*1961 1. An instrument in the form of a lease, whereby property is expressly leased with an option to the lessee to purchase within the term, can not be treated as a conveyance or sale, on oral testimony of the lessor's attorney as to his understanding, derived from oral conversations with the lessee, that the lessee's exercise of the option was reasonably certain, and a commission unconditionally paid for negotiating the lease can not be treated as part of the cost to the lessor of the property in determining gain from a sale made pursuant to the option.
2. Profit realized by the petitioner on the cash basis, in 1923 and 1924, from the sale in 1923 of leaseholds, owned by himself and another jointly, to a corporation organized to take over the property, determined on the basis of the difference between (a) total payments received, either constructively or actually, in 1923 and 1924 (consisting of one-half of net receipts in each year as reflected in an account of joint venturers with the corporation; one-half of mortgage indebtedness of joint venturers assumed and paid by the corporation in 1923, as shown by an account of the corporation kn the books of the mk rtgagee! and the amounts*1962 paid to petitioner in each year representing advances by petitioner and interest assumed by the corporation as part consideration for the leases), reduced by one-half of the total advances made by petitioner during the joint ownership and interest on the total advanced; and (b) one-half of the admitted total cost of the leaseholds, the latter amount being first applied against the total payments, less advances and interest, received in 1923.
3. On the evidence, there is no justification for the conclusion that the receipts which went into the account of the joint venturers were chargeable to the petitioner only to the extent of actual withdrawals by him, or that petitioner suffered a loss on account of embezzlement by his coventurer through excessive withdrawals.
4. Petitioner and F, who were joint venturers in numerous projects organized a corporation for the purpose of negotiating a loan through it, to be used in erecting a building and paying carrying charges. The unused portion of the loan was charged on the books of the corporation to petitioner and F, in equal proportions, with a notation that petitioner and F agreed that the unused funds should be treated as anticipated*1963 profits and divided equally and and that they were paid into an account for use in carrying other properties held by petitioner and F jointly. Three years later the accounts of petitioner and F were brought into balance by entries crediting them and charging profit and loss. The books were kept by F. Petitioner knew nothing of the entries and testified he never received a penny from the corporation. Held, the book entries supported the Commissioner's conclusion that the first entry was a joint advance to petitioner and F and the closing of the accounts was in substance a distribution of profits of the corporation; that the receipt of the unused funds by F for the joint account of petitioner and F constituted a constructive receipt by petitioner; and the amount so received on behalf of petitioner could not be excluded from his gross income on his testimony that it did not come into his actual possession.
*1134 The respondent determined a deficiency in petitioner's income tax of $6,803.96 for 1923 and $1,554.79 for 1924. The petitioner contends*1964 (1) that he is entitled to have brokerage commissions added *1135 to the cost basis of property sold; (2) that income with which he has been charged by the respondent as having been derived as profit upon the sale of certain realty was not in fact received, despite indications shown by bookkeeping records; (3) that income attributed to him by the respondent for 1924 as derived from a realty corporation was not in fact received; and (4) that to the extent that any of the foregoing items may be resolved against him, the measure of the tax is the capital gain tax and not that imposed upon ordinary income.
FINDINGS OF FACT.
The petitioner, an individual residing at 23131 Lake Shore Boulevard, Cleveland, Ohio, is a retired manufacturer and president of the board of directors of the National Acme Co.
1. On September 16, 1919, the petitioner leased a certain tract of land known as the Boyd property, situated in an industrial center on the lines of the Cleveland & Mahoning Valley Railroad, in Warrensville Township, Cuyahoga County, Ohio, to the Harbutt Realty Co. for a term of five years, at an annual rental of $9,000. The lease was in writing and gave the lessee an option*1965 to purchase the property at any time within the term of the lease, for $150,000 for the whole or for $3,000 per acre if the option was exercised as to only a portion. The petitioner in 1919 paid a commission fee of $4,500 for the negotiation of this lease. In 1923 and 1924 the petitioner sold the leased property, in two parcels, to the Harbutt Realty Co.
2. In 1916 the petitioner agreed with J. L. Free, who was engaged in a real estate business in Cleveland and interested in developing a business thoroughfare known as Prospect Avenue, to assist in financing some of the latter's realty operations. It was agreed that Free should conduct and manage all of the affairs of the joint interests; that the petitioner should furnish the funds necessary to carry any properties which might be acquired jointly, until they could be disposed of; and that the gains and losses arising from transactions in which they were jointly interested should be shared equally by the two parties.
Between 1916 and 1924 Free acquired several properties for the joint interests. Most of the properties were vacant lands in the vicinity of Prospect Avenue and were acquired under 99-year leases, under which*1966 the petitioner and Free were joint lessees. From time to time during that period, the petitioner made advances to Free to pay the carrying charges on properties of the joint interests, his advances for this purpose amounting in all to approximately $500,000.
Under the arrangement between them, Free had control over all funds. Free never told the petitioner that he was drawing on the funds of the joint interests for his personal use and the petitioner *1136 did not learn that Free had been doing so until after an examination of the accounts in 1927 by a certified public accountant. At the close of 1923 and 1924 the account of Free, on the Prospect Avenue Account, showed credit balances of $39,308.84 and $12,341.73, respectively.
All financial transactions of the joint interests were recorded in a set of books and records, known as the Prospect Avenue Account. There were also recorded in these books financial transactions of Free in which the petitioner had no interest whatever. These books and records were kept under the personal supervision of Free, and the petitioner never saw them. Free furnished the petitioner with annual statements purporting to show the receipts*1967 and expenditures of the joint interests.
