1929 BTA LEXIS 2117">*2117 1. Petitioner, in order to get the Government to build a fireproof hospital instead of a frame hospital, agreed to make a contribution of $1,000,000 toward its erection. He also guaranteed the contractor against loss in the erection of the hospital. Held that an amount paid in 1921 under such guaranty does not constitute a net loss within the provisions of section 204 of the Revenue Act of 1921.
2. Held that respondent erred in allowing as a deduction as a loss in 1922 an amount paid in that year in accordance with such guarantee.
18 B.T.A. 21">*21 This proceeding is for the redetermination of a deficiency in income tax of $1,927.73 for 1922. The only matter put in controversy by the petition is whether an amount of $467,362.23 paid by the petitioner in 1921 in connection with his acting as guarantor on a construction contract is a net loss within the provisions of section 204 of the Revenue Act of 1921. At the hearing, the respondent amended his answer by alleging that in allowing a deduction of $17,347.15 from taxable1929 BTA LEXIS 2117">*2118 income for 1922 as a loss sustained in that year in connection with the petitioner's acting as a guarantor on the above mentioned contract was erroneous and that the amount should be restored to taxable income for 1922.
FINDINGS OF FACT.
The petitioner is an individual residing at Evanston, Ill. He is president of the Edward Hines Lumber Co., hereinafter referred to as the lumber company, and has held that office continuously since about the time of the company's organization in 1892. Sometime during 1917 the petitioner took a trip to California. Prior thereto the lumber company had entered into a contract with the Speedway Park Association for furnishing lumber for building an automobile speedway about 15 miles due west from the court house of the City of Chicago. Prior to leaving for California, Hines delegated a certain amount of authority in the management of the lumber company to one Wiehe, the secretary of the company. While Hines was in California, Wiehe, acting in excess of his authority, and contrary to the knowledge of Hines, entered into what appeared to be a moral guarantee of certain indebtedness of the Speedway 18 B.T.A. 21">*22 Park Association by the lumber company. 1929 BTA LEXIS 2117">*2119 This involved the lumber company to the extent of several hundred thousand dollars. Upon Hines' return the opening date of the speedway as advertised was only a short time off and he had to meet a situation requiring that the lumber company go ahead and complete the speedway or leave it in an unfinished state at what at that time appeared to be a great loss. The matter had to be decided quickly in order to have the speedway completed on the advertised date, so Hines took upon himself personal authority that might be questioned as regarded his position as president of the lumber company and had the lumber company pay the several hundred thousand dollars of the "indebtedness guarantee" and also furnish the money to pay the labor and other things to complete the project. As a result of these payments, the lumber company acquired mortgage securities of the Speedway Park Association of a par value of $1,194,000 or 12/13 of the total of such securities outstanding. Later, the lumber company, in order to keep the Speedway Park Association from going into the hands of a receiver, to provide for unpaid claims of stockholders, to acquire their stock interest and to get complete control1929 BTA LEXIS 2117">*2120 of the project, paid out an additional amount of $64,177.94. The property of the Speedway Park Association covered by the mortgage securities consisted of 320 acres of land, a speedway composed of a large steel grand stand and a wooden speedway surrounding a circle of a mile.
Hines subsequently made an investigation to determine what the prospects were of utilizing the speedway park for purposes other than for racing. As a result of this investigation, he concluded that if the property were then used for a real estate development or subdivision, a very large loss would result, and owing to its distance from street cars and other modes of getting in and out of the city, it would be several years before it could be used for such a purpose. He also concluded at that time that if the property could be held intact for a period of eight or ten years, it would be worth from a million to a million and one-half dollars for subdivision purposes.
Hines, feeling a personal responsibility as president of the lumber company in having it make the expenditures it had made in connection with the Speedway Park Association, and there being some question among the lumber company's stockholders1929 BTA LEXIS 2117">*2121 in regard to it, offered the lumber company $550,000 for the mortgage securities of the Speedway Park Association. The following are the minutes of a special meeting of the directors of the lumber company held December 15, 1917:
A special meeting of the directors of the Edward Hines Lumber Co., was held at the office of the company, Room 1324, Otis Building, Chicago, Illinois, at 3:00 o'clock p.m., December 15th, 1917.
18 B.T.A. 21">*23 The meeting was called to order by the President, and upon roll-call it appeared that the following Directors were present, constituting a quorum: Edward Hines, L. L. Barth, C. F. Wiehe.
The minutes of the preceding meeting were read and approved.
