*1400 1. Action of the Commissioner sustained in holding that the readily realizable market value of stock received by petitioners in a reorganization which took place in 1923 was at least equal to the fair market value of the stock of a corporation, a party to the reorganization, held by petitioners March 1, 1913, and that therefore the cash received by them in 1923 in excess of the stock received in the reorganization represented taxable gain to them.
2. Taxable gain in 1925 determined where stock held by them on March 1, 1913, was exchanged in 1923 for stock in another corporation and a part of the stock received in 1923 was retired in 1925.
3. Action of the Commissioner sustained in denying certain deductions claimed on account of bad debts, automobile expenses and club dues.
4. The amount expended as fees in the negotiation of a long-term lease may not be allowed as a deduction in its entirety in the year in which the amount was expended, but should be amortized over the term of the lease.
*1292 These proceedings, which were consolidated, involve deficiencies in income tax as determined by the Commissioner as follows:
| Petitioner | 1923 | 1924 | 1925 |
| George W. Griffiths | $36.13 | $39.28 | $4,938.60 |
| John Griffiths | 4,339.66 | 27,814.02 |
The Commissioner also determined that a fraud penalty in the amount of $13,907.01 should be asserted against John Griffiths for 1925, but that issue was abandoned by the respondent. Since the *1293 Commissioner did not determine a deficiency against John Griffiths for 1923, but rather found an overassessment, the Board does not have jurisdiction of that year with respect to the petition of John Griffiths.
The principal errors assigned relate to the capital net gain realized by the petitioners through the reorganization in 1923 of a corporation in which they were the sole stockholders. A further issue involving some of the same considerations arises on account of a determination by the Commissioner that the petitioners realized capital net gain in 1925 when preferred stock held by them was retired. Other minor issues are also involved*1402 with respect to certain deductions for bad debts, expenses for the operation of an automobile, club dues, and expenses incident to the negotiation of a lease.
FINDINGS OF FACT.
1. The petitioners are individuals with their residence and place of business in Chicago, Illinois.
2. John Griffiths was about 85 years of age at the time of the hearing in these proceedings and had been engaged in the business of general contractor and builder in Chicago, Illinois, for 55 years. George W. Griffiths is the son of John Griffiths and had been associated with his father in his various undertakings for 27 or 28 years.
3. John Griffiths began business as an individual and later operated as a partnership. The first partnership was succeeded in 1904 by another partnership under the name of "John Griffiths and Son" (hereinafter referred to as the partnership). The petitioners in these proceedings were the partners in the aforementioned partnership, the father owning 95 per cent and the son 5 per cent.
4. On December 26, 1911, the petitioners created and organized John Griffiths and Son Company, an Illinois corporation, for the purpose of taking over the assets and succeeding to*1403 the business theretofore carried on by the partnership. Among the purposes stated in the charter of the Illinois corporation was the following:
To acquire and take over as a going concern the general contracting business now carried on at Chicago, Illinois, by John Griffiths and George W. Griffiths co-partners under the firm name of John Griffiths and Son, and in connection therewith to purchase the good will, business and all or any of the assets and to undertake, assume, carry out and complete in its name and for its bene fit all or any of the building contracts or undertakings of the said co-partnership.
5. The resolution of the Illinois corporation, dated December 30, 1911, and accepting the offer of the petitioners to transfer the property of the partnership to the corporation, reads in part as follows:
RESOLVED, that this Company accept the proposition of John Griffiths and Geo. W. Griffiths to sell to this Company the business now conducted by them *1294 under the firm name of John Griffiths and Son consisting of the office furniture and supplies, plant, stock on hand, machinery, tools and apparatus of every description, together with the good-will of the business, *1404 with the understanding that this Company is to take over the business as a going concern and to assume carry out and complete in its name and for its benefit, and at its sole cost and charge the unfinished portions of the building contracts and undertakings of said co-partnership from January 1st, 1912 as follows: the unfinished portion of the contract with Mandel Brothers dated December 17th 1910; the unfinished portion of the contract with Rothschild and Company dated June 5th 1911; the unfinished portion of the contract with Mollie Netcher and Mollie Netcher Trustee dated August 29th 1911; at and for the sum of $35,000 payable in the stock of this Company, and this Board of Directors do hereby adjudge and declare that the said property is of the fair value of $35,000 and that the same is necessary for the business of the company.
6. At the same time an agreement was entered into between the petitioners and the Illinois corporation which reads in part as follows:
Article One: The Vendors hereby sell, assign, transfer and set over unto the vendee, its successors and assigns, the following property, contracts, rights and choses in action at and for the price of thirty five thousand*1405 dollars, viz: - the business now conducted by the vendors at 112 W. Adams Street, Chicago, under the firm name of John Griffiths and Son, consisting of the office furniture and supplies, plant, stock on hand, machinery, tools and apparatus of every description, together with the good will of the business, with the understanding that the vendee corporation takes over the business as a going concern and assumes and agrees to carry out and complete in its name and for its benefit and at its sole cost and charge the unfinished portions of the building contracts and undertakings of the said vendors from and after January first 1912 as follows: the unfinished portion of the contract with Mandel Brothers, dated December 17th 1910: the unfinished portion of the contract with Rothschild and Company dated June 5th 1911: and the unfinished portion of the contract with Mollie Netcher and Mollie Netcher Trustee, dated August 29th 1911.
Article Two: The vendee hereby purchases from the vendors the property, contracts, rights and choses in action enumerated in Article One, and at the price therein stated of thirty five thousand dollars, and subject to the conditions therein stated.
Article*1406 Three: The vendee hereby issues unto the vendors and the vendors accept from the vendee, capital stock of the vendee corporation at par value in the sum of thirty five thousand dollars, being 350 shares at the par vale of one hundred dollars each, in full payment and discharge of the purchase price of the said property before enumerated.
The vendee agrees to issue certificates for the said stock as follows:
| To John Griffiths | 322 Shares |
| To George W. Griffiths | 28 Shares |
The said stock is hereby declared full paid and non-assessable.
7. The authorized capital stock of the Illinois corporation was $100,000, consisting of 1,000 shares of a par value of $100 per share. *1295 Stock of a par value of $35,000 was issued to the petitioners for their interests in the partnership, and of such stock the father received 322 shares and the son 28 shares. The remaining stock of a par value of $65,000 (650 shares) was paid for in cash at par by the petitioners, John Griffiths receiving 600 shares and George W. Griffiths 50 shares. On March 1, 1914, January 29, 1915, and January 2, 1923, George W. Griffiths received shares of stock in the corporation as gifts from*1407 John Griffiths in the respective amounts of 47 shares, 15 shares, and 46 shares. As a result of the foregoing acquisitions and transfers, John Griffiths held 814 shares and George W. Griffiths 186 shares, which holdings continued until the Illinois corporation was succeeded by a Delaware corporation as hereinafter shown.