Among the properties acquired for the joint interests, were two adjacent properties on Prospect Avenue, known as the Hatch and Dagleisch properties, which were acquired in 1916 and 1917 under 99-year leases. The cost of these leaseholds and the buildings erected thereon was $69,292.31. In 1923 the petitioner and Free organized, under the laws of Ohio, a corporation known as the 1600 Prospect Co., for the purpose of taking over and improving these properties. All of the shares of the corporation, consisting of 100 shares of no-par value common, except qualifying shares to directors, were issued to the petitioner and Free, in equal amounts. The cost to the petitioner of the shares issued to him was $250. The petitioner and Free transferred their interests in said Hatch and Dagleisch properties to the corporation, and on March 1, 1923, the transaction was recorded on the corporate books by the following journal entries:
| Debits | Credits | ||
| Inventory | $201,720.01 | ||
| Prospect Avenue Account | $160,232.72 | ||
| A. W. Henn | 41,487.29 | ||
| To set up Hatch & Dagleisch property leases, carrying charges as below: | |||
| Hatch property interest: | |||
| Nov. 1, 1917 to Mar. 1, 1923 | $4,531.54 | ||
| Carrying charges | 22,055.16 | ||
| Dagleisch property interest: | |||
| Apr. 1, 1917 to Mar. 1, 1923 | 2,313.74 | ||
| Carrying charges | 12,586.85 | ||
| 41,487.29 | |||
| Prospect Avenue Account | 41,600.00 | ||
| Notes Payable Union Mortgage Co | 41,600.00 | ||
| To 1600 Prospect Company assuming this mortgage to apply as purchase price of leases. |
*1968 Between March 1 and July 18, 1923, the petitioner's account on the books of the 1600 Prospect Co. was credited with interest in the sum of $954.12, which, with the credit item of $41,487.29 shown by the above journal entry, brought the credit balance in that account to $42,441.41.
On or about March 1, 1923, the 1600 Prospect Co. issued its bonds of a total face amount of $200,000 to the Union Mortgage Co. The *1137 following is a transcript of the account with the 1600 Prospect Co. on the books of the Union Mortgage Co.:
| Date | Description of item | Debits | Credits | |
| Mortgage bond issue | $200,000.00 | |||
| Accrued interest, 4-1-23 to 4-17-23 | 661.04 | |||
| Discount on bonds (sold at 88.3) | $23,400.00 | |||
| Notes payable - Union Mortgage | 41,600.00 | |||
| Interest payable - Union Mortgage | 986.51 | |||
| Prospect Avenue Account: | ||||
| Note | $20,000.00 | |||
| Interest | 1,529.88 | |||
| 21,529.88 | ||||
| H. & F. Realty Company: | ||||
| Interest, 3-10-23 | 5,282.31 | |||
| Financial expense - Attorney bill | 600.00 | |||
| Apr. 19, 1923 | Cash | 23,262.34 | ||
| July 8, 1923 | Cash | 14,000.00 | ||
| Oct. 25, 1923 | Cash | 14,000.00 | ||
| Dec. 31, 1923 | Cash | 14,000.00 | ||
| Apr. 1, 1924 | Cash | 14,000.00 | ||
| Apr. 1, 1924 | Cash (Advance on July) | 7,000.00 | ||
| May 19, 1924 | Cash (Advance on July) | 6,930.00 | ||
| Discount | 70.00 | |||
| July 30, 1924 | Cash | 13,720.00 | ||
| Discount | 280.00 | |||
| 200,661.04 | 200,661.04 |
*1969 The debit item "Note payable - Union Mortgage, $41,600" in the above transcript, represents the indebtedness of the petitioner and Free, secured by a mortgage against the Hatch and Dagleisch leaseholds, which was assumed by the 1600 Prospect Co. as a part of the consideration for the transfer of said leaseholds to the latter by the petitioner and Free. The debit item "Prospect Avenue Account, $21,529.88" represents a borrow of $20,000 made by the joint interests early in 1923, and interest thereon, of $1,529.88, which was assumed by the 1600 Prospect Co. as a part of the consideration for the transfer of the Hatch and Dagleisch leaseholds by the petitioner and Free.
Under date of July 18, 1923, the petitioner, Free, the 1600 Prospect Co., and the George W. Stone Co. entered into the following agreement:
THIS AGREEMENT by and between A. W. Henn, hereinafter termed First Party, J. L. Free, hereinafter termed Second Party, The 1600 Prospect Company, hereinafter termed Third Party, and The George W. Stone Company, hereinafter termed Fourth Party, WITNESSETH:
That, WHEREAS first and Second Parties, as Lessees in the two certain leases of property situated on Prospect Avenue, which*1970 said leases are known as the Hatch and Dagleisch leases, have heretofore as of January 1, 1923, executed sub-leases of said premises to Third Party, which said sub-leases are respectively recorded in Vol. 126, pages 67-76, inclusive, and Vol. 122, pages 392-400, inclusive, of Cuyahoga County Records of leases, and which said subleases have been modified and amended by indentures of lease executed of even date with this agreement; and
WHEREAS, First and Second Parties own in equal amount all the authorized eapital stock of Third Party, all of which is issued and outstanding, to-wit: one hundred (100) shares of common stock of no par value; and
*1138 WHEREAS, Third Party is indebted to First Party in the amount of $42,441.41, principal and interest to July 18, 1923; and
WHEREAS, Third Party is also indebted to First and Second Parties in the amount of the proceeds of certain $200,000.00 face value of first mortgage leasehold bonds secured by mortgage to The Midland Bank of Cleveland, Ohio, as Trustee, which said bonds were sold by Third Party to the Union Mortgage Company, less such an amount of said proceeds as were required by the company to pay its other obligations and*1971 will be required by the company to pay its fixed charges, including rentals and interest due and payable on January 1, 1924, and taxes for the first half of the year 1923, payable on December 20, 1923; and
WHEREAS, said Fourth Party desires to purchase from First Party all of the stock of Third Party which is owned by First Party, to-wit fifty (50) shares;
Now, THEREFORE, in consideration of these mutual promises said parties agree as follows:
Fourth Party will assume the said obligation of Third Party to First Party in the amount of $42,441.41, paying to First Party $10,000 in cash on the execution of this instrument, and the balance as follows: $10,000.00 in sixty (60) days; $10,000.00 in one hundred twenty (120) days; and $12,441.41 in one hundred eighty (180) days, the deferred payments to draw interest at six per cent.