Mr. Hines then brought up the matter of the indebtedness of the Speedway Park Association to the Edward Hines Lumber Co. and stated that as he had been principally instrumental in his company extending credit to the Speedway Park Association and had advised the acceptance of the present mortgage securities of the par value of $1,194,000.00 and had further advised the expenditure of additional sums aggregating $64,177.94 for the protection of said mortgage indebtedness, and as the company desired to dispose1929 BTA LEXIS 2117">*2122 of these securities in order to use the money in its business, and as the securities were not readily saleable, he stated that he felt morally bound to take these securities from the Company. Mr. Hines further stated that he had made some considerable investigation regarding the value of these securities, and that he felt that they were not worth over $500,000.00 and that a ready sale could not be found for them at that price. He stated, however, that since he felt that he was largely instrumental in this loss being sustained by the company he desired to pay more than their actual value, and, therefore, he offered to pay the Company therefor the sum of $550,000.00 provided the company would give him Five years timein which to pay said amount at the rate of Five per-cent interest, taking his collateral notes for $110,000.00, due, One, Two, Three, four and Five years respectively.
The directors then engaged in an informal discussion of the proposition, after which Mr. L. L. Barth moved that the officers of the company be instructed to sell to Mr. Hines the aforesaid securities for the sum of $550,000.00 and to take his notes in payment therefor as proposed, due on or before Five1929 BTA LEXIS 2117">*2123 years after date, with interest at the rate of Five Per-cent per annum, said notes to be secured by the aforesaid securities as collateral. This motion was seconded by Mr. Wiehe, and was carried.
There being no further business, the meeting on motion adjourned.
Hines executed the notes referred to in the minutes and subsequently paid them. Prior to making the offer, Hines had formed the intention that if the disposition of the property resulted in a return of more than $550,000, any excess up to the amount of $1,194,000 would be given to the lumber company. At December 15, 1917, the war had entirely stopped the racing on the speedway and it stood idle for some time.
After acquiring the mortgage securities of the Speedway Park Association referred to above, Hines heard of a company of doctors from Washington who were visiting Chicago and looking for a site for a large hospital. They made inquiry as to the land where the speedway was located. From that and by various stages there developed a proposal to build a large frame hospital on the speedway site. Negotiations between Hines and the Government for building the hospital began in the spring of 1918.
Hines took issue1929 BTA LEXIS 2117">*2124 with the idea of a frame hospital. He came to Washington, saw the doctors and the War Department and tried to show them that a fire-proof hospital should be built and that it 18 B.T.A. 21">*24 could be built for an amount per bed space not greatly in excess of a frame hospital. He proposed that there should be a group of hospitals built in Boston, New York, Chicago and other cities and when the war was over the hospitals could be taken over by the cities at comparatively less than cost and they would not be a complete sacrifice as if frame structures were built. Hines' proposal was not favorably received and he was "rather ridiculed" for the statement that a fireproof hospital could be built at near the cost of a frame structure. At the instance of Hines, Shank & Co., contractors, proposed to build a fireproof hospital for a certain amount per bed along the lines of certain defined specifications and plans. A contract embodying the proposal was entered into on March 13, 1920. As the contract lacked the signature of a certain official of the War Department, more or less differences arose and Hines put up $2,000,000 in Liberty bonds with the Secretary of the Treasury to buy the hospital1929 BTA LEXIS 2117">*2125 when the war was over at so many years' option to the Government, and give it to the City of Chicago as a nonsectarian hospital. The War Department stopped getting material and it was not until after the enactment of certain legislation that the hospital was completed. At the time the contract was entered into, labor was unemployed and building materials were very cheap. However, when building operations were resumed after the interruption, both labor and building materials had advanced and the cost of the hospital was much more than had been anticipated by the petitioner.
In order to induce the Government to build a fireproof instead of a frame hospital, Hines agreed to and did make a contribution of $1,000,000 toward the erection of it. He also agreed to indemnify or guarantee Shank & Co. against any loss sustained in the erection of the hospital under its contract with the Government.
The respondent, in approving the findings of a revenue agent, determined that the cost of the hospital known as the Edward Hines, Jr. Hospital was $5,049,840.32 and that the amount received from the Government under the contract for the acquisition of the site and uncompleted buildings and1929 BTA LEXIS 2117">*2126 completion of the hospital was $3,282,498.79, making a loss of $1,767,341.53. By deducting the contribution of $1,000,000 promised by the petitioner toward construction of the hospital, he determined the petitioner's loss as guarantor to Shank & Co. was $767,341.53. Of this amount the respondent determined that the petitioner paid $282,632.15 in 1920, $467,362.23 in 1921, and $17,347.15 in 1922. In an audit of the petitioner's return for 1920 there was allowed as a deduction the amount of $282,632.15 as representing a loss. For 1921 the respondent, by allowing as a deduction representing a loss the amount of $467,362.23, determined that the petitioner had a net loss for that year 18 B.T.A. 21">*25 of $389,483.27. In determining the petitioner's tax liability for 1922, the respondent allowed as a deduction representing a loss the amount of $17,347.15, but refused to apply the 1921 net loss against the net income of $35,515.33 determined for 1922.