8. (a) Prior to the formation of the Illinois corporation the partnership had been engaged since about 1905 in the construction of the "Charles Netcher Building," hereinafter referred to as the "Boston Store." The building was constructed in sections and several sections had been completed by 1911. On August 29, 1911, the partnership entered into an agreement for the construction of a part of the building known as Section 7, such part to be completed by July 1, 1912, for a consideration of $521,401. On March 21, 1912, additions were made to the contract of August 29, 1911, for further work on the same building for the further consideration of $1,064,608. The additions to the contract were executed by and on behalf of the partnership, and the time for completion was extended to September 1, 1912. In the execution of the aforementioned contracts the contractor's*1408 bond was waived.
8. (b) The execution of the additions to the foregoing contract by the partnership instead of by the corporation was at the insistence of the owners of the Boston Store, who had dealt with John Griffiths individually and whom they had found reliable and financially responsible. Further, the said owners had an arrangement with the partnership by which time for payment might be extended and they desired the same arrangement to be continued in connection with the work contracted for. However, the construction of the buildings and additions specified in the contracts was carried out by the Illinois corporation.
8. (c) The work on the Boston Store referred to above was completed sufficiently for occupancy about October, 1912. The total contract price (including certain extras) was $1,631,045.98 and the cost to the contractors of completing the contracts was $1,020,990.76, thus *1296 showing a profit on the contracts of $610,055.22. Payments under the contract were made as follows:
| Date | Manner of payment | Amount |
| 10/30/11 | Cash | $5,000.00 |
| 12/20/11 | Cash | 60,000.00 |
| 1/30/12 | Cach | 80,000.00 |
| 3/8/12 | Cash | 46,400.00 |
| 4/18/12 | Cash | 10,000.00 |
| 4/18/12 | Cash | 4,375.00 |
| 5/14/12 | Cash | 35,000.00 |
| 6/11/12 | Cash | 135,000.00 |
| 7/16/12 | Cash | 185,000.00 |
| 8/21/12 | Cash | 185,000.00 |
| 9/16/12 | Cash | 168,000.00 |
| 10/10/12 | Cash | 86,000.00 |
| 10/20/12 | Cash | $295.40 |
| 11/30/12 | Cash | 50,000.00 |
| 12/6/12 | Cash | 60,000.00 |
| 2/13/13 | Cash | 15,000.00 |
| 5/1/13 | Cash | 19,000.00 |
| 8/4/13 | Cash | 100,000.00 |
| 12/19/13 | Cash | 43.20 |
| 12/19/13 | Cash | 3,300.00 |
| 4/30/14 | Loan account | 375,578.78 |
| Sundry | 8,053.60 | |
| Total | 1,631,045.98 |
*1409 8. (d) The corporation accounted for its profit on the completed-contract basis.
8. (e) The foregoing profit of $610,055.22 on the Boston Store contracts was credited to profit and loss on the books of the Illinois corporation on June 30, 1914. Prior thereto, on April 30, 1914, a charge was made to profit and loss on the books of the Illinois corporation and a credit to the partnership in the amount of $475,578.78, which had with it the explanation "Contra Credit to John Griffiths and Son, Partnership - Portion of Profit Earned on Boston Store Contract - Sections 7 and 8." On March 14, 1914, a check was drawn by the Illinois corporation in favor of the partnership in the amount of $425,578.78, and on the same day a check was drawn by the partnership and made payable to John Griffiths in the same amount as that paid by the corporation to the partnership. At the time the foregoing amount was transferred John Griffiths was considering the acquisition of certain real estate for which he desired to make payment in cash.
8. (f) The partnership was not dissolved on December 31, 1911, when the corporation was formed, but continued in existence until about 1915 or 1916.
8. (g) *1410 On August 1, 1911, John C. Ruettinger entered into an employment contract with the partnership for a period of three years, and, while the contract was assigned to the corporation upon its organization, it was desired by Ruettinger that the petitioners remain liable thereunder.
9. The partnership profits from March 1, 1908, to December 31, 1911, were as follows:
| Period | Amount |
| 3-1-08 to 10-31-08 | $2,953.17 |
| Year ended 10-31-09 | 401,524.48 |
| Year ended 10-31-10 | 13,729.80 |
| 11-1-1910 to 12-31-1911 | 10,323.29 |
| Total | 428,530.74 |
*1297 10. The profits of the partnership and the Illinois corporation for the calendar year 1912 are shown by the following statement:
| Item | Partnership | Corporation | Combined |
| Gross income from operations | $145,801.70 | $15,789.33 | $161,591.03 |
| Less: Expenses | 309.31 | 65,614.91 | 65,924.22 |
| 145,492.39 | 49,825.58 | 95,666.81 | |
| Add: Interest and other income | 8,324.01 | 3,884.44 | 12,208.45 |
| Net profit | 153,816.40 | 45,941.14 | 107,875.26 |
11. The capital of the partnership at the beginning and end of the fiscal years ended October 31, 1907, to October 31, 1911, inclusive, was as follows:
| Fiscal year ended - | Capital at beginning of year | Capital at end of year |
| 10/31/1907 | $82,971.38 | $86,754.48 |
| 10/31/1908 | 86,754.48 | 89,941.31 |
| 10/31/1909 | 89,941.31 | 451,913.78 |
| 10/31/1910 | 451,913.78 | 405,698.83 |
| 10/31/1911 | 405,698.83 | 332,269.61 |
*1411 12. In November, 1922, the Illinois corporation declared a stock dividend of $900 per share, thus increasing its capital stock to $1,000,000.
13. On September 5, 1923, a new corporation was organized under the laws of Delaware and having the same name as the Illinois corporation heretofore referred to. It had an authorized capital stock of $2,000,000, consisting of 10,000 shares of 7 per cent preferred stock of a par value of $100 per share and 40,000 shares of common stock of a par value of $25 per share.
14. Upon its organization, the Delaware corporation acquired all of the stock of the Illinois corporation then outstanding in the amount of $1,000,000, issuing therefor to the petitioners who were the sole stockholders of the Illinois corporation preferred stock of a par value of $1,000,000 and common stock of a par value of $750,000 and paying cash to the petitioners in the amount of $500,000. The Delaware corporation thereupon liquidated the Illinois corporation and took over its assets. In carrying out the reorganization the following resolution was adopted by the board of directors of the Illinois corporation on September 5, 1923:
WHEREAS, John Griffiths and Son*1412 Company, a corporation organized under the laws of the State of Delaware, has acquired the entire capital stock of this corporation and by virtue thereof and in consideration of the premises *1298 has requested this corporation to declare a liquidating dividend and to convey and transfer to it all of the real estate, personal property, assets, contracts, business, and good will of this company; and
WHEREAS, said John Griffiths and Son Company has offered to assume all of the debts and obligations of this corporation; and
WHEREAS, in the opinion of this Board of Directors said John Griffiths and Son Company is entitled by virtue of its ownership of the entire capital stock of this corporation to such dividend;
NOW, THEREFORE, BE IT RESOLVED that a dividend of all of the assets of this company be, and the same is hereby declared payable in kind to the John Griffiths and Son Company of Delaware, and that the President or Vice President and Secretary be and they are hereby authorized, instructed and empowered to execute such deeds, bills of sale and other instruments as may from time to time be necessary to carry into effect the provisions of this resolution and to make distribution*1413 of all assets; and
BE IT FURTHER RESOLVED that after the payment of such liquidating dividend and after the payment of all of the debts of this corporation all necessary steps be taken to dissolve this corporation pursuant to the laws of the State of Illinois.
