*1245 Upon the facts disclosed, it is held:
(1) A one-fifth interest in a farm, acquired by petitioner Robert M Harriss in 1920 and sold to a brother in 1933, was a capital asset and the loss realized on the sale was a capital loss.
(2) A gain of $72,747.67 realized in 1934 upon the sale by petitioner Robert M. Harriss of certain cotton futures contracts and credited to him in that year on the books of the cotton firm of Harriss & Vose, represented income to him in that year to the extent of his one-half interest therein.
(3) Of a total of $7,013 in commissions credited to petitioner Robert M. Harriss on the books of Harriss & Vose in 1934, the sum of $4,845 represented credits not subject to his withdrawal in that year and consequently not then taxable to him as income realized. As to the balance of $2,168, the respondent's inclusion thereof in income for 1934 is not shown to have been in error.
(4) Petitioner Robert M. Harriss did not sustain a deductible loss in 1934 with respect to his interest in One and Three South William Street Building Corporation.
*999 Respondent has determined deficiencies in income tax against Robert M. Harriss and Abbeline C. Harriss of $37,896.55 and $120,316.39, for the years 1933 and 1934, respectively. These taxpayers filed joint returns as husband and wife for those years. A number of issues raised by the petition have been settled by stipulation. Effect will be given thereto in the settlement under Rule 50. Four issues remain for decision. They are: (1) Whether a loss in the amount of $49,100.41, stipulated to have been sustained by petitioner Robert M. Harriss in the year 1933 on the sale of a farm, is a capital or an ordinary loss; (2) whether petitioner Robert M. Harriss realized taxable gain in the amount of $36,373.83 in 1934 in the sale of cotton futures contracts; (3) whether petitioner Robert M. Harriss realized income of $7,013 in the year 1934 in commissions in excess of the amount reported by him for that year; and (4) whether petitioner Robert M. Harriss sustained a deductible loss in 1934 with respect to his investment in the One and Three South William Street Building Corporation.
FINDINGS OF FACT.
Robert M. Harriss, hereinafter*1247 referred to as petitioner, a resident of Forrest Hills, New York, and Abbeline C. Harriss, his wife, *1000 now deceased, filed joint income tax returns for the taxable years 1933 and 1934 with the collector of internal revenue for the second district of New York.
Since 1915, with the exception of an interval of two years, petitioner has been a partner in the firm of Harriss & Vose, New York City, engaged in the cotton business, both "spot" and futures. This firm also traded in other commodities. Petitioner formerly lived in Oklahoma and Texas and through the years since 1910 has made a number of purchases of improved and unimproved real estate there and in many other parts of the country. Some of these were sold shortly after their purchase, others were held for long periods of time and then sold and others are still owned by petitioner.
Among petitioner's real estate ventures was the purchase in 1920 of a farm of approximately 6,175 acres in La Salle County, Texas. He bought this farm together with four brothers, at a cost of $234,402.15. Petitioner contributed one-fifth of the purchase price. Upon this acquisition petitioner's brother, Bayless Harriss, of Galveston, *1248 Texas, was placed in charge as manager. Shortly thereafter, petitioner and his brothers undertook the improvement and development of the property, clearing part of the land for farming. Tenant houses were built, a commissary store was installed, a church was built and a manager's home erected. Many other improvements to the farm were made and the necessary equipment for its operation was purchased. The cost of all this was borne equally by the five brother.
The operation of the farm did not prove successful and in 1926, upon the death of Bayless Harriss, petitioner and his remaining brothers leased it to others. In 1933, petitioner sold his one-fifth interest for $10,000, sustaining a loss of $49,100.41.
Petitioner's interest in the La Salle County farm was not an asset carried by him for sale to customers in the ordinary course of a business carried on by him, but constituted a capital asset.
During the year 1934 petitioner, together with Eugene Smith and Charles L. Tarver, of Dallas, Texas, engaged in the purchase and sale of cotton futures. These were carried on through the cotton firm of Harriss & Vose in New York City and petitioner had a one-half interest in each*1249 account. In that year petitioner had two accounts with the firm of Harriss & Vose in which he and Smith were associated and two in which he and Tarver had equal interests. No margins were posted by petitioner and his associaties on these accounts, but petitioner guaranteed them to the firm of Harriss & Vose.
