from the fair market value of the sales contracts at the time of the sales. Such contracts may or may not have a fair market value, as the evidence adduced in each particular case warrants. Cf. ; .
To support its contentions upon this point the petitioner submitted the testimony of several witnesses, all of whom testified that in their opinion the 50 per cent valuation used by the respondent in the determination of deficiencies was entirely too low. They testified, generally, that in their opinion the contracts had a fair market value of from 90 to 100 per cent of their unpaid balances. The respondent, on the other hand, submitted the testimony of several witnesses, well qualified to express an opinion upon the value of such contracts, who testified that in their opinion the contracts had no *1258 fair market value at the date of their receipt. This*1240 was predicated, in part, upon the fact that the selling agent was entitled to receive a commission of 25 per cent of the sales price, whereas the down payment by the lot purchaser ranged generally from 20 to 30 per cent and in some cases less than 20 per cent; also upon the fact that it was not customary to sell contracts of this sort and that there was no established market for them.
From a consideration of all of the evidence we are of opinion that the fair market value, if any, of the contracts was not in excess of 50 per cent of the unpaid balances upon the contracts. That is the amount used by the Commissioner in the computation of deficiencies. Whether the fair market value at the date of the receipt of the contracts was less than the amount determined by the respondent is not necessary for us to determine. The petitioner's contention upon this point is not sustained.
The next issue is raised by the following allegation:
(c) In each of the years 1928 and 1929 the Commissioner has erroneously included in Petitioner's income moneys placed in the hands of the Petitioner by purchasers for the payment of city and county taxes, to which the Petitioner still held title for*1241 security purposes. Said moneys were in no sense income to the Petitioner. The Petitioner was merely a conduit through which purchasers who still owed balances on the purchase price of their properties paid their city and county taxes.
By motion duly granted, the respondent moved to amend the pleadings to conform to the proof and affirmatively alleges that:
(g) In the alternative, the respondent erred in allowing as deductions county and city taxes paid in the amount of $12,879.46 and $9,086.71 for the years 1928 and 1929, respectively, or any amounts.
There is no dispute as to the amounts received by the petitioner from the lot purchasers or as to the amounts of taxes paid by the petitioner. It appears from the evidence that the petitioner paid the taxes upon the lots standing in its name at the date the assessment was made and then collected from the lot purchasers the amount of tax assessed against or allocated to the lot covered by the contract of purchase. The petitioner kept no separate records of the funds thus collected from the lot purchasers. Collections from this source were commingled with the general funds of the trust. The difference between the amount received*1242 by the petitioner and the amount paid for taxes in the years 1928 and 1929 is unexplained, unless it be that some of the collections were for taxes paid by the petitioner in prior years. In the determination of the deficiencies the petitioner has been allowed the deduction for all taxes paid by it, and since the amounts received from the lot purchasers were not segregated on the petitioner's books of account or treated as trust *1259 funds, and since we have no knowledge of the taxes, if any, paid by the petitioner on lots repossessed and owned by it, we have no basis for disturbing the respondent's determination. His action in including the amounts received in the petitioner's gross income is sustained. It will be unnecessary to discuss the alternative allegation of the respondent.
The remaining allegation of error in Docket No. 58311 is that:
(d) The Commissioner has erroneously failed and neglected to allow as deductions to the Petitioner certain amounts paid out in each of the years 1928 and 1929 for services rendered in the successful operation of said Trust.
The petitioner claims as an ordinary and necessary expense deductions of $92,500 in 1928 and $57,700*1243 in 1929, which it contends are reasonable allowances for compensation for services actually rendered by Thom, Leimert, Bates, Borland, Cotton, and Cooper. There is no evidence to show that these amounts were actually paid by the trust or that these parties received such amounts as compensation, or to show that if paid the respondent has disallowed them as deductions from gross income in the computation of the deficiencies. The record discloses that the 50 per cent of the profits specified in Article VII of the trust agreement was payable to Thom, after the beneficiaries had received 200 per cent on their investment and 50 per cent of the balance of the profits. Pursuant to this provision certain amounts were paid to Thom. All of the parties sharing in these sums were beneficiaries of the trust. Leimert was sales agent and as such received a commission of 25 per cent of the selling price of each lot. Bates and Borland were the improvement contractors and as such were paid the contract price for their work. The services of these several individuals were doubtless valuable and may not have been adequately compensated for otherwise, yet the plain language of the trust instrument*1244 does not show that these payments were made as compensation. It is reasonable to infer from the terms of the trust and the activities of these persons (as shown by the record) in the interest of the Bellehurst property, that provision was made for them to have a greater share in the profits than those beneficiaries who were not as active. While under the terms of the trust agreement there was a liability to Thom for the 50 per cent of the profits, there was no provision for compensating him and his associates for any services to be rendered. The petitioner has not even attempted to prove that the trust was liable for such compensation to these individuals. But in any event, we have not been shown the reasonableness of the claimed deductions. In the circumstances we leave the parties as we found them.
Reviewed by the Board.
Judgment will be entered for the respondent.