15. Incidental to the closing of the books of the Illinois corporation and the transfer of assets to the Delaware corporation the following journal entry was made:
| Surplus | $1,114,681.01 | |
| Capital Stock | 1,000,000.00 | |
| Good Will | 135,318.99 | |
| To Investment | $2,250,000 |
16. An opening entry on the books of the Delaware corporation, except for two minor items not here involved, reflected a charge to "Investment account" of $2,250,000 and the following credits:
| Cash | $500,000 |
| Preferred stock | 1,000,000 |
| Common stock | 750,000 |
The explanation of the entry was that it was made to record the investment in the Illinois corporation.
17. At the time of the reorganization George W. Griffiths held 1,860 shares of stock in the Illinois corporation and John Griffiths the remainder, that is, 8,140 shares. In exchange for such stock the petitioners received stock of the Delaware corporation and*1414 cash as follow:
| George W. Griffiths | |
| Preferred stock, 1,860 shares (par value $100) | $186,000 |
| Common stock, 5,580 shares (par value $25) | 139,500 |
| Cash | 93,000 |
| Total | 418,500 |
| John Griffiths | |
| Preferred stock, 8,140 shares (par value $100) | 814,000 |
| Common stock, 24,420 shares (par value $25) | 610,500 |
| Cash | 407,000 |
| Total | 1,831,500 |
| Combined total | 2,250,000 |
*1299 18. In their income-tax returns for 1923, the petitioners, George W. and John Griffiths, reported capital net gain in the respective amounts of $93,000 and $407,000 and gave as an explanation therefor "Stock acquired prior to 1921 and exchanged on reorganization in 1923 for securities and cash."
19. On December 27, 1923, the following instrument was executed by the petitioners:
TO GEORGE W. GRIFFITHS:
This memorandum is to confirm the agreement we have had since February, 1915, that, if you remain an executive of John Griffiths & Son Co. until my death, you are, immediately upon my death, to purchase all my stock in that Company at its book value as shown on the books of that Company at the time of my death.
Under the terms of my present will which was executed in 1915, you were*1415 to pay the book value at the time of purchase, but in order that a more exact agreement I now agree that my estate will immediately upon my death sell this stock to you at its book value as above set forth, such price to be payable within one year after my death, the amount from time to time unpaid to bear interest at the rate of Six Per Cent. (6%) per annum, payable semi-annually.
The deferred installments shall be represented by your collateral notes secured by the pledge of all of the stock, such notes to be in form satisfactory to my executors, other than yourself, and to contain a clause that, in case of default in payment of interest on or principal of any note, all notes may immediately be declared due.
Your execution of a copy of this memorandum will constitute it our binding agreement, enforceable by you and by my estate, that my estate will sell and you will purchase this stock on the terms above set forth.
[Signed] JOHN GRIFFITHS
I accept the foregoing and agree to purchase whatever stock may be owned by John Griffiths at the time of his death and to pay for it in the manner set forth.
[Signed] GEO. W. GRIFFITHS
20. The charter of the Delaware corporation*1416 contains the following provision with respect to the redemption of its preferred stock:
The preferred stock, or any portion thereof, shall be subject to redemption at One Hundred Five Dollars ( $105) per share and unpaid cumulative dividends accrued thereon on any dividend payment date upon thirty days notice and in such manner as may be prescribed by the board of directors.
21. On October 30, 1925, the board of directors of the Delaware corporation adopted the following resolution:
*1300 RESOLVED that the entire issue of preferred stock of this corporation be redeemed on December 5, 1925 in accordance with the provisions of the Certificate of Incorporation of this corporation, at the price of $120.75 per share.
BE IT FURTHER RESOLVED that holders of said preferred stock desiring to convert said stock into cash on or after October 31, 1925, and in advance of the redemption date, be paid $120.06 per share, plus interest at the rate of six per cent (6%) per annum, computed from October 31, 1925 to the date of the surrender of their certificates of preferred stock.
22. In accordance with the foregoing resolution, the entire issue of preferred stock was retired in*1417 December, 1925, and upon such retirement the following distribution was made:
| Item | John Griffiths (81.4%) | George Griffiths (18.6%) | Total (100%) |
| Cash for par of stock | $814,000.00 | $186,000.00 | $1,000.000.00 |
| Premium | 40,623.12 | 9,282.43 | 49,905.55 |
| Dividend | 122,665.28 | 28,029.17 | 150,694.45 |
| Total | 977,288.40 | 223,311.60 | 1,200,600.00 |
23. In their returns for 1925, the petitioners made the following report of the above distribution:
| Item | George W. Griffiths | John Griffiths |
| Amount received | $223,311.60 | $977,288.40 |
| Value as of Mar. 1, 1913 | 58,149.09 | 254,480.43 |
| Capital net gain | 165,162.51 | 722,807.97 |
The same explanation was furnished with respect to each petitioner, namely, "Stock acquired in reorganization in 1923 in exchange for stock acquired prior to March 1, 1913."
24. The net income of the Illinois corporation for the five-year period ended August 19, 1923, was as follows:
| 1919 | (loss) | $7,050.73 |
| 1920 | 62,067.63 | |
| 1921 | 85,526.57 | |
| 1922 | 492,202.65 | |
| 1923 | 521,247.11 | |
| Total income | 1,153,993.23 | |
| Average for the five-year period | 230,798.65 |
25. The net tangible assets at August 19, 1923, as*1418 shown by the balance sheet of that date, were in the amount of $1,773.177.89 and the average net tangibles for the five-year period ended August 19, 1923, were in the amount of $1,163,293.11.
26. The books of the Illinois corporation show good will at March 1, 1913, in the amount of $17,717.16 and at the time of the reorganization in 1923 in the amount of $135,318.99.
*1301 27. The contracting business with which the petitioners were connected (including that of the partnership and the two successor corporations) was one of the largest of its kind in the Chicago district, where its principal operations were carried on. It had as much as $33,000,000 of work in performance at one time and a weekly pay roll of as much as $150,000. It constructed one of the largest buildings in the world and has carried out some of the biggest construction projects in Chicago. With the exception of minor losses in one or two instances the business has always operated at a substantial profit. The business has always been in a strong financial position and until subsequent to the years with which we are concerned had never had to borrow money to carry on its operations. There was little*1419 change in the organization and key men who carried on the business as between 1913 and 1923.