Petitioner and his associates believed that cotton would rise in price and bought contracts in these accounts for future delivery. *1001 Petitioner agreed with each of his associates that they should carry these purchases and when delivery date neared on any futures contract that any profit resulting from sale of the contract would not be drawn down, but a purchase of futures contracts in the same number would be made for a more distant delivery date.
Accordingly purchases of futures contracts were made. These were sold later and the profits resulting were credited by Harriss & Vose to the account and, under orders given by petitioner, a concurrent purchase of a similar number of contracts for a more distant delivery date was made.
Petitioner did not withdraw any of the profits upon the sales made in 1934 and, under the custom and usage of the trade, in cotton*1250 futures such withdrawals could not have been made by him under conditions such as here existed after purchase of an additional number of futures contracts in the place of those sold. The custom in the cotton business is that where a customer orders, as in this case, what is termed a "switch" from one delivery date to another, namely, a "long" sale of a specific number of contracts and a concurrent purchase of a similar number with delivery in a more distant month, the profit realized from the sale must remain as a guarantee or credit against the new purchase.
In the four accounts of petitioner and his two associates with the firm of Harriss & Vose at the end of the year 1934, there were net credits totaling $72,747.67, on sales on futures made during that year, of which credits petitioner's share was $36,373.83. All of these credits, with one exception, were realized from sales made under order to buy a similar number of futures contracts for more distant delivery. The only exception was that in one of petitioner's accounts with Tarver there was on March 19, 1934, a sale of ten contracts for May delivery and no corresponding future purchase. The profit on this sale was $7,829.50, *1251 which was credited by Harriss & Vose to the proper account.
Petitioner in filing his income tax return for the year 1934 did not include as taxable income his one-half interest in the total credits on these transactions with his associates, Smigh and Tarver. N0 part of these credits was drawn by petitioner from Harriss & Vose in 1934.
During 1934 petitioner, who was a member of the New York Cotton Exchange, carried out through Harriss & Vose certain speculative transactions in cotton futures for Frierson & Co., a cotton firm of New Orleans, Louisiana, which firm was not a member of the New York Cotton Exchange. Petitioner owned a 51 percent interest in Frierson & Co. Petitioner guaranteed the Frierson & Co. accounts to Harriss & Vose and, because of such guarantee of a nonmember's *1002 account, was entitled to participate in commissions charged such nonmember by Harriss & Vose. Petitioner also during that year individually carried out various transaction in the speculative sales and purchases of other cotton futures contracts. These contracts, while consummated through the partnership of Harriss & Vose, were individual transactions by petitioner as distinguished*1252 from partnership business. On these, petitioner guaranteed the accounts and was entitled to participate in the commissions charged by Harriss & Vose.
On its books the firm of Harriss & Vose carried an account of the commissions earned by petitioner. The amount credited to him in this account during 1934 was $7,013. There were no entries in the account denoting the particular transaction in which the commissions were earned, but not less than $4,845 of the total amount constituted commissions from the Frierson & Co. transactions.
Under custom and usage of the cotton business, commissions such as the credit of $7,013 are not subject to withdrawal by the guarantor of the account unless the guaranteed account upon the then market has an equity in excess of the amount of the commissions. In the case of Frierson & Co., the account showed no equity and this fact was called to petitioner's attention by the managing partner of Harriss & Vose, who reminded him that the commissions were not to be withdrawn until the Frierson account showed an equity above the amount of the commissions. Petitioner made no withdrawal during 1934 of any part of the $7,013 credited to him as commissions*1253 earned. In a later year this credit was applied by the firm of Harriss & Vose in liquidating the deficits in the Frierson and other accounts on which petitioner was obligated then and, under his guarantees, then owed a large indebtedness.
In 1924, petitioner and his brother, W. Leslie Harriss, purchased certain unimproved real estate on Long Island, New York, for the sum of $80,000, of which petitioner paid one-half. In 1926, some adjoining lots were purchased at a cost of $18,694.62 to each brother. Thereupon, petitioner and his brother transferred this property to a corporation known as the One and Three South William Street Building Corporation in exchange for all of its capital stock issued to them in equal shares. This property was the only asset owned by the corporation from 1926 through the year 1934.