At the time the petitioner purchased the mortgage securities of the Speedway Park Association from the lumber company he did not have, nor has he had at any other time, any trade, occupation or business except being president of the lumber1929 BTA LEXIS 2117">*2127 company and its affiliated subsidiary organizations.
At the time the petitioner was reimbursing Shank & Co. for its losses in the construction of the hospital there was no one he could look to to reimburse him.
OPINION.
TRAMMELL: The petitioner contends that the loss resulting in 1921 from the payment in that year of the amount of $467,362.23 under his agreement with Shank & Co. to indemnify or guarantee it against loss on the erection of the hospital was a net loss within the meaning of section 204(a) of the Revenue Act of 1921, and that it more than offsets his income for 1922, thereby resulting in no tax liability for that year.
Section 204(a) of the Revenue Act of 1921 provides in part as follows:
That as used in this section the term "net loss" means only net losses resulting from the operation of any trade or business regularly carried on by the taxpayer (including losses sustained from the sale or other disposition of real estate, machinery, and other capital assets, used in the conduct of such trade or business) * * *.
The question before us is whether the loss sustained by the petitioner under the circumstances set out in our findings of fact constitutes a1929 BTA LEXIS 2117">*2128 loss resulting from a trade or business regularly carried on by the petitioner. The petitioner urges that the loss resulted from his being president of the Edward Hines Lumber Co., and in which he was regularly engaged. We think there is no question but that the petitioner was regularly employed as president of the lumber company and have found as a fact from his own testimony that he had no other trade or business. The loss that we are here considering resulted directly from the petitioner having agreed to indemnify or guarantee Shank & Co. against loss in the erection of the hospital. The Government contemplated building a frame structure on the speedway site, but the petitioner was so desirous that a fireproof structure be erected that he agreed to make a contribution of $1,000,000 toward the erection thereof, and also guaranteed the contractor against loss. From the evidence in the 18 B.T.A. 21">*26 case it is not shown that the loss here involved resulted from the operation of any trade or business regularly carried on by the petitioner. While the petitioner acquired certain mortgage securities on the site where the hospital was erected because of his being president of the lumber1929 BTA LEXIS 2117">*2129 company, the loss involved here is not connected with such securities but arises from the agreement guaranteeing Shank & Co. against loss.
We have heretofore had occasion to consider the meaning of the term "trade or business regularly carried on" as used in section 204 of the Revenue Act of 1921 and have held that it means a vocation and not occasional or isolated transactions. ; . Since the agreement guaranteeing Shank & Co. against loss appears to be the only one of its or a similar kind ever entered into by the petitioner, we think it comes within the class of occasional or isolated transactions. Inasmuch as the petitioner's loss was sustained in an occasional or isolated transaction, it did not constitute a net loss within the meaning of section 204 of the Revenue Act of 1921. The action of the respondent in refusing to apply the net loss for 1921 against the net income for 1922 is therefore approved.
At the hearing the respondent amended his answer as follows: "Respondent avers that in allowing a deduction of $17,347.15 from taxable income for the year 1922, he was in error and1929 BTA LEXIS 2117">*2130 further avers that said amount should be restored to taxable income for said year." The respondent contends that the total amount expended by the petitioner under his agreement to guarantee Shank & Co. against loss constituted an additional contribution toward having the hospital built and, since there was no one to reimburse the petitioner for the payment of Shank & Co.'s loss, the petitioner's agreement really was an agreement to make as an additional gift whatever amount Shank & Co. lost in the completion of the hospital.
For the amount to be deductible as a loss it would have to be a loss incurred in trade or business or one incurred in a transaction entered into for profit though not connected with the trade or business. We think it is clear that the petitioner was not engaged in the indemnity or guaranty business. A careful consideration of the record fails to disclose anything to indicate that the petitioner expected to realize any profit from his guaranteeing Shank & Co. against loss. It could not be said to have been a transaction entered into for profit. From the record we think the petitioner was interested in having a fireproof hospital built and was willing to do1929 BTA LEXIS 2117">*2131 what was necessary to have it done. This being true, it is 18 B.T.A. 21">*27 our opinion that the $17,347.15 paid by the petitioner in 1922 in accordance with his guaranty agreement constituted nothing more than an additional contribution toward having the hospital built. We think the respondent erred in allowing the amount as a deduction as representing a loss.
Reviewed by the Board.
Judgment will be entered under Rule 50.