28. Prior to June 8, 1921, John Griffiths' daughter Margaret married Alfred Betancourt, a broker of Havana, Cuba, who carried on business under the name of Betancourt and Company.
29. In 1921 Mrs. Betancourt came to Chicago and negotiated an advance or loan from her father, John Griffiths, for $100,000 to her husband for the purpose of constructing a cable line from Havana, Cuba, to New York City. A check for $100,000, dated June 8, 1921, was turned over to George W. Griffiths, who delivered it to Alfred Betancourt in New York City. Subsequent to the delivery of the check to Betancourt, the following note was delivered to John Griffiths:
$100,000.00 CHICAGO, ILLS., June 8th, 1921.
On or before two years after date, for Value Received, We Promise To Pay to the order of John Griffiths the principal sum of One hundred thousand Dollars, with interest thereon at the rate of six per cent. per annum, payable semi-yearly, to wit: on the eighth day of June and of December in each year, until said principal sum is fully paid. Both principal and interest are payable at Chicago, Illinois.
*1420 It is further expressly agreed, that, if default be made in the payment of any one of the installments of interest aforesaid, at the time and place aforesaid, when and where the same becomes due and payable, and such default shall continue for ten days after such installment becomes due and payable, as aforesaid, then, and in that event, the said principal sum of one hundred thousand Dollars shall, at the election of the legal holder hereof, at once become and be due and payable, anything hereinbefore contained, to the contrary notwithstanding; such election to be made at any time after the expiration of said ten days, without notice.
The payment of this Note is secured by mortgage on real estate in The Republic of Cuba.
[Signed] ALFRED BETANCOURT
MARGARET G. BETANCOURT
BETANCOURT & COMPANY.
BY ALFRED BETANCOURT
*1302 The above note bears the following endorsement: "Pay to order of Margaret G. Betancourt without recourse on me. (Signed) John Griffiths." The foregoing endorsement was placed on the note by John Griffiths in order that his daughter might not be annoyed for payment in case of his death prior to the time when the note was paid. The note was*1421 never used and was always kept in possession of John Griffiths.
30. No interest or principal was ever paid on the aforementioned note. Betancourt and Company failed a short time after the money was advanced by John Griffiths. Investigations made by or on behalf of John Griffiths failed to disclose any assets in the hunds of Alfred Betancourt from which payment could be made. Margaret G. Betancourt had an income of $15,000 from a trust fund and Alfred Betancourt lived on money supplied by her. John Griffiths claimed a deduction in his return for 1925 in the amount of $40,000 on account of the worthlessness of the note and the entire deduction was disallowed by the Commissioner.
31. On May 6, 1921, John Griffiths made a loan of $5,000 to Thomas P. Shean, which was evidenced by a promissory note bearing interest at 6 per cent. The loan was secured by 92 shares of stock of the Shean Steel Window Company of a par value of $9,200, of which corporation Shean and his son were the principal stockholders. No interest was ever paid on the loan nor has the principal or any part thereof been paid. Shean was not a man of financial responsibility and the Shean Steel Window Company*1422 was in bad financial condition in 1922, 1923 and 1925. John Griffiths claimed a deduction in his return for 1925 of $5,000 on account of the foregoing loan and the Commissioner disallowed the deduction.
32. John Griffiths was, during the years here involved, a man of advanced age and it was necessary for him to use an automobile to go to his place of business. During the winters he spent a few months in Florida, and usually when he went to the office he left it about two or three o'clock in the afternoon. No deduction was claimed in his return for 1923 on account of automobile expense, but when an additional assessment was proposed for 1923 he made claim for a deduction, which was allowed to the extent of $552. In the 1924 return of John Griffiths, automobile expenses were set out in the amount of $4,022.20 and a deduction claimed to the extent of 75 per cent thereof, that is, $3,016.65. The Commissioner allowed only $600.96 of the amount claimed. In 1925 John Griffiths claimed a deduction of $1,949.73 as automobile expense and the Commissioner allowed $604.43.
33. On or about January 1, 1924, John Griffiths executed a lease for 99 years on certain property and in connection*1423 with such transaction *1303 paid commissions and fees to real estate brokers and attorneys in the amount of $31,108.54. In his return for 1924, he claimed a deduction of the entire amount as an ordinary and necessary expense, but the Commissioner, in his deficiency notice, treated the amount as a capital expenditure and allowed a deduction of one ninety-ninth thereof. In explanation of the action, it is stated in part: "All the above items are for expenses in connection with the 99 year lease of 29-35 S. Wabash Ave. to Von Lengerke and Antoine * * *."
OPINION.
SEAWELL: Collateral issues have been so magnified in the voluminous record presented for consideration in these proceedings that we deem it pertinent to state the two major issues involved, namely: (1) What capital net gain, if any, was realized by the petitioners in 1923 when in a reorganization they exchanged their stock in the Illinois corporation for stock of the Delaware corporation and cash? and (2) What capital net gain, if any, was realized by the petitioners in 1925 when the Delaware corporation redeemed its preferred stock? Both issues are closely related in that the parties are agreed that the starting*1424 point for the determination of gain in each instance is the March 1, 1913, value of the stock of the Illinois corporation. A great part of the petitioners' proof and argument deals with the proposition whether certain profits on the Boston Store contract were profits of the partnership or profits of the Illinois corporation; in fact, so much is this point emphasized that it would seem that petitioners are convinced that an answer to this question is decisive as to both of the principal issues involved. We disagree. We are not seeking to determine a tax on such profits, nor are we concerned with a tax on either the partnership or the Illinois corporation. It is of course true that earnings of a corporation prior to a given date are often used as a basis of values on that date, but we know of no rule of law from which it would follow that because the average earnings of a corporation prior to a given date were in a certain amount a valuation of its stock could necessarily be predicated thereon. The main purpose of the petitioners in urging that the profits from the Boston Store contract be considered as earnings of the Illinois corporation prior to March 1, 1913, is to arrive at*1425 the value of its intangible assets on that date under the method employed by the Commissioner in his ruling referred to as A.R.M. 34, but, as we said in , "since it is the stock we are considering and not the corporation's tangible or intangible assets, we are not directly concerned with a method, like, for instance, that set forth in A.R.M. 34, 2 C.B. (1920) 31, for arriving at the value of good *1304 will or other intangibles separately from the tangible or other assets, or a method for classifying or segregating the constituent parts which are reflected in the value of the stock representing the whole."
And, further, we are not particularly concerned with recommendations relied upon by petitioners which were made by various subordinates in the Bureau, but which were not accepted or acted upon by the Commissioner in determining the deficiencies here involved. Much is said by the petitioners with respect to conferences held in the Income Tax Unit and investigations made by revenue agents after the deficiency notices were issued; but suffice it to say that whatever conclusions were reached or recommendations*1426 made, they were not accepted by the Commissioner.