The purchase of this property by petitioner and his brother was with the idea of erecting thereon an apartment building or a sale of it for that purpose. Shortly after this purchase a mortgage of $75,000 was placed on the property securing a loan in that amount by the Brooklyn Trust Co. The proceeds of this loan were divided between petitioner and his brother. In making*1254 the loan, the Brooklyn *1003 Trust Co. required that petitioner and his brother give personal collateral mortgage bond. Thereafter efforts were made to sell the property, but owners of adjacent property opposed this upon the ground that restrictions in the title or the existing zoning regulations precluded such use. This condition prevented a sale of the property for apartment house construction.
In May 1928 petitioner and his brother caused the corporation to have increased to $100,000 the mortgage on the property, securing the additional loan of $25,000 from the Brooklyn Trust Co. Petitioner being absent at the time in Texas, his brother executed a personal collateral mortgage bond for this additional sum. In May 1928, the One and Three South William Street Building Corporation instituted suit in the New York Supreme Court asking a declaratory judgment of its right to erect an apartment buliding on the property. This litigation ultimately went to the highest appellate court of New York State which, in January 1933, finally held that an apartment house could be lawfully erected thereon.
Petitioner and his brother paid equally the attorneys' fees and expenses in connection*1255 with the restrictions litigation, petitioner's share being $12,551.91. Upon the termination of that litigation efforts were resumed to dispose of the property but, in 1933, the market for such property was so depressed that a purchaser could not be found. Since the acquisition of the property, its cost had been increased by payments of taxes, mortgage interest, and street and sewer assessments. Prior to 1932, such payments by petitioner individually amounted to $9,356.71 for taxes; $15,510.41 for interest on the mortgage, and $488.81 for street and sewer assessments. In 1932, petitioner's brother was financially unable to pay his portion of such expenditures and petitioner thereafter paid all taxes, interest and street assessments on the property of $8,162.85, $11,000, and $311.36, respectively.
In August 1934, the corporation being in arrears to the extent of approximately $5,000 in its tax payments and interest on the mortgage, the Brooklyn Trust Co. threatened to foreclose on the property, but finally agreed not to foreclose and to reduce the interest rate on the $100,000 mortgage loan from 6 percent to 4 percent if the arrears in taxes and interest were paid. Petitioner*1256 thereupon paid up the arrears in the taxes and interest and since that time has paid all taxes and interest on the property.
At the time of the threat of foreclosure by the Brooklyn Trust Co. petitioner, through his attorney, offered to deed the property to the trust company in consideration of the release of the mortgage and liability under the personal bond. This offer was refused. Petitioner's brother then advised petitioner that he considered their interest *1004 in the property of no value and he would put up no additional funds. He then endorsed and delivered his stock to petitioner. This stock was never transferred to the petitioner on the books of the corporation.
This property is not income-producing and is without improvements. The One and Three South William Street Corporation still holds the record title to the property, although the corporation was dissolved in 1936 for nonpayment of franchise taxes. The Brooklyn Trust Co. has never foreclosed on the mortgage.
Petitioner, in filing his income tax returns for the years 1925, 1933, and 1934 deducted the amounts of the taxes and interest on the mortgage and the street assessments paid by him on this*1257 property. Respondent allowed these deductions. In filing his income tax return for 1934, petitioner claimed no deduction on account of his investment in the stock of the William Street Corporation or on account of a loss in respect to the Forest Hills properties, but now claims a deductible loss in the amount of $43,935.69, computed as follows:
| Total cost of Property | $58,694.62 |
| Less 1/2 recovered on mortgage | 50,000.00 |
| Balance | 8,694.62 |
| Add: | |
| Litigation & Rezoning costs | 12,551.91 |
| Taxes, mortgage Int., Street Assessments | 44,830.14 |
| Total | 66,076.67 |
| Less: Taxes, Interest deducted on 1925, 1933, 1934 returns | 22,141.45 |
| Loss | 43,935.22 |
Petitioner's investment in the Forest Hills property did not become worthless in 1934 and that property was not abandoned in that year.
OPINION.
LEECH: Petitioner sustained a loss upon the sale of the Texas farm in 1933 in the amount of $49,100.41. The sole issue as to the deficiency for 1933 is whether this loss was an ordinary or capital loss.
This issue is one of fact. Petitioner contends that he has been regularly engaged for many years in the real estate business, buying and selling improved and unimproved properties, *1258 and that this farm was purchased in the ordinary course of that business and held for sale to customers. Although it is admitted that his principal business is his cotton business with Harriss & Vose, this, of course, does not preclude him from carrying on the other business of buying and selling real estate in which his purchases, if held as a stock in trade for sale to customers in the regular course of that business, would not constitute *1005 capital assets under section 101(c)(8) of the Revenue Act of 1932. 1.