First Party agrees that, upon the completion of said payments, as aforesaid, he will transfer and deliver to Fourth Party said one-half interest, i.e. fifty (50) shares of the stock of Third Party owned by First Party.
Third Party agrees that said indebtedness so assumed and paid by Fourth Party shall be transferred to Fourth Party.
Fourth Party agrees*1972 that it will carry said indebtedness of Third Party and likewise advance to Third Party such sums as may be required, over and above Third Party's income, to meet Third Party's carrying charges from and after January 1, 1924, i.e., interest, rentals, taxes and all other expenses, and will not demand or receive payment therefor until such time as Third Party shall have refinanced itself by a bond issue or mortgage loan upon its said properties sufficient to pay Third Party's outstanding indebtedness including that to Fourth Party, and in addition to provide funds sufficient for the erection of a building or buildings upon said leasehold properties costing not less than $500,000.00, and carrying charges and incidental expenses until such buildings are completed; it being the intention of the parties that Third Party will issue and Fourth Party will purchase bonds to provide funds for the purposes aforesaid at such time as said parties shall agree that it is wise to undertake said improvement. It is agreed that all carrying charges of Third Party, including interest and rentals due and payable January 1, 1924, and taxes due and payable on December 20, 1923, to the extent that same are*1973 not met by the income of Third Party, shall be defrayed from the proceeds of said $200,000.00 leasehold bonds sold to The Union Mortgage Company, and that the balance of the proceeds from the sale of said bonds shall be paid to First and Second Parties, and that said sums, together with the sums heretofore paid by Third Party to First and Second Parties from the proceeds of said bond issue, shall be in full satisfaction and discharge of all claims of First and Second Parties against Third Party, other than the $42,441.41 assumed as aforesaid.
IN WITNESS WHEREOF, the parties have hereunto set their hands as of the 18th day of July, 1923.
*1139 The petitioner did not read the above quoted contract before he affixed his signature thereto. It was not his custom to read contracts of this nature; he usually referred them to his attorney and if the latter approved, the petitioner signed them. The petitioner never received any promissory notes or other evidences of indebtedness of the 1600 Prospect Co. He had been advised by Free that the proceeds of the company's bond issue were to be used by the company for improvement of the Hatch and Dagleisch properties. Free never advised*1974 the petitioner of the nature of any entries, debit or credit, made to the latter's account on the books of the Prospect Avenue Account or of the 1600 Prospect Co.
After the sale by the petitioner of his stockholdings in the 1600 Prospect Co. to George W. Stone Co., and on September 15, 1923, an entry was made on the books of the 1600 Prospect Co., charging the petitioner's account and crediting the account of the George W. Stone Co. with the sum of $42,441.41, the entry bringing the petitioner's account into balance.
The books and records of the 1600 Prospect Co. and of the Prospect Avenue Account can not be located; Free, under whose supervision the books and records were kept, is now deceased. The following is a statement of the cash receipts and disbursements of the Prospect Avenue Account for 1923 and 1924, prepared by a certified public accountant in 1927 when the books and records were available.
| 1923 | 1924 | |||
| BALANCE | ||||
| Beginning of period | $33.63 | $12,689.07 | ||
| RECEIPTS | ||||
| Properties | ||||
| Hatch-Dagleisch | $4,639.71 | 0 | ||
| Evans | 4,807.90 | $5,078.75 | ||
| Talgarth Hotel | 38,878.11 | 32,136.97 | ||
| Prince | 4,083.33 | 0 | ||
| Gregg | 1,500.00 | 1,500.00 | ||
| Page | 1,885.00 | 1,790.00 | ||
| Metzger | 222.50 | 125.00 | ||
| McKelvey | 222.50 | 0 | ||
| Advances | ||||
| 1600 Prospect Co | 72,102.50 | 33,760.00 | ||
| J. L. Free Co | 12,695.00 | 4,640.00 | ||
| H. & F. Realty Co | 4,370.00 | 800.00 | ||
| Boliver Prospect Co | 2,550.00 | 1,000.00 | ||
| Winton Hotel Co | 1,500.00 | 2,300.00 | ||
| Nela Overlook Land Co | 300.00 | 0 | ||
| J. L. Free | 30,348.67 | 900.00 | ||
| Ohio Truck Farms | 0 | 6,500.00 | ||
| 5000 Prospect Co | 0 | 3,490.00 | ||
| V. J. Free | 0 | 400.00 | ||
| Proceeds loans, etc. | ||||
| Reliance Trust Co | 7,192.39 | 0 | ||
| Cleveland Realization Co | 0 | 12,632.96 | ||
| Interest | 30.13 | 0 | ||
| Total receipts | 187,327.74 | 107,053.68 | ||
| Total to be accounted for | 187,361.37 | 119,742.75 | ||
| DISBURSEMENTS | ||||
| Properties | ||||
| Hatch-Dagleisch | $2,204.22 | 0 | ||
| Evans | 4,237.12 | $5,592.45 | ||
| Talgarth Hotel | 31,966.74 | 31,310.50 | ||
| Prince | 886.65 | 0 | ||
| Gregg | 6,160.00 | 6,044.99 | ||
| Page | 1,408.22 | 1,439.95 | ||
