*1085 Petitioners, during the taxable year, transferred to their creditor mortgage certificates issued by the creditor for which they received credit on their indebtedness equal to the face value of the certificates. The contract under which the indebtedness was assumed provided for satisfaction of the debt in this manner. Held, petitioners realized no income even though the certificates cost them less than their face value. The transaction was, in effect, an exchange in which petitioners received property, the value of which was not in excess of the cost of the certificates.
*1212 In these proceedings the following deficiencies in income and excess profits taxes for the calendar year 1934 are contested:
| Docket No. | Income tax | Excess profits tax |
| 93962 | $4,640.54 | $1,458.30 |
| 93964 | 271.30 | 36.16 |
These deficiencies arise from the respondent's determination that the petitioners realized income from the discharge of certain obligations through the acceptance by petitioners' creditor at their face *1213 value of certain mortgage*1086 certificates of the creditor which petitioners had acquired at less than par. The issue presented is whether petitioners realized income from these transactions in the amount of the difference between the price at which they acquired the bonds and the price at which the bonds were accepted on petitioners' indebtedness.
The Cherokee Co., the petitioner in Docket No. 93962, claims an overpayment in taxes for 1934 in the amount of $57.29.
Certain of the facts have been stipulated and they are by this reference adopted as our findings. The substance of the stipulations is set out hereinafter with the other findings of fact.
FINDINGS OF FACT.
The petitioners are California corporations, with offices in Los Angeles, California. They were dissolved on December 30, 1935, but are authorized by the applicable laws to continue to act for the purpose of winding up their affairs.
On November 1, 1932, the petitioner, Cherokee Co., entered into an agreement with the Mortgage Guarantee Co. for the purchase of certain real property in Los Angeles, California, under the terms of which in February 1933 there was conveyed to petitioner a parcel of realty improved by an unfurnished apartment*1087 building. The purchase price specified in the contract was $175,000 to be paid by petitioner's assumption of an $85,000 mortgage on the property then outstanding and petitioner's execution of a note for $90,000 to be secured by a deed of trust to the property. The note was made payable in five annual installments of $18,000 each, with interest at 6 1/2 percent. The petitioner, Cherokee Co., agreed to furnish the building, thus purchased, at a cost of not less than $35,000, and to execute a chattel mortgage to the vendor on the furnishings.
The contract of sale contained, in addition, the following paragraph:
Said Seller does hereby agree to accept in partial payment of the indebtedness to be evidenced by the note in the principal sum of $90,000.00 to be executed by said Buyer, at any time within five years from date hereof, (time being expressly of the essence) First Mortgage Assignments and Policies of Mortgage Insurance, issued by said Seller, in the sum of $1,000.00 or any multiple thereof, at their face value, to be applied upon the principal of said $90,000.00 note first maturing, provided such First Mortgage Assignments and Policies of Mortgage Insurance are issued out*1088 of Trusts that permit the withdrawal of loans upon cancellation of the First Mortgage Assignments and Policies of Mortgage Insurance, and provided further that the insured date of each of such First Mortgage Assignments and Policy of Mortgage Insurance be a date not later than the first day of January, 1938.
During the years 1933 and 1934, the petitioner, Cherokee Co., purchased and, on the dates purchased, transferred to the Mortgage Guarantee Co., in satisfaction of its $90,000 indebtedness, first mortgage *1214 assignments and policies of mortgage insurance, issued by the seller, with a face value of $90,000. These certificates were purchased by petitioner in lots and at prices as follows:
| Date of purchase | Face value of certificates | Cost to petitioner | ||
| 11/4/33 | $475.00 | $223.25 | ||
| 12/29/33 | 7,500.00 | 3,075.00 | ||
| 12/31/33 | 10,100.00 | $18,075.00 | 4,141.00 | $7,439.25 |
| 6/8/34 | 625.00 | 335.94 | ||
| 7/19/34 | 5,000.00 | 2,450.00 | ||
| 9/6/34 | 6,000.00 | 3,090.00 | ||
| 10/1/34 | 6,000.00 | 3,120.00 | ||
| 10/19/34 | 100.00 | 52.00 | ||
| 10/26/34 | 200.00 | 105.00 | ||
| 12/15/34 | 54,000.00 | $71,925.00 | 28,080.00 | $37,232.94 |
| Total | 90,000.00 | 44,672.19 |
All of these certificates*1089 were purchased by the petitioner, Cherokee Co., on the open market with the exception of the lot acquired on December 15, 1934, which was bought by the Mortgage Guarantee Co. for the account of and with money furnished by the petitioner.
The petitioner, Sunset-Lucille Co., during the year 1932 purchased from the Mortgage Guarantee Co. two parcels of real estate in Los Angeles, California, each improved by a furnished apartment house. The purchase price, totaling $112,500, was payable as follows: $71,000 by petitioner's assumption of a first mortgage on the property then outstanding in that amount, $19,000 payable in cash on the date of purchase, and $22,500 by the execution of petitioner's notes in that amount. By a provision in the contract of purchase similar to that quoted above from the Cherokee contract, the notes were made payable either in cash or in first mortgage assignments and policies of mortgage insurance, issued by the vendor, to be accepted by the vendor at their face value within five years of the date of purchase.