The testimony as to petitioner's activity over a long term of years in real estate*1259 may be sufficient to show that during this time he was carrying on a real estate business and that many of the properties purchased were held for sale by him in the course of that business. However, the facts in connection with his acquisition of an interest in the La Salle County, Texas, farm does not indicate to us that this property was acquired as an incident in the carrying on of his real estate business and held for sale to customers.
Petitioner, it seems, purchased this farm together with his four brothers, each taking a one-fifth interest. It was not cleared. They took steps to clear and improve it for the purpose of carrying on extensive farming operations. These continued for some years with one of the brothers in active charge and after his death the farm was leased as a revenue-producing property. It was not until 1933, 13 years after the acquisition of this property, that petitioner sold his one-fifth interest and then, it is noted, that the sale was to one of his brothers.
This does not appear to be a case of a property purchased as an incident of a business carried on by petitioner of buying and selling real estate. We think it was rather an expenditure by*1260 petitioner and his four brothers in the organization and operation of a business of farming.
It is, accordingly, held that petitioner's one-fifth interest in the La Salle County farm constituted a capital asset and the loss realized by him as stipulated is a capital loss allowable to the extent of 12 1/2 percent.
The second issue is whether respondent erred in increasing petitioner's income for 1934 by one-half of the total gain of $72,747.67 which respondent contends he realized with two associates in carrying on the purchase and sale of cotton futures contracts.
The findings of fact disclose the method of operation of petitioner and his two associates, Tarver and Smith, in their purchase of futures contracts whcih, when the delivery date approached, were sold and a similar number purchased at the market on that date, for delivery at a more subsequent date. It is petitioner's contention that in the sale of such futures contracts the profit from such sales, although credited to his account, did not constitute realized income because *1006 it was merely an incident in a definite plan under which a new commitment was made simultaneously which, under the usage and custom*1261 of the cotton business, precluded his withdrawal of the profit realized on such sales. He contends that these transactions were in the nature of hedging operations and subject to the rule followed in , and . But here, petitioner and his associates were not selling futures against the purchase of "spot" cotton. Their only sales were futures contracts which they owned. Their position in the market was always long under their method of operation, and the transactions were purely speculative.
Moreover these sales of futures contracts can not be considered as a part of the concurrent purchase of a similar number of futures contracts for a more distant delivery date. In each instance when a sale was made and a profit realized it was unquestionably subject then to the absolute control and enjoyment of petitioner and his associates except for their voluntary action in carrying out another transaction of purchase under which the realized profit was to be held as a deposit of guarantee. See *1262 . In every sale petitioner and his associate could have closed the account without another purchase. In fact this was actually done after one of the sales, resulting in a profit of $7,829.50. That amount is a part of the total of $72,747.67 which respondent contends was realized by petitioner and his associates. As to this item, petitioner now admits that it constituted a realized gain and that he is taxable upon his one-half interest therein.
To sustain petitioner in his contention would be to hold that one who derives a gain may postpone its realization and recognition as such by concurrently entering into another contract under which that gain is pledged. We agree with the reasoning of the court in the case of ; certiorari denied, . There the same question arose upon facts almost identical with those here. The Circuit court there said:
It is appellant's contention that taxable gains or deductible losses from its transactions resulted only when it, in closing out a cotton contract, did not simultaneously purchase another contract for*1263 the future delivery of a like amount of cotton; but we cannot accept this view under the facts set forth in the agreed statement. There is no dispute about the profit that was made on these purchases, and the fact that other contracts for the purchase of an equal quantity of cotton of the same grade, staple, and character were simultaneously made by it is not sufficient to relieve the appellant of the tax upon the profit actually realized upon the contract which was finally closed out during the taxable year.
Respondent is sustained on this issue.
*1007 The third issue is the propriety of respondent's action in including in income for 1934, $7,013 constituting commissions credited to petitioner upon the books of Harriss & Vose as his share of the commissions charged by that company to customers on contracts which had been personally guaranteed by petitioner.
