*714 1. For many years petitioner had carried on a manufacturing business in a building held under lease. Under threat of condemnation by a railway company the petitioner sold its leasehold to it. Being unable to find a building suitable for its business in the same locality, it forthwith and within the taxable year used a part of the money received from the railway company for the construction, upon land owned by it, of a building. It moved its machinery and equipment to the new building and conducted therein the same manufacturing business formerly carried on in the leased building. Held, an involuntary conversion within the meaning of section 112(f) of the Revenue Act of 1928, and gain is not to be recognized on that portion of the amount receive from the railway company which was expended in the construction of the new building.
2. Petitioner did not report the amount received from the railway company as taxable income, but its return of income disclosed the receipt of said amount. Held, under the circumstances no negligency penalty will be imposed.
*438 The Commissioner determined a deficiency in petitioner's income tax for the year 1930 in the amount of $10,471.86. He also determined that part of the deficiency was due to negligence, or intentional disregard of rules and regulations but without intent to defraud, and added 5 percent of the total amount of the deficiency, or $523.59, under section 293(a) of the Revenue Act of 1928.
The first issue is whether the amount of $95,000, or any part thereof, treated as taxable income by the respondent, was, as contended by petitioner, received by it in connection with an involuntary or compulsory conversion of its property into property similar or related in service or use to the property so converted. If petitioner's contention be sustained, then the gain or loss in connection therewith is not to be recognized, under section 112(f) of the Revenue Act of 1928, except to the extent that the money received exceeds the money expended in the acquisition of other property similar or related in service or use. If it be determined that there is a deficiency in tax, then it must also be determined whether or not the 5 percent negligence penalty*716 should be imposed.
FINDINGS OF FACT.
The petitioner is an Illinois corporation, organized in 1899 and engaged in the business of manufacturing and selling pressure regulating valves, relief valves, back pressure valves, air valves, steam traps, and other specialities. Its authorized capital stock was 1,500 shares of the par value of $100 a share. During 1929 and 1930 it had 1,060 shares issued and outstanding as follows:
| Name | Shares |
| George C. Davis, president and director | 629 |
| Hamilton National Bank of Chattanooga, Tenn., as trustee of the estate of W. E. Davis, deceased | 273 |
| Harold A. Davis, director | 5 |
| J. C. Kinsley, secretary and director | 93 |
| George E. Davis, as trustee | 60 |
Since its organization and until June 15, 1930, the petitioner occupied a building known as 422-4 and 426 Milwaukee Avenue, Chicago, Illinois, under successive leases from the owners thereof, in which it conducted its manufacturing business. The property known as 422-4 Milwaukee Avenue (four lots) was owned, until sold on March 19, 1930, by George C. Davis and Hamilton National Bank of Chattanooga as trustee of the estate of W. E. Davis, deceased, in equal shares. The*717 property known as 426 Milwaukee Avenue (two lots) was owned, until sold on March 19, 1930, by George C. Davis. From and after January 10, 1929, the petitioner occupied such property as lessee under two leases dated January 10, 1929, each running for a term of 20 years ending January 10, 1949. Both leases required the *439 lessee to pay all taxes and to make all repairs, and provided, among other things, that "this lease is renewable at will at termination of term." The lease covering 422-4 Milwaukee Avenue provided for the payment of an annual rent of $1,500 and the lease covering 426 Milwaukee Avenue provided for the payment of an annual rent of $1,020. The building thereon was mill-constructed, consisted of two stories and an English basement, and had a floor area of approximately 25,000 square feet. It was built to accommodate on overhead crane for the loading and unloading of heavy machinery and was equipped with heavy and light machinery and accessories necessary for the valve manufacturing industry.
In the latter part of 1929, George C. Davis, hereinafter referred to as Davis, was approached by a real estate broker for the purchase of the above property ostensibly*718 for garage purposes. There being no necessity for a garage building in that vicinity, an investigation was made, which disclosed that the Chicago & Northwestern Railway Co., a public utility corporation, hereinafter referred to as the railway company, was interested in acquiring the property. The railway company was authorized by law to exercise the power of eminent domain in the State of Illinois. It had acquired considerable property in the vicinity of petitioner's plant and intended to acquire the latter also, all to provide a site for a proposed express terminal. Negotiations for the acquisition of the property by the railway company were thereafter carried on between Larimer, an employee of the railway company whose duty it was to acquire in behalf of the railway company the land necessary for the contemplated improvement, and Davis, acting in his own behalf as part owner of the property, as agent for the Hamilton National Bank, trustee, and as president of the petitioner. Davis was assisted by Kuhn, a realtor employed by him.
During the course of the negotiations, and on or about October 1, 1929, Larimer, on behalf of the railway company, addressed the following letter*719 to Davis:
In connection with the negotiations for the purchase from yourself and W. E. Davis Estate of the real estate now occupied by George M. Davis Regulator Company's tenants, we beg to state that our railroad company needs and must have this property in connection with the development of its terminal facilities. Because of the public interest involved in such necessary and needed development of terminals by this railroad, you will understand that we can and will, if necessary, resort to proceedings under the applicable laws as to eminent domain. Under eminent domain proceedings this railroad can, of course, acquire any property that it needs as a public utility and the price of such property will be fixed to the owners by legal process.
In our negotiations we are offering you a price which, in our judgment, is equivalent to the price which the owners can hope to secure under such legal process. Since the needs of this railroad compel us to acquire this property, *440 we hope that this frank statement of our position will facilitate the negotiations we have in progress with you. As you know, we own adjacent and surrounding property and despite use and occupancy*720 inconvenience to the owners and their tenants, we are compelled to proceed in the acquisition of the property as stated.