| Metzger | 3,425.00 | 2,480.63 | ||
| McKelvey | 1,175.00 | 1,050.00 | ||
| Advances | ||||
| 1600 Prospect Co | 2,860.33 | 7,060.07 | ||
| J. L. Free Co | 13,771.50 | 11,892.25 | ||
| H. & F. Realty Co | 5,453.64 | 2,400.00 | ||
| Winton Hotel | 1,500.00 | 0 | ||
| Nela Overlook Land Co | 1,675.00 | 2,610.00 | ||
| J. L. Free | 59,137.29 | 32,259.33 | ||
| Ohio Truck Farms | 2,100.00 | 100.00 | ||
| Bolivar Prospect Co | 2,400.00 | 915.00 | ||
| V. J. Free | 500.00 | 400.00 | ||
| A. W. Henn | 250.00 | 0 | ||
| Accounts payable, paid | ||||
| Invoices - Hotel Talgarth | 10,808.12 | 5,618.64 | ||
| Taxes: | ||||
| Prince property | 787.83 | 0 | ||
| 1600 Prospect | 3,454.99 | 0 | ||
| Bolivar Garage | 1,776.03 | 0 | ||
| Gregg property | 2,868.67 | 0 | ||
| Talgarth Hotel | 5,410.60 | 6,193.52 | ||
| Evans | 1,075.00 | 0 | ||
| Other accounts payable | 5,524.84 | 3,157.78 | ||
| Miscellaneous disbursements | ||||
| Bills payable | 692.00 | 423.00 | ||
| Allen loan | 100.00 | 0 | ||
| Carris | 1,000.00 | 0 | ||
| Expenses | 63.51 | 49.95 | ||
| Miscellaneous | 0 | 8.46 | ||
| Total disbursements | $174,672.30 | $121.006.52 | ||
| Balance, end of period | 12,689.07 | 1 1,263.77 |
*1140 The items listed above under the caption "Properties," under both receipts and disbursements, are properties which were owned jointly by the petitioner and Free. As to the items listed under the caption "Advances," under both receipts and disbursements, the petitioner owned one-half of the capital stock of the 1600 Prospect Co. and of the H. & F. Realty Co., a part of the capital stock of the J. L. Free Co., of the Bolivar Prospect Co., and of the Winton Hotel Co., and he was interested in the Bolivar Garage. He did not own any stock or interest in the Nela Overlook Land Co., the Ohio Truck Farms, or the 5000 Prospect Co. The item "Allen Loan, $100," listed under miscellaneous disbursements for 1923, represents a joint advance to a manager. The books of the Prospect Avenue Account show that the sum of $20,000 was received from the Union Mortgage Co. in March, 1923, and this item is included in the total receipts from the 1600 Prospect Co. for 1923, of $72,102.50.
The respondent determined that the sale of the Hatch and Dagleisch leaseholds to the 1600 Prospect Co. in 1923 resulted in a taxable *1141 gain for that year of $132,427.70, *1976 representing the difference between an alleged selling price of $201,720.01 and a cost of $69,232.31. After deducting an item of interest in the amount of $6,845.28, which respondent held to be taxable to the petitioner alone, the respondent determined that the remainder of said profit, $125,582.42, was taxable to the petitioner and Free in equal amounts, and he has included one-half thereof, $62,791.21, in the petitioner's income for 1923.
3. In 1921 the petitioner and Free organized the H. & F. Realty Co., a corporation, for the purpose of obtaining a loan, which the petitioner and Free had individually been unable to obtain, to be used for erecting a building on a vacant lot and for payment of the carrying charges on the property. All of the capital stock of this corporation was owned equally by the petitioner and Free. The corporation successfully negotiated the borrow and erected a building, known as the Crawford Block.
On August 31, 1921, an entry was made in the journal, and posted to appropriate accounts in the general ledger, of the H. & F. Realty Co., as follows:
| Debit | Credit | |
| Prospect Avenue Account | $283.33 | |
| J. L. Free | 10,000.00 | |
| A. W. Henn | 10,000.00 | |
| Union Mortgage Co | $20,283.33 |
*1977 Money advanced 8/1/21, $20,000 and interest thereon to 9/10/21, date of bond issue. This money represents amount over and above amount required for building and carrying charges. It is therefore agreed by and between J. L. Free and A. W. Henn that this $20,000 should be treated in the nature of anticipated profits on Crawford Block, and divided equally. This was done and the entire amount was placed in the Prospect Avenue Account for use in carrying other properties held jointly by A. W. Henn and J. L. Free. See Prospect's books for credit accordingly. Accrued interest from 8/1 to 9/10, date of bond issue should be paid by Prospect Avenue Account, that account enjoying use of the money.
On December 31, 1924, a further entry, which carries no explanation, was made in the journal, and posted to the proper accounts in the general ledger, of the H. & F. Realty Co., crediting each of the accounts of the petitioner and Free with the sum of $10,000 and charging profit and loss account $20,000. This entry brought the petitioner's account into balance.
On January 1, 1925, another entry was made in the journal, and posted to proper accounts in the general ledger, of the H. & F. *1978 Realty Co., charging Crawford inventory account and crediting surplus account with the sum of $20,000. This journal entry contains the explanation: "To charge items advanced to J. L. Free and A. W. Henn, to Crawford inventory instead of loss."