Of the total amount so credited we have found that $4,845 was commissions credited to petitioner's account in connection with certain cotton transactions executed for Frierson & Co. The remainder of the commissions is not identified with any particular account. There is no evidence indicating that petitioner*1264 was restricted in his absolute control and enjoyment of them when credited to him. We think that they were income realized by petitioner in 1934. See
However, as to the credit of $4,845 a different condition exists. It is clearly established that, although these commissions were credited to petitioner's account, they were not subject to his withdrawal because of the fact that the Frierson account did not show an equity in excess of those commissions. It is true that they were entered upon the books as a credit due him. But whether he would ever receive them depended upon the Frierson account being closed without a liability on the part of petitioner under his guarantee or that the account, because of a market rise, showed such an equity, or paper profit, that Harriss & Vose would voluntarily permit their withdrawal. Neither of these conditions occurred. The evidence discloses that, although these commissions were credited, petitioner was advised that they were not available to him. Under such conditions, we conclude they can not be considered as subject to his unfettered use and therefore realized by and taxable to him. See*1265
The last issue involves petitioner's claim of a deductible loss in the amount of $43,935.22 alleged to have been sustained in 1934 on his investment in stock of the One and Three South William Street Building Corporation or in property on Long Island acquired by himself and brother, the title to which was held by that corporation for them. Petitioner argues that occurrences in the year 1934, to wit, the threat of foreclosure of the mortgage held by the Brooklyn Trust Co., the refusal by petitioner's brother to bear any further expense in connection with the property, his endorsement and delivery of his shares of stock in the corporation to petitioner, and the refusal by the trust company to accept petitioner's offer of a transfer of the property in satisfaction of the mortgage, fix and identify a loss as occurring in that year.
It is not entirely clear whether petitioner's position is that the basis for computing the amount of his loss is the value of his stockholding *1008 in the corporation or his investment in the property, disregarding the corporate entity and treating the property as personally owned by himself and his*1266 brother. His computation of the amount of the loss would appear to be upon the latter basis, since it includes not only the item of the cost to him of his stock in the corporation which was the original cost of the property when acquired, but also the expense borne individually by him since that time.
Undoubtedly, the corporation was used merely for the purpose of holding title for petitioner and his brother. It had no income, kept no accounts and the expenditures by petitioner and his brother for taxes, mortgage interest, and attorneys' fees were never charged as advances by them to the corporation but as individual expenditures on their own account in connection with property owned by them. In fact, petitioner appears to have deducted, individually, taxes paid by him on the property. Even for the year 1934, involved here, in arriving at the deficiency, respondent has allowed the deduction of amounts in taxes paid on this property by petitioner personally and claimed on his return.
Under these conditions we think the issue is resolved by whether the property could be considered as having become worthless in 1934 and thus support a loss then realized. Cf. *1267 . Petitioner argues that, for all practical purposes, he abandoned the property in 1934 and the loss was then realized, as in .
However, in the Hoffman case, the taxpayer refused to pay either taxes, insurance, interest, or other charges. The amount of these then owing totaled a large sum and the value of the property was far below the amount of the outstanding mortgage. Here, at the close of the taxable year, 1934, there was no indebtedness against the property other than the mortgage of $100,000. Petitioner had paid all arrears in taxes and interest. He has continued to pay these charges since that time, and it does not appear that as of that date the value of the property was less than the outstanding mortgage.
It is further urged by petitioner that under the rule in , the loss must be considered as sustained in 1934, since the record reveals that the value of his investment was then extinct and therefore no sale or disposition of the property was necessary in order to determine it as having been then realized. Under*1268 this edict, however, no deductible loss occurred in 1934. The evidence indicates that if the investment was worthless in that year its value was even less in prior years. In fact, the evidence indicates that in 1934 there had been improvement in the market value of the property over prior years. In 1934 the existence or effectiveness of restrictions upon apartment construction *1009 thereon no longer existed. Certain of petitioner's valuation witnesses testified that the value of the property in 1934 was less than it was in 1928, but these witnesses valued the property at only $69,000 in 1928, which was far less than the amount of the mortgage. They agreed that its value in 1933 was less than that in 1928. Thus, even if it could be held that petitioner realized a loss through diminution in the value of the property, (see ), it was sustained long prior to the taxable year here involved and, of course, can not be postponded.
No deductible loss was realized in 1934.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 101. CAPITAL NET GAINS AND LOSSES.
(c) DEFINITIONS. - For the purposes of this title -
(8) "Capital assets" means property held by the taxpayer for more than two years (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 in the course of his trade or business. ↩