1. In short, the situation presented as to the first issue may be summarized as follows: For some 36 years prior to December 31, 1911, John Griffiths had been engaged in business as a contractor and builder, and during the seven or eight years immediately preceding December 31, 1911, he had associated with him in a partnership his son, George W. Griffiths, the two aforementioned individuals being the petitioners in these proceedings. On January 1, 1912, the partnership was succeeded by an Illinois corporation and stock of a par value of $35,000 was issued to the petitioners for the assets of the partnership and the remainder of the corporation's stock, $65,000, was paid for in cash by the petitioners. In 1922 a stock dividend was declared, which increased the outstanding stock to $1,000,000 and all of the stock continued to be held by the petitioners until September 5, 1923, though after March 1, 1913, certain gifts of stock were made by the father to the son. On September 5, 1923, the Illinois corporation was succeeded by a Delaware corporation in a reorganization through which the petitioners received preferred stock of a par*1427 value of $1,000,000 and common stock of a par value of $750,000 and $500,000 in cash for the stock held by them in the Illinois corporation. The Commissioner held that the foregoing transaction is governed by that part of section 202(e) of the Revenue Act of 1921 as amended by the Revenue Act of March 4, 1923, which reads as follows:
* * * when property is exchanged for property specified in paragraphs (1), (2), and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the amount of the gain resulting from succh exchange shall be computed in accordance with subdivisions (a) and (b) of this section, but in no such case shall the taxable gain exceed the amount of the money and the fair market value of such other property received in exchange.
That is, as we understand the situation, the Commissioner determined that the aggregate readily realizable market value of the common *1305 and preferred stock of the Delaware corporation received by the petitioners on September 5, 1923, was in excess of the March 1, 1913, value of the stock of the Illinois corporation*1428 held by them on that date, and that accordingly the gain to them, under the above-quoted provision, would be limited to the cash received by them, namely, $93,000 in the case of George W. Griffiths and $407,000 in the case of John Griffiths.
In the first place, it is contended by the petitioners that the stock received did not have a readily realizable market value because of an alleged agreement existing between the father and son as to the sale of the stock. Conceding for the purpose of discussion that the instrument set out under paragraph numbered 19 of our findings together with certain ambiguous statements appearing in the record establishes that an oral agreement existed at the time of the reorganization of the nature set out in the written instrument, we fail to see why that would have any effect on the market value of the stock at that time. The agreement would not become operative until the death of John Griffiths and he was not only alive at the date of the reorganization, but also at the time of the hearing in these proceedings. Such agreement did not restrict sales of stock by John Griffiths and George W. Griffiths only agreed to buy "whatever stock may be owned*1429 by John Griffiths at the time of his death." When the reorganization occurred John Griffiths could have sold his stock without legal cause for complaint on the part of George W. Griffiths by virtue of the agreement and a similar freedom of action existed on the part of George W. Griffiths, who owned the remainder of the stock.
In the next place, the petitioners contend with much earnestness that a valuation of the stock of the Illinois corporation at March 1, 1913, based upon the five-year period prior thereto (including the operations of the partnership from March 1, 1908, to December 31, 1911, and those of the corporation from January 1, 1912, to March 1, 1913), shows a value for such stock in excess of a value for the stock of the Delaware corporation on September 5, 1923, and $500,000 in cash when such value is arrived at in a similar manner by taking the five-year period of operations immediately preceding September 5, 1923. The following computation is used by the petitioners in arriving at the average earnings for the five-year period ended March 1, 1913:
| Total earnings of partnership from March 1, 1908, to December 31, 1911 (stipulated) | $428,530.74 |
| Combined earnings of partnership and corporation for the calendar year 1912 | 107,875.26 |
| Earnings of corporation - January 1, 1913, to March 1, 1913 | 898,655.37 |
| Total | 1,435,061.37 |
| Average for the five-year period | 466,690.35 |
*1430 *1306 While denying the materiality of the above earnings as a basis for valuing the stock at March 1, 1913, the Commissioner questions their accuracy, particularly for the period January 1, 1913, to March 1, 1913, and much of the evidence before us has to do with that feature. Specifically, what the petitioners contend in this connection is that no income is to be attributed to the partnership after the formation of the corporation, whereas the Commissioner maintains that the earnings for the period January 1, 1913, to March 1, 1913, are overstated to the extent of at least $475,578.78, which he considers as income of the partnership and therefore, even if we should adopt the method urged by the petitioners for valuing the stock, the earnings shown by the petitioners for that period should be reduced by the aforementioned amount. In further pursuance of the same method of valuation the Commissioner objects to the average net tangibles used by the petitioners for the five-year period in the amount of $466,690.35 on similar grounds. We have set forth in our findings the capital of the partnership at the beginning and end of the years October 31, 1907, to October 31, 1911, as*1431 stipulated by the parties, and as we understand the situation the parties are agreed that by the use of the foregoing stipulated amounts and taking into consideration the combined operations and assets of the partnership and corporation from October 31, 1911, to March 1, 1913, with appropriate adjustments, the average net tangible assets are as stated by the petitioners. Broadly speaking, the parties differ as to the continuing interest of the partnership in earnings and assets after it was succeeded by the Illinois corporation. We think it clear from the resolutions adopted at the time such succession took place that it was intended that all assets of the partnership would pass to the corporation and that all business thereafter would be carried on by the corporation, but we are likewise convinced that subsequent developments prevented the carrying out of the plan in all of its details. At the time of the formation of the corporation, the partnership had entered into a contract with the Netcher Estate for the construction of a section of the Boston Store. Prior to that time the partnership had constructed other parts of the same building and in awarding these contracts to the*1432 partnership the Netcher Estate relied much on the financial responsibility and reputation of the petitioners. Subsequent to the organization of the corporation, namely, March 21, 1912, supplemental contracts were entered into for another section to the Boston Store and certain other additions and the Netcher Estate insisted that these further contracts be executed by the partnership. In such work the Netcher Estate recognized only the partnership and looked to it for carrying out the terms of the contract. Slightly more than two-thirds of the cost *1307 of completing the contracts executed in 1911 and 1912 applied to the 1912 contracts. The total profit on the projects was $610,055.22. The work under the contracts was practically completed in 1912 or at least prior to March 1, 1913. In 1914 John Griffiths withdrew $475,578.78 from the corporation, which was shown on its books as the partnership's share of the profit on the Boston Store contracts.