*1142 The petitioner did not personally receive any part of the proceeds of the loan obtained by the H. & F. Realty Co., and the books of that company do not show any cash payment to the petitioner. The petitioner never saw the books of the H. & F. Realty Co.; he never gave any instructions to the bookkeeper of the company with reference to any entries made on the company's books under dates of August 31, 1921, and December 31, 1924, by which his account was charged and credited, respectively, with the sum of $10,000. In computing the petitioner's net income for 1924, the respondent has included the sum of $10,000. The respondent has increased the net income for 1924, as reported by the petitioner, by the sum of $10,000, on the ground that "the stock of the H. & F. Realty Company appears to have been sold during the year 1924 and the liability to repay the loan or advance was cancelled in that year."
The net incomes reported by*1979 the petitioner in the returns for 1923 and 1924 were computed upon the cash receipts and disbursements basis; and respondent's determinations of deficiencies for those years are based upon net incomes computed upon the same basis.
4. In computing petitioner's net income for 1923, the respondent determined gains and losses from sales or other dispositions of properties, as follows:
| GAINS | ||
| 1. East Eighty-second Street property | $9,005.00 | |
| 2. Harbutt Realty Co. (Boyd property) | 35,813.07 | |
| 3. Lake Erie Metal Products (Industrial Park) | 2,635.21 | |
| 4. Free deal (Industrial Park) | 5,191.50 | |
| 5. The 1600 Prospect transaction | 62,791.21 | |
| Total | $115,435.99 | |
| LOSSES | ||
| 1. International Steel Tube Co. stock | 5,000.00 | |
| 2. William Richey transaction | 52,441.57 | |
| Total | 57,441.57 | |
| Excess of gains over losses | 57,994.42 |
The gains, amounting to $115,435.99, were derived from sales or other dispositions of properties which had been held by the petitioner for more than two years; but the losses, amounting to $57,441.57, are stipulated to be not capital losses within the meaning of the Revenue Act of 1921. In computing the deficiency for 1923, the respondent has*1980 not taxed said gains of $115,435.99 at the rate of 12 1/2 per cent as provided in section 206 of the Revenue Act of 1921.
*1143 OPINION.
STERNHAGEN: 1. In 1923 and 1924 petitioner sold in two respective parts his interest in a tract of land purchased sometime prior to 1919. In 1919 the tract had been leased by petitioner for five years with an option to the lessee to purchase during that period in whole or in part, and for the brokerage service petitioner paid $4,500. He now seeks to have this payment treated as part of the cost of the property to be used as the basis for determining the gain derived from its sale, and to support this theory argues that, although the transaction consummated by the broker was in form a lease the express terms of which were unambiguous, it was really regarded by petitioner as a sale because his counsel had been told by the lessee that a steel-manufacturing company was interested in the site and expected to buy it, and that the lessee's exercise of the option was reasonably certain, all of which in fact took place, the sales of 1923 and 1924 being those expected in 1919. The only evidence of these extraneous circumstances is the oral*1981 testimony of petitioner's attorney as to his understanding and belief derived from oral conversations. This does not serve to convert the contract from the lease, which it ostensibly is for all other purposes, into a conveyance, or to justify attributing the commission to the later sales instead of to the lease which alone was executed when the commission was paid. The commission may have been unusually high for the service of negotiating a five-year lease, but whether it be so or not, it was unconditional, and there is no evidence upon which it could be apportioned to both the lease and the prospective sale. In accordance with earlier decisions of the Board, the proper recognition of the outlay in 1919 was to spread it over the term of the lease and deduct it in the years during which the rental was derived. ; ; . This requires an adjustment as to the unexhausted part of the commission in 1923 and 1924 when the land was sold, but this is a mathematical adjustment which can and should be made by the parties.
2. The*1982 second issue relates to both 1923 and 1924. Petitioner contends that the respondent erred in determining that he realized a profit of $62,791.21 in 1923 from the sale of his interest in the Hatch and Dagleisch leaseholds to the 1600 Prospect Co.; and that the respondent erred in failing to allow a loss of $65.43 for 1924 in connection with the same transaction. The cost of these leaseholds and the improvements thereon to the petitioner and Free are agreed by the parties to be $69,292.31. The respondent determined that the petitioner and Free transferred these leaseholds to the 1600 *1144 Prospect Co. for a consideration of $201,720.01, and that the profit to the joint interests from this transaction was $132,427.70, all of which was realized in 1923. He further determined that, of the total profit of $132,427.70, $6,845.28 was taxable to the petitioner alone, as interest, and that the remainder, $125,582.42, was taxable to the petitioner and Free in equal amounts. Accordingly, in computing petitioner's net income for 1923, the respondent included therein the sum of $62,791.21 as the petitioner's share of the profit derived from this transaction.
The respondent indicates*1983 in his brief that his determination as to the consideration involved in this transaction is based upon the entry in the journal, and properly posted in the ledger, of the 1600 Prospect Co., under date of March 1, 1923, by which the inventory account was charged with $201,720.01 and the accounts of the Prospect Avenue Account and the petitioner were credited with $160,232.72 and $41,487.29, respectively. The journal entry is set out in full in the findings of fact. It will be noted that the explanation in the journal entry sets out the details of the credit of $41,487.29 to the petitioner's account, which includes two distinct items totaling $6,845.28, and it is this latter sum which the respondent deducted from the alleged profit of $132,427.70, to arrive at the profit realized by the petitioner and Free jointly.
The petitioner contends that the Hatch and Dagleisch leaseholds were transferred to the 1600 Prospect Co. for a consideration which was indefinite in amount. It is alleged that the real consideration in this transaction is set forth in the fifth paragraph of the agreement of July 18, 1923, under which the petitioner disposed of his stockholdings in the 1600 Prospect*1984 Co. and a claim of $42,441.41 against that company to the George W. Stone Co. The agreement, to which Free and the 1600 Prospect Co. were also parties, is set out in full in the findings of fact. Briefly summarized, it recites that the petitioner and Free, as lessees of the Hatch and Dagleisch leaseholds, have executed subleases to the 1600 Prospect Co.; that the petitioner and Free are the owners, in equal amounts, of all of the 100 shares authorized no-par value common stock of the 1600 Prospect Co.; that the 1600 Prospect Co. is indebted to the petitioner in the amount of $42,441.41, principal and interest to July 18, 1923; that the 1600 Prospect Co. is indebted to the petitioner and Free "in the amount of the proceeds of certain $200,000 face value of first mortgage leaseholds bonds * * * sold * * * to the Union Mortgage Company," less such an amount as is required to pay the latter's obligations and fixed charges, including rentals, taxes and interest; that the George W. Stone Co. desires to purchase the petitioner's 50 shares of common stock of the 1600 Prospect Co.; and then provides, that the George W. Stone Co. will assume the obligation *1145 of the 1600 Prospect*1985 Co. to the petitioner, in the amount of $42,441.41, payment to be made in four installments, the last of which is due 180 days from July 18, 1923; that the 1600 Prospect Co. agrees that its indebtedness of $42,441.41 to the petitioner shall be transferred to the George W. Stone Co.; and "that all carrying charges of the Third Party [1600 Prospect Co.] * * * to the extent that same are not met by the income * * * shall be defrayed from the proceeds of said $200,000 leasehold bonds sold to the Union Mortgage Company, and that the balance of the proceeds * * * shall be paid to First and Second Parties [the petitioner and Free], and that said sums, together with the sums heretofore paid * * * from the proceeds of said bond issue, shall be in full satisfaction and discharge of all claims of First and Second Parties against Third Party, other than the $42,441.41 assumed as aforesaid."
While under this agreement there was some possibility of liquidation of the 1600 Prospect Co.'s indebtedness to the Prospect Avenue Account at less than its face value, it can not be said to alter the terms of the transaction by which the petitioner and Free (the Prospect Avenue Account) transferred the*1986 Hatch and Dagleisch leaseholds to the 1600 Prospect Co. The terms of that transaction are indicated only by the journal entries of the 1600 Prospect Co. set forth in the findings. Under the quadrilateral agreement of July 18, 1923, Henn and Free, acting under the Prospect Avenue Account, might receive the entire amount credited to that account on the books of the 1600 Prospect Co. on account of the purchase price of the Hatch and Dagleisch leaseholds, or might receive less, depending entirely upon the net proceeds of the bond issue of the 1600 Prospect Co. which under the last paragraph of that agreement would ultimately be available for that purpose. From the entry on the books of the 1600 Prospect Co. of March 1, 1923, it appears that the Prospect Avenue Account and the petitioner were credited with $160,232.72 and $41,487.29, respectively, a total of $201,720.01, on account of the purchase price of the Hatch and Dagleisch leaseholds, and we think from all the evidence that this must be taken to reflect the facts.
The statement of cash receipts and disbursements of the Prospect Avenue Account for 1923 and 1924, prepared from the books by a certified public accountant in 1927*1987 when the books were available, and which is set out in the findings of fact, discloses that in those years there were received from the 1600 Prospect Co. $72,102.50 and $33,760, respectively. The statement also shows disbursements by the Prospect Avenue Account of $6,315.32 for 1923 and $7,060.07 for 1924, as advances to the 1600 Prospect Co. Consequently, the net receipts by the Prospect Avenue Account from the 1600 Prospect Co. amounted to $65,787.18 for 1923 and $26,699.93 for 1924; and *1146 since there is no evidence of other transactions between the 1600 Prospect Co. and the Prospect Avenue Account, these net receipts should be applied entirely to the purchase price of the Hatch and Dagleisch leaseholds.
In addition to these receipts from the 1600 Prospect Co., the petitioner and Free were the direct beneficiaries of a certain payment made by the 1600 Prospect Co. The transcript of the account of the 1600 Prospect Co. on the books of the Union Mortgage Co. shows that the latter liquidated out of the proceeds of the 1600 Prospect Co.'s bond issue, in 1923, an obligation of the petitioner and Free of $41,600, secured by a mortgage against the Hatch and Dagleisch leaseholds. *1988 The obligation of $41,600 was assumed and paid by the 1600 Prospect Co. as a part of the consideration for the Hatch and Dagleisch leaseholds. This payment by the 1600 Prospect Co. was constructively received by the petitioner and Free in 1923, and the parties agree that it should be applied to the purchase price of the Hatch and Dagleisch leaseholds.
The evidence is that no promissory notes or other evidences of indebtedness were received from the 1600 Prospect Co. in connection with the transaction under consideration.
As previously pointed out, the acquisition by the 1600 Prospect Co. of the Hatch and Dagleisch leaseholds from the petitioner and Free was recorded on the books of the 1600 Prospect Co. at a purchase price of $201,720.01, of which $41,487.29 was credited to the petitioner's account. The journal entry which Free caused to be made on the books of the 1600 Prospect Co. indicates that the Prospect Avenue Account was indebted to the petitioner for advances made to pay the carrying charges on the Hatch and Dagleisch properties, in the principal sum of $34,642.01, and interest thereon of $6,845.28, and that this indebtedness was assumed by the 1600 Prospect Co. as*1989 a part of the consideration for the Hatch and Dagleisch leaseholds. Between March 1 and July 18, 1923, the petitioner's account was credited with additional interest of $954.12, bringing the credit balance in that account, on the latter date, to $42,441.41. It was this indebtedness of the 1600 Prospect Co. to the petitioner which was assumed by the George W. Stone Co. under the quadrilateral agreement of July 18, 1923. Under the terms of the agreement, this indebtedness was to be paid by the George W. Stone Co., as follows: $10,000 on execution of the agreement, $10,000 in 60 days, $10,000 in 120 days, and $12,441.41 in 180 days. There is no evidence as to when these installments were paid; but if they were paid when due, the first three installments, totaling $30,000, were paid in 1923, and the fourth installment of $12,441.41 was paid in 1924.
The assumption and payment by the George W. Stone Co. of the 1600 Prospect Co.'s indebtedness to the petitioner was the consideration *1147 for the assignment of that indebtedness and the transfer of 50 shares of common stock of the 1600 Prospect Co. by the petitioner to the George W. Stone Co. Thus it appears that as the indebtedness*1990 was paid by the George W. Stone Co., there was a realization upon (1) the indebtedness of the 1600 Prospect Co. amounting to $42,441.41 ($41,487.29 assumed indebtedness of the Prospect Avenue Account and interest of $954.12), and (2) the selling price, if any, of the 50 shares of stock of the 1600 Prospect Co.; but there is no evidence as to what part of the consideration, if any, applied to the 50 shares of stock; and even if an apportionment were intended, the record furnishes no satisfactory basis therefor. Under these circumstances, we must follow the respondent in applying the entire consideration to the indebtedness of the 1600 Prospect Co. These payments of the George W. Stone Co. should be apportioned to principal anl interest as follows:
| Apportionment of payments | |||
| Payments in 1923 | Payments in 1924 | ||
| Assumed indebtedness of Prospect Avenue Account: | |||
| Advances | $34,642.01 | $24,486.95 | $10,155.07 |
| Interest | 6,845.28 | 4,838.63 | 2,006.65 |
| Interest due from 1600 Prospect Co | 954.12 | 674.42 | 279.69 |
| Total payments by George W. Stone Co | 30,000.00 | 12.441.41 |
The total payments received by the petitioner, either constructively or actually, in 1923*1991 and 1924 amounted to $83,693.59 and $25,791.38, respectively, made up as follows:
| 1923 | 1924 | |
| One-half of net receipts of Prospect Avenue Account from 1600 Prospect Co | $32,893.59 | $13,349.97 |
| One-half of indebtedness of the petitioner and Free assumed and paid by the 1600 Prospect Co. in 1923 | 20,800.00 | |
| Payments made to the petitioner by the George W. Stone Co | 30,000.00 | 12,441.41 |
| Total payments received | 83,693.59 | 25,791.38 |
The parties agree that the cost of the Hatch and Dagleisch leaseholds and the improvements thereon, to the petitioner and Free, was $69,292.32. The petitioner is entitled to compute his gain or loss from the sale of the Hatch and Dagleisch leaseholds upon the basis of one-half of this cost, or $34,646.16. It appears, however, that the petitioner was to recover out of the proceeds from the sale of the leaseholds to the 1600 Prospect Co. whatever was due him on account of the advances which he made to pay the carrying charges on the Hatch and Dagleisch properties incurred during the *1148 period of his and Free's ownership. This is the inference to be drawn from the entry on the books of the 1600 Prospect Co. crediting his personal*1992 account with $41,487.29 of the purchase price of the leaseholds, and the debit entry of a corresponding amount against his personal account on the books of the Prospect Avenue Account, these entries indicating a transfer of the liability from the Prospect Avenue Account to the 1600 Prospect Co. Under the arrangements between them, the petitioner and Free were to share equally the gains and losses of their transactions. So, when Henn paid the carrying charges on the Hatch and Dagleisch properties, he, in effect, was paying his half share of such charges and was advancing the other half to Free. The petitioner's total payment of carrying charges amounted to $34,642.01, of which one-half, or $17,321.01, represented advances to Free; and therefore this amount of $17,321.01 is all the petitioner is entitled to recover.
From the foregoing it appears that the petitioner realized a profit from the sale of the Hatch and Dagleisch leaseholds in 1923 and 1924 in the respective amounts of $26,213.37 and $23,505.04, computed as follows:
| 1923 | 1924 | |||
| Total payments from all sources | $83,693.59 | $25,791.38 | ||
| Less: Payments for interest | $5,513.05 | $2,286.34 | ||
| Payments for reimbursement of carrying charges | 17,321.01 | |||
| 22,834.06 | 2,286.34 | |||
| Balance representing payments on account of selling price of leaseholds | 60,859.53 | 23,505.04 | ||
| Deduct: One-half cost of leaseholds | 34,646.16 | |||
| Profit on sale of leaseholds | 26,213.37 | 23,505.04 |
*1993 The petitioner contends that receipt by the Prospect Avenue Account of $65,787.17 from the 1600 Prospect Co. in 1923 did not constitute receipt by him, and that he can not be charged with the receipt of any part of such funds except to the extent of his actual withdrawals, that is, $250 and one-half of whatever part of such funds was used to defray the expenses of properties owned by himself and Free jointly. Failing this, then the petitioner raises the alternative contention, in the brief, that he is entitled to a loss deduction on account of embezzlement by Free in an amount equal to Free's excess withdrawals.
The petitioner unequivocally testified that under the arrangements between them, Free was to conduct and manage all of the affairs of their joint interests; that Free had absolute control over all of the funds of the joint interests; and that the books and records were kept under Free's personal supervision. Counsel for petitioner made the statement, at page 32 of the record, that there were a number of written agreements between the petitioner and Free; but they were not placed in evidence and we have only the testimony of the petitioner *1149 as to the nature*1994 of his relations with Free. From the evidence, we must, as a matter of law, regard Free as authorized to act for both, and we are of opinion that petitioner must be charged pro tanto with Free's receipts.
The petitioner testified that Free furnished him with annual statements purporting to show the receipts and expenditures of the Prospect Avenue Account; that he (the petitioner), at the time, believed such statements to be correct; that Free had no authority to draw on the funds of the Prospect Avenue Account for personal uses; that Free did not advise the petitioner that he was drawing on the funds of the Prospect Avenue Account for personal uses; and that he did not learn that Free was drawing on the funds of the Prospect Avenue Account for personal uses until after an examination of the accounts by a certified public accountant, in 1927. The inference which petitioner seeks to have drawn from this testimony is that the annual statements of receipts and expenditures of the Prospect Avenue Account which Free furnished to him were false, in that they failed to disclose that Free was drawing on the funds of the Prospect Avenue Account, for personal uses, amounts in excess*1995 of what he was actually entitled to. From an examination of the accounts in evidence, it appears that Free's withdrawals for 1923 and 1924 were $10,450.52 and $16,297.67, respectively, in excess of one-half of the cash receipts of the Prospect Avenue Account for those years. However, notwithstanding these apparently excess withdrawals by Free, his personal account on the books of the Prospect Avenue Account shows credit balances of $39,308.84 and $12,341.73 at the close of 1923 and 1924, respectively. In view of this we can not say that there was embezzlement by Free, a conclusion which we should be slow to reach after Free's death. The records which petitioner intimates were falsely kept by Free are the very records upon which he relies here.
Based upon the evidence and the admissions of counsel for the respondent at the hearing, there are findings of fact that the net incomes reported by the petitioner in his returns for 1923 and 1924 were computed upon the cash receipts and disbursements basis, and that the respondent's determination of deficiencies for those years is based upon net incomes computed upon the same basis. Under these findings, it is clear that the respondent*1996 erred in holding that the entire profit from the sale of the Hatch and Dagleisch leaseholds was realized in 1923, because a substantial part of the consideration involved in that transaction was not received until 1924. Since, however, respondent makes no claim for increase in deficiency for 1924, we do not add the payments received in that year to petitioner's 1924 income.
3. The third issue relates to 1924. Petitioner contends that the respondent erred in including in income an item of $10,000 treated *1150 by the respondent as having been received by the petitioner from the H. & F. Realty Co. in that year. It appears from the journal entry of August 31, 1921, on the books of the H. & F. Realty Co., that the proceeds of the latter's bond issue to the Union Mortgage Co. were $20,000 in excess of the amount required for the construction of a building known as the Crawford Block; that Free and the petitioner agreed that this excess of funds should be "treated in the nature of anticipated profits on the Crawford Block and divided equally"; and that the entire sum of $20,000 was turned over to the Prospect Avenue Account "for use in carrying other properties held jointly" *1997 by the petitioner and Free. The accounts of the petitioner and Free, on the books of the H. & F. Realty Co., were each charged with the sum of $10,000. On December 31, 1924, another journal entry was made, unaccompanied by an explanation, crediting each of the accounts of the petitioner and Free with the sum of $10,000 and charging profit and loss with the sum of $20,000. This entry brought the petitioner's account into balance, thus in effect discharging him from the existing obligation in that amount.
In the deficiency notice the respondent added to net income for 1924, as returned by the petitioner, under the heading "Other income increased," the sum of $10,000, with the explanation, "This increase represents your share of the cash received from the proceeds of a bond issue." The respondent now contends that the payment of $20,000 by the H. & F. Realty Co. to the Prospect Avenue Account, as evidenced by the journal entry of August 31, 1921, was in the nature of a joint advance to the petitioner and Free; and that the closing of the petitioner's account by journal entry of December 31, 1924, was, in substance, a distribution of profits by the H. & F. Realty Co.
The two journal*1998 entries of August 31, 1921, and December 31, 1924, and the testimony of the petitioner, to the effect that he never received a penny from the H. & F. Realty Co. and did not know anything about the book entries, is all the evidence we have bearing upon this issue. Free, who kept the books, is dead. The two journal entries seem to support the respondent's position. The explanation in the journal entry of August 31, 1921, indicates that the disbursement to the Prospect Avenue Account was in the nature of an advance to be liquidated out of future earnings; and there is probably no other explanation for charging this disbursement to the accounts of the petitioner and Free and permitting such charges to remain on the books for a period of three years. If the disbursement was not an advance, it must have been a return of capital, since the company apparently had no accumulated profits out of which to make a distribution; but there is nothing in the journal entry to indicate an intent to reduce the capital of the company. The journal entry of December 31, 1924, by which the petitioner's and Free's accounts *1151 were charged off against surplus, would indicate that there were sufficient*1999 accumulated earnings at that time to liquidate the advances.
As to the petitioner's testimony that he never received a penny from the H. & F. Realty Co., we construe that to mean that he never had physical possession of any part of the funds which that company turned over to the Prospect Avenue Account; but for reasons heretofore stated, we are of the opinion that receipt of such funds by Free for the Prospect Avenue Account constituted a constructive receipt by the petitioner. It is not enough to justify the exclusion of these items from his gross income derived in the course of complicated financial transactions such as are disclosed by the evidence, for petitioner to say merely that he did not receive the money in his actual possession.
4. The last contention to be considered is that the respondent erred in failing to tax the gains derived from certain transactions in 1923, as capital gains, under the provisions of section 206 of the Revenue Act of 1921; but the taxpayer elects to have his income from capital gains taxed under the provisions of section 206, only in case a saving results therefrom. The parties have stipulated five transactions entered into in 1923, involving*2000 the sale of capital assets. The respondent, in the brief, admits that the gains derived from these five transactions may be taxed under section 206, and in redetermining the deficiency that should be done.
Judgment will be entered under Rule 50.
Footnotes
1. Red. ↩