During the years 1933 and 1934, the petitioner, Sunset-Lucille Co., purchased and, on the dates purchased, transferred to the Mortgage Guarantee*1090 Co., in satisfaction of its $22,500 indebtedness, first mortgage assignments and policies of mortgage insurance issued by the seller with a face value of $22,500. These certificates were purchased by the petitioner in lots and at prices as follows:
| Date of purchase | Face value of certificates | Cost to petitioner | ||
| 10/30/33 | $5,500.00 | $2,580.00 | ||
| 11/4/33 | 125.00 | $5,625.00 | $58.75 | $2,638.75 |
| 3/14/34 | 7,500.00 | $3,750.00 | ||
| 6/8/34 | 9,375.00 | 16,875.00 | 5,039.06 | 8,789.06 |
| Total | 22,500.00 | 11,427.81 |
*1215 All of these certificates were purchased on the open market by the petitioner, Sunset-Lucille Co., with the exception of the lot acquired on March 14, 1934, which was purchased by the Mortgage Guarantee Co. for the account of and with money furnished by the petitioner.
In 1932 there were outstanding first mortgage assignments and policies of mortgage insurance of the type specified in the two contracts with a total face value of some $28,000,000. These certificates were not listed on any exchange but were readily available through local bond houses.
The value in 1932 of the realty with improvements purchased by the petitioner, Cherokee*1091 Co., from the Mortgage Guarantee Co. was not in excess of $129,672.19.
The value in 1932 of the two parcels of realty with improvements purchased by the petitioner, Sunset-Lucille Co., from the Mortgage Guarantee Co. was not in excess of $101,427.81.
OPINION.
HILL: The common issue in these consolidated proceedings is whether under the facts stated the petitioners realized income during the taxable year equal to the difference between the petitioners' cost and the face value of certain mortgage certificates which were accepted by the Mortgage Guarantee Co. at the latter figure in satisfaction of petitioners' indebtedness. There were set forth in the petitions additional assignments of error which apparently were abandoned before trial, as to which we render no decision.
The argument of the petitioners is that the terms of the purchase of the realty provided for an exchange of property - the mortgage certificates for the real estate - and that the gain, if any, is to be determined under sections 111 and 112 of the Revenue Act of 1934. Petitioners contend that no gain resulted from the exchange, since the fair value of the property acquired in each case did not exceed petitioners' *1092 cost.
The $175,000 price named in the Cherokee contract and the $112,500 set forth in the Sunset-Lucille contract, petitioners argue further, are merely figures in "a method of accounting adopted by the parties, and a definite and fixed obligation on the part of the petitioners to pay the face amount thereof in money or money's worth was not incurred."
The respondent's position, on the other hand, is that the obligation of the petitioners to pay fixed amounts in money is plain on the face of the contracts and that the satisfaction of those debts at less than their face value resulted in income to the petitioners.
We think the petitioners must be sustained.
The two agreements for the purchase of the realty here involved must be construed each as a whole. Whatever obligations the contracts *1216 created to pay in money the petitioners' notes, were modified by the provision for their payment in mortgage certificates to be accepted at their face value. Passing for the moment petitioners' argument that the effect of this provision is to remove any obligation to pay the notes in money, we think the least force that may be assigned to it is to construe the provision as*1093 allowing an exchange of properties as an alternative method of discharging the debt. By following this method through the petitioners acquired, in so far as the mortgage certificates were accepted in exchange for the real estate, properties the fair value of which in each case is to be compared with petitioners' cost in recognizing the gain, if any, arising from these dealings. We think the naming of a price for the properties in excess of the fair value in each case can not alter the character of the transactions. In the method employed by the petitioners in discharging their obligations it had no more importance than a book entry to balance the aggregate par value of the certificates transferred.
This alternative method of payment provided in the original obligation is the factor here present which differentiates this case from those on which the respondent places reliance. In , and in , the debts which were discharged at less than their face value were absolute obligations not modified by any alternative methods of payment. *1094 The taxpayers escaped the full measure of their liabilities through dealings wholly unconnected with their original contracts. In the present case, on the other hand, the obligations assumed were met in the very terms which were specified and no income has resulted unless, as will presently be considered, gain may be recognized on the exchange. Cf. also, ; .
We conclude, viewing these transactions as an exchange of property in so far as the mortgage certificates were accepted in payment for the realty, that the fair value of the property so acquired did not exceed the cost of the certificates transferred. We have considered all the pertinent evidence and have found that the property acquired by the Cherokee Co. at the time of acquisition had a value not in excess of $129,672.19. Since this is the aggregate cost of the obligations transferred from the purchaser to the vendor plus the $85,000 first mortgage indebtedness, we hold that the Cherokee Co. realized no gain or income from the transaction here in question.
The value of the properties acquired by the Sunset-Lucille*1095 Co., which we have also determined from a consideration of all the pertinent evidence, was at the time of purchase not in excess of $101,427.81. Since this amount does not exceed the aggregate cost *1217 of the certificates transferred plus the $71,000 first mortgage indebtedness and the $19,000 cash payment, we hold that the Sunset-Lucille Co. realized no gain or income from the transaction here in question.
The situation in the present case is not unlike that in , where the taxpayer corporation declared a dividend of a certain fixed amount payable in certain stock, owned by the corporation, at its par value. The Commissioner determined that the taxpayer realized income through the discharge of its obligation to pay the dividend so declared equal to the difference between the cost of the stock distributed and its par value. We held that although the declaration of the dividend named a fixed sum, it was made payable, in effect, in kind and no income therefore was realized by the corporation. See also *1096 ; affd., . Cf. .
If the contracts here are regarded as essentially contracts of purchase and sale, as distinguished from exchanges, with provisions permitting payment in either one of two ways, the result is the same regardless of the value of the property purchased. There is no gain or loss on the purchase of property. . By making payment in the medium most advantageous to them, the petitioners acted entirely within the terms of the contracts, discharging fully their obligations in the manner provided for and not for any lesser sum. The optional provisions for payment through the medium of the vendor's obligations modified those provisions of the contracts which stated a definite sum, so that it can not be said that there was a money obligation on the part of the purchasers. See
Reviewed by the Board.
Decision will be entered under Rule 50.