Much evidence was introduced by the petitioners for the purpose of showing that all profits under the Boston Store contracts as well as all other contracts completed by the corporation after its organization belonged exclusively*1433 to the corporation, but we are not convinced from what appears in the preceding paragraph and other evidence in the record that such is the case. From the maze of exhibits offered, including ledgers, journals, contract records, journal entries and adjusted journal entries, balance sheets and adjusted balance sheets, and other similar data, it is difficult to reach any conclusion other than that a very confused state of affairs existed and that certainly to some extent the partnership or the petitioners apart from the corporation were directly concerned in the activities carried on after the formation of the corporation. Whether the amount by which the corporation profits should be reduced in arriving at the average profits for the five-year period ended March 1, 1913, was $475,578.78, the amount contended for by the Commissioner, we do not find it necessary to determine. Suffice it to say that with a condition thus existing we see little that is helpful in the earnings presented as a basis for valuing even the assets of the corporation, much less the stock, which is our immediate concern. In this connection, it should be observed that approximately two-thirds of the earnings for*1434 the five-year period contended for as a basis of valuation by the petitioners fall within the two-month period ended March 1, 1913, thus indicating an abnormal situation as to earnings. What the petitioners seem to be trying to establish is a value of good will@ or intangibles in addition to the tangible assets and from these combined assets arrive at a value for the stock, but when we consider the very irregular earnings here presented, the confused state of affairs existing from January 1, 1912, to March 1, 1913, and the personal element involved on the part of the petitioners in earning the income, we think it open to serious question whether such earnings afford any guide as to a valuation of the good will of the business here involved. Cf. . Much of any excess earnings over a fair return on tangible assets is certainly attributable to the efforts and reputation of the petitioners themselves, who were the sole stockholders of the corporation. An example of this personal element is shown in connection with the Boston Store contracts to which we have referred and we think a fair *1308 conclusion from*1435 the record to be that other large contracts came to the corporation in a similar manner. A purchaser of the stock, particularly if the petitioners thereby became dissociated from the business, would therefore certainly not pay a price for the stock based upon prior earnings when an important element in the production of such earnings would, after acquisition of the stock, be no longer present in the corporation.
We have considered the question of earnings as indicative of value at some length, not only because of the earnestness with which it has been urged upon us by the petitioners as a method of valuing the stock in question, but also because the average earnings and average net tangible assets form the basis of the so-called expert testimony produced. There were no sales of the stock of either corporation in 1913 or 1923 and therefore the petitioners sought to value the stock not only on the basis of earnings (A.R.M. 34, supra ), but also presented the testimony of three witnesses who testified as to the value of the stock of the Illinois corporation at March 1, 1913, and that of the Delaware corporation on September 5, 1923. However, when we come to analyze their testimony*1436 we find little in their qualifications or knowledge of stock values either in general or with reference to the particular stock here involved which would help us in solving the problem before us. As we said in , the "force of the opinion is derived from the care and ability used in forming it," and "opinions as to value are in each instance not arbitrarily to be either rejected or accepted entirely, but are reasonably to be weighed with all the other evidence in accordance with the demonstrated qualifications of each witness to form an opinion." And, as the court said in the recent case of ; certiorari denied, :
A jury need not accept the opinions of even a bevy of disinterested witnesses (); nor need a judge, (. It is hard to see why the Board should be more constrained; it acts as a judicial body. * * *
The first witness offered was Myron D. Goldberg, bank cashier, who had been in the banking business for some 25*1437 years and had had some experience in valuing stock, though the extent is not shown. His valuations were based on what is referred to as a banker's or "rule of thumb" method by which the value of a business would be determined by taking ten times the average annual earnings over a five-year period. In answer to a hypothetical question in which it was considered that the average annual earnings for the five-year period ended March 1, 1913, were approximately $287,000 and that *1309 for the five-year period ended September 5, 1923, were $230,000, he stated that in his opinion the value of the business on March 1, 1913, was $2,870,000, and on September 5, 1923, $2,300,000. The average earnings used at March 1, 1913, were those heretofore referred to as being contended for by the petitioners and which we have indicated our unwillingness to accept in their entirety, and the witness admitted that the personal element on the part of the petitioners was a factor to be considered in such valuation. While he testified that he knew the general reputation of the petitioners and the concerns with which they are or had been associated as contractors and builders, the knowledge seems to*1438 have been of the most general character. He knew nothing of the capital structure of any of the concerns and apparently did not consider such knowledge essential to a stock valuation; in other words, ten times the average annual earnings would show the value of a going business and the stock value would follow therefrom.
The next witness, O. P. Decker, was even less satisfactory than Goldberg. He was a young man 28 years of age, who had had a very limited experience in work which would qualify him to testify to the values with which we are concerned, and he had little knowledge edge of the petitioners' businesses here involved. His method was similar to that of Goldberg, namely, ten times the average earnings over a five-year period, and of course he reached a similar conclusion. He further stated that "the value of the business would not be influenced by the quantity of the tangible assets"; in other words, it would seem that giving to this witness the average earnings of a concern for a given period, the value of the business and its stock could be computed without difficulty. Simple, but how dependable and to what extent would a prospective purchaser invest funds therein*1439 on that basis?
The last witness offered in this connection was David Wyland, an accountant in the employment of Paysoff Tinkoff and Son Company, but we do not understand that it was purported to qualify him as an expert on stock values other than in the sense that an accountant might make a computation based upon a given statement of average earnings and net tangible assets - certainly, his experience as stenographer, auditor, and revenue agent in the Bureau of Internal Revenue and accountant for the period of two years since leaving the Government service would not seem to qualify him further. The factors used by him were the earnings and assets to which we have already referred and it is unnecessary to refer to the infirmities therein previously mentioned.
What the petitioners were seeking to establish by the above witnesses was that the stock of the Illinois corporation had a greater *1310 value on March 1, 1913, than the stock of the Delaware corporation on September 5, 1923, when received by the petitioners, and in further support of that contention each of the witnesses was asked the following, or a similar, question:
Would the fact that there was a restrictive*1440 agreement existing between the sole stockholders, who were father and son, whereby the father had contracted not to sell the stock to anyone except the son during his lifetime, and in case of death, the son should purchase the same; would that affect your valuation, Mr. Wyland?
The purpose of the question was to show that since only a negligible intangible value appeared on the books of the corporations and since the agreement referred to contemplated the acquisition of the stock at book value, no intangible value or at least none of a substantial amount could exist after the agreement was entered into, which was subsequent to March 1, 1913. But even if we should concede that the existence of such an agreement would seriously impair intangible values otherwise existing and stock values based thereon (cf. , we fail to see the materiality of questions as to the effect of an agreement when it is not shown to have existed. The instrument which the petitioners presented related to an agreement whereby George W. Griffiths agreed to purchase whatever stock John Griffiths might own at the latter's death, and nowhere do we find any provision*1441 "whereby the father had contracted not to sell the stock to anyone except the son during his lifetime." John Griffiths was still living at the date of the hearing in these proceedings.