As you and your tenants have long been esteemed patrons of our railroad may we not say that we have delayed the acquisition of your property as long as we can possibly delay it, having in mind the inconvenience that we may put you and your tenants to in their removal after the sale to us. We want you to understand our good will in this matter and also our immediate needs and legal basis.
After considerable negotiations the railway company offered $256,000 as its maximum price for the property, subject to the cancellation of the leases thereon, stating that such offer was final and that if it were not accepted, condemnation proceedings would be instituted. Kuhn, the realtor employed by Davis, recommended acceptance of the offer, advising that in his opinion it was very fair and considerably more than could possibly be secured under condemnation proceedings.
Under date of December 10, 1929, Kuhn, the realtor wrote Davis advising that the railway company had authorized the offer of "a net price of $219,450.00 in cash, which represents $95,000 as damages to*721 the business of the G. M. Davis Regulator Co. and $124,450. for the property commonly known as the Davis Regulator Co. property located at 422 Milwaukee Ave., Chicago." The total amount paid appears to have been $256,000, allocated as follows:
| To Walter E. Davis estate | $41,483.33 | |
| To George C. Davis | 82,966.67 | |
| To Davis Regulator Co | 95,000.00 | |
| Total | $219,450.00 | |
| To Geo. C. Davis (lot 45) | 23,750.00 | |
| To Farnham-Kuhn, realtors' commission | 12,800.00 | |
| Total | 256,000.00 |
At a special meeting of the directors of petitioner corporation, held on February 8, 1930, Davis recommended "that the terms of sale for the lease be accepted by the corporation" and at the same time he also submitted "a proposal for the construction of a new building to be owned by the corporation." At said meeting "it was unanimously voted to accept the offer of $100,000 [sic] made by the Chicago & Northwestern Railway Co. for the lease of the corporation" and "to appropriate all or any part of the $100,000 to be realized from the sale of the lease, for the design and erection of a suitable building to house the corporation, on the ground now owned at 25th Place & Washtenaw Ave. Chicago, *722 Ill." Proposals from various *441 contractors, whose bids had been received, were examined and the officers were authorized to enter into a contract with one of them.
Paragraphs 7 and 8 of the stipulation of facts are as follows:
7. On or about March 19, 1930, there were deposited with Chicago Title and Trust Company under its Escrow No. 79622 the following: Deeds from the owners thereof conveying 422-4 and 426 Milwaukee Avenue to the Railway, and a check of the Railway for $256,000 payable to the order of George C. Davis. Thereupon the deeds were delivered to the Railway; the check was delivered to George C. Davis, who paid the sum of $95,000 to the Company. On receipt of said sum of $95,000 the Company credited the same to its "New Factory Building Account", to which account no other funds were credited.
8. In the year 1917 the Company acquired certain vacant land at the corner of 25th Place and Washtenaw Avenue, Chicago, Illinois, which is now known as 2541 Washtenaw Avenue, being Lots 60 to 72 inclusive shown on the plat attached hereto and made a part hereof as Exhibit G. In February 1930 and thereafter during 1930 the Company let out various architects', construction*723 and other contracts for the erection of a building on said land and for the moving thereto and installation therein of the Company's machinery and equipment, all of which contracts were completely carried out during the year 1930 at a cost to the Company of $82,574.55, which sum was paid and wholly charged by the Company in 1930 to its "New Factory Building Account," and comprised the following items:
| Architects' and Contractors' fees and commissions | $6,561.26 |
| Construction costs | 72,132.69 |
| Moving and installing machinery and equipment | 3,880.60 |
| Total | $82,574.55 |
The petitioner executed an instrument releasing all of its interest in the premises involved, but the railway company "consented to the occupancy of the premises by the Davis Company to June 15, 1930." The new building was completed about June 1, 1930, and by that date petitioner had moved all of its machinery and equipment into it. The change did not improve petitioner's manufacturing facilities nor increase the volume of its business. The new building contained practically the same machinery, equipment and facilities for handling castings and other parts as the old plant had. The railway company completed*724 the improvement which it contemplated when it acquired the property from Davis, his associates, and petitioner.
The petitioner in its 1930 income tax return did not report the $95,000 received by it as taxable income, but "Schedule L - Reconciliation of Net Income and Analysis of Changes in Surplus" of such return disclosed a credit to surplus as follows: "Capitalization of Assets and Residual Values of Leasehold Provided by Damages Received upon Involuntary Conversion of Leasehold $85,556.30."
The respondent added the amount of $95,000, received by petitioner for the cancellation of its leasehold, to the net income reported by it in its return of income for the year 1930.
*442 OPINION.
MELLOTT: The petitioner contends that no part of the $82,574.55, expended by it in the acquisition of a new building for its manufacturing business out of the $95,000 received in connection with the sale or cancellation of its leasehold, represents recognizable gain to it because of the provisions of section 112(f) of the Revenue Act of 1928. The section, in so far as pertinent here, is set out in the margin. 1
*725 The respondent contends that there was merely a sale or release by petitioner of a portion of its personal property and the subsequent purchase by it of real property; that "the conversion of money received for damages to business and vacation of leasehold property into real estate and buildings is not a conversion into property similar or related in service or use as contemplated by section 112(f)", supra; and that it was not the intention of Congress, in the enactment of the section, to provide a method to enable taxpayers to escape the taxes on profits derived from the sale of a leasehold through the reinvestment of such profits