In view of the foregoing and a careful consideration of all evidence presented on this issue, we are of the opinion that the action of the Commissioner in considering that the stock of the Delaware corporation received by the petitioners on September 5, 1923, had a readily realizable market value at least equal to the fair market value of the stock of the Illinois corporation on March 1, 1913, should be sustained and that accordingly the cash received represents taxable gain to them. The determination of the Commissioner is prima facie correct and the burden of proving higher values or different values from those shown by the Commissioner is on the petitioners. . We do not think such burden is met by the character of evidence here presented; in fact, the record tends to favor rather than discredit the Commissioner's determination. The amounts included by the Commissioner as taxable gain to the petitioners of $93,000 and $407,000 are the amounts*1442 reported by them in their returns, and we think such a determination is amply supported by the record. A small number of shares of stock were received by George W. Griffiths in 1914 and 1915 *1311 as gifts from John Griffiths, which would be valued as of the date of acquisition (section 202(a)(2) of the Revenue Act of 1921), but from the meager evidence submitted on this point we are not convinced that a value different from that used by the Commissioner may be applied. Some shares were also received by George W. Griffiths in 1923 as gifts from John Griffiths, but since these acquisitions took place after December 31, 1920, the basis would be the same as in the hands of the donor, who held the stock on March 1, 1913 (section 202(a)(2), supra ), and therefore what we have heretofore said as to the value of the stock on March 1, 1913, would be applicable to this stock.
2. The next issue is whether the Commissioner properly computed capital net gains for the year 1925 in the respective amounts of $155,157.28 and $679,021.64 in the cases of George W. Griffiths and John Griffiths on account of the redemption in that year of prefererd stock owned by them in the Delaware*1443 corporation. The entire issue of cumulative preferred stock of the Deleware corporation was called and retired on December 5, 1925, at $105 per share plus accumulated dividends. As a result cash was distributed to the preferred stockholders (petitioners in these proceedings) in the amount of $1,200,600, divided as follows:
| Redemption of stock | $1,049,905.55 |
| Accumulated dividends | 150,694.45 |
| 1,200,600.00 |
The preferred stock was acquired in 1923 at the time of the reorganization of the Illinois corporation, when $1,000,000 of common stock of that corporation was exchanged for $1,000,000 of preferred stock and $750,000 of common stock in the Delaware corporation plus $500,000 in cash. We held under the previous issue that the readily realizable market value of the stock of the Delaware corporation received by the petitioners was at least equal to the fair market value of the stock of the Illinois corporation held by them on March 1, 1913, and that therefore the entire amount of cash received was taxable to the petitioners. It was then unnecessary to determine the specific March 1, 1913, value of the stock, but in order to dispose of the present issue it becomes*1444 necessary to compare the March 1, 1913, value of the stock then held with the amount received in the retirement of the preferred stock in 1925, since the stock exchange in 1923 was considered nontaxable. The Illinois corporation had only common stock outstanding and therefore we must determine not only the value of that stock on March 1, 1913, but also what part of such value may be considered as allocable to the preferred stock which was issued by the Delaware corporation in 1923 and retired in 1925.
*1312 In computing the gain in question the Commissioner first determined stock values as follows:
| March 1, 1913, value of all stock of the Illinois corporation | $579,073.31 |
| Value on September 5, 1923, of the common stock of the Delaware corporation | $1,684,292.24 |
| Value on September 5, 1923, of the preferred stock of the Delaware corporation | 1,000,000.00 |
| Total value of all stock of the Delaware corporation | 2,684,292.24 |
In the above determination, the preferred stock of the Delaware corporation was assigned its par value, and the common stock of the Delaware corporation was given a value based upon the following computation:
| Average earnings for five-year period as set forth in supplemental protest | $261,786.53 |
| Deduct preferred stock dividend | 70,000.00 |
| $191,786.53 | |
| Deduct earnings sufficient to give common stock a par value on basis of $10 per share | 75,000.00 |
| $116,786.53 | |
| Capitalize balance at 12 1/2%, gives an additional value of | 934,292.24 |
| Add par value | 750,000.00 |
| Total value | 1,684,292.24 |
*1445 The March 1, 1913, value of the stock of the Illinois corporation as shown above is the same as the book value of assets of that corporation as set out in one of the numerous protests filed by or on behalf of the petitioners.
After determining the above values for the respective issues of stock, the Commissioner computed the amount of the March 1, 1913, value of the stock of the Illinois corporation allocable to the preferred stock of the Delaware corporation and the taxable gain to the petitioners on account of the redemption of the preferred stock as follows:
| $1,000,000.00/$2,684,292.24 of $579,073.31 = Amount of March 1, 1913, value of | ||
| the stock of the Illinois corporation allocable to the preferred stock of the Delaware corporation | $215,726.63 | |
| Distribution on Preferred (Exclusive of dividend) | 1 1,049,905.55 | |
| Less: Basis (above) | $215,726.63 | |
| Total gain | $834,178.92 | |
| John Griffiths | 81.40% | 679,021.64 |
| George W. Griffiths | 18.60% | $155,157.28 |
*1446 *1313 Under the previous issue we pointed out some of the reasons why the evidence offered as to the value of the stock of the Illinois corporation on March 1, 1913, and that of the Delaware corporation on September 5, 1923, was not acceptable as showing that the former stock did not have a greater value than the latter on the respective dates mentioned. The same evidence is relied upon in connection with the present issue and it is, of course, unnecessary to repeat what has been said. However, when we consider the record before us in all of its remifications (including the aforementioned evidence of value offered by the petitioners), we find ourselves unable to agree with the determination of the Commissioner on this point. In the first place, it appears that the Commissioner in order to reach the results obtained by him found that the total value of the stock of the Delaware corporation on September 5, 1923, was $2,684,292.24, whereas he found a total value for the stock of the Illinois corporation on March 1, 1913, of only $579,073.31, that is, approximately one-fifth of the former value. And when we come to examine the method by which these results were reached, we*1447 find that the 1913 valuation purports to be based upon book values, whereas the 1923 valuation is arrived at through a capitalization of average annual earnings over the five-year preceding period and thereby adding approximately $1,000,000 in the form of an intangible value to existing book values. The methods used are not only very different, but also, in the light of the record presented, we do not think the results may be supported. The stock of both corporations was closely held and we have no sales to serve as a guide to values. The corporations in which the petitioners held stock were a continuation of a business which has been in operation for 55 years. The books of the corporation showed good will on March 1, 1913, in the amount of $17,717.16 and at September 5, 1923, of $135,318.99. Apparently, both amounts were merely balancing figures and did not purport to represent actual values. How much good will or intangible value may attach to a business of this kind, or at least might be considered in determining the fair market value of the stock where so much of a personal element is involved, it is difficult to determine.
However, when we consider that the business had*1448 been in operation many years prior to March 1, 1913, and that practically the same organization existed on September 5, 1923, an on March 1, 1913, we are unwilling to accept a valuation which places a value on such intangibles *1314 of approximately $1,000,000 at September 5, 1923, and practically leaves out of consideration intangibles at March 1, 1913. The net tangibles at August 19, 1923, were in the amount of $1,773,177.89, and we have already indicated our difficulty in arriving at the net tangibles at March 1, 1913, because of the mixed corporate and partnership relations on that date. As indicated above, the Commissioner used a net book value on March 1, 1913, of $579,073.31 which apparently included a good will value of $17,717.16, whereas the petitioners contend for net tangibles on that date of $900,944.17. Asset values back of stock are of course no infallible guide to the value of the stock itself, but, in closely held corporations where we have no sales, the values back of the stock may be used as an aid in determining fair market value. Cf. *1449 (affd., , and certiorari denied, Oct. 26, 1931). When we consider the earnings of the business prior to March 1, 1913, as well as prior to September 5, 1923, and the history of the business, we are convinced that some intangible value attached to the business and that it is unreasonable to find, as the Commissioner has found, that the intangible value was negligible at March 1, 1913, but had a value of approximately $1,000,000 on September 5, 1923.
After considering all the evidence of record, including the opinion evidence offered by the petitioner, the earnings prior to the two dates in question, the asset values, and the determination as made by the Commissioner, we have reached the conclusion that the fair market value of the stock of the Illinois corporation on March 1, 1913, was $1,000,000 and that of the Delaware corporation (including both common and preferred stock) on September 5, 1923, was $2,000,000, one-half of which should be allocated to common and one-half to preferred stock. Since one-half of the total value of both the common and preferred stock of the Delaware corporation on September 5, 1923, is*1450 attributable to the preferred stock, we think a reasonable allocation of the total March 1, 1913, value of the stock of the Illinois corporation of $1,000,000 would be in the same proportion, that is, $500,000 to the preferred stock, and $500,000 to the common stock. (Cf. .) John Griffiths held 81.4 per cent of the stock and George W. Griffiths, 18.6 per cent and therefore the part of the March 1, 1913, value allocable to the preferred stock which would be attributable to their respective interests would stock which would be attributable to their respective interests would be $407,000 and $93,000. As shown in our findings, the total cash of $1,200,600 distributed in the redemption of the preferred stock was paid to the petitioners on the basis of their respective interests, John Griffiths receiving $977,288.40 and George W. Griffiths, $223,311.60. The capital gain realized is therefore $570,288.40 ($977,288.40 less $407,000) in the case of John Griffiths and $130,311.60 ($223,311.60 less $93,000) in the case of George W. Griffiths.
*1315 3. The third issue is the claim of petitioner John Griffiths that he is entitled to a deduction*1451 in 1925 of $100,000 on account of a loan in that amount to his son-in-law, Betancourt, in 1921, which petitioner says became worthless in 1925. The contention of the petitioner is that the transaction by which Betancourt received the $100,000 was entirely of a business character, that this petitioner determined in 1925 that he could never hope to recover any of it, and that therefore a deduction should be allowed as a worthless debt. We are not convinced that either premise upon which the conclusion is based is sound. In the first place, we can not overlook the relationship of the parties and the circumstances surrounding the advancing of the money. Of course, a man may make a loan to his son-in-law in the same business sense as to a stranger, but where the loan is made at the instigation of his daughter, where the son-in-law was without means to secure the loan and where the father made little or no investigation of the practicability or soundness of the scheme in which the funds would be used, we question the correctness of saying that a loss should be allowed when the scheme in which the funds are invested fails and the son-in-law fails to make repayment. An advance to the*1452 son-in-law or daughter would not be an allowable deduction when made, and likewise we think that a deduction may not be allowed on account of such advance when it is found that it can not be returned, even though it was hoped that it might be returned when made.
But even if we should say that there was a bona fide loan, we fail to see the justification for saying that it or any part of it became worthless in 1925. The loan was made in 1921 and the evidence indicates that Betancourt lost it long before 1925 and had no other assets from which recovery might have been had. The daughter had an annual income of $15,000 and had signed the note, but there is no indication that the father sought to have her make payment on the note. In fact, the endorsement on the note ("Pay to the order of Margaret G. Betancourt without recourse upon me. [Signed] John Griffiths."), which was explained by the father as being placed thereon "So that my daughter would not be annoyed by it in case of my death or harassed to be paid," would indicate that the father was unwilling to seek payment from one of the parties shown on the note as liable regardless of her financial condition. The observations*1453 of the Court of Appeals of the District of Columbia in the recent case of , and which involved a somewhat similar situation, are here pertinent:
And our consideration of the record leads us to the same conclusion, for the taxpayer is neither required to be an incorrigible optimist and ignore the worthlessness of a debt that stares him in the face, nor to throw good money *1316 after bad to get the judgment of a court and the failure of a sheriff to demonstrate a fact he already knows. ; .
But where the taxpayer, because of family ties or personal relations between himself and his debtor, is not willing to enforce payment of his debt, in whole or in part, he is not thereby entitled to deduct it from his income tax as worthless.
On the whole record, we are of the opinion that the deduction claimed may not be allowed either in whole or in part.
4. With respect to the deduction claimed by John Griffiths in 1925 on account of a loan of $5,000 to Thomas P. Shean in 1921, we are not convinced*1454 that the debt was ascertained to be worthless in 1925. The most we know is that the Shean Steel Window Company, of which the debtor and his son were the principal stockholders, was in bad financial condition in 1925, but it was apparently still in existence. Petitioner George W. Griffiths, who gave us the only information we have on this issue, was sure that the Shean corporation was in bad financial condition in 1925 and that Shean himself was not a man of financial responsibility, but he did not know whether the corporation's liabilities exceeded its assets. He further testified that the note with collateral attached was practically worthless in 1922 and 1923, stating that he might have given a hundred dollars for it in those years. The action of the Commissioner in disallowing the deduction is sustained.
5. A deduction is claimed by John Griffiths for each of the years involved on account of an automobile which he used partly for business and partly for pleasure. From the meager evidence submitted on this point, we are unwilling to say that the deductions allowed by the Commissioner are not sufficient to cover the amount allowable, and therefore his action is sustained.
*1455 6. With respect to the contentions of the petitioners that each of them is entitled to a deduction of $5,000 in 1925 on account of stock of the Espenhain Dry Goods Company, determined to be worthless in that year, and the further contention that George W. Griffiths is entitled to a deduction in 1925 on account of club dues, the evidence is either so unsatisfactory or so deficient that we are unable to make any findings on these issues or to reach any conclusion contrary to that followed by the Commissioner, and his action is accordingly sustained.
7. The final issue is whether the amounts expended by John Griffiths in 1924 in negotiating a lease on property owned by him should be allowed as a deduction in that year or should be allocated over the term of the lease and a pro rata part allowed as a deduction in each year. The Commissioner pursued the latter course, *1317 which is in accordance with the decisions of the Board. ; affd., , and cases therein cited. The action of the Commissioner is accordingly sustained.
Judgment will be entered under Rule 50.
TRAMMELL did*1456 not participate in the consideration of or decision in this report.
Footnotes
1. The Commissioner conceded in his brief that in accordance with the provisions of section 201(c) and (g) of the Revenue Act of 1926 the accumulated dividends on the preferred stock paid at the time of its retirement should be considered as part of the full amount received in computing the capital net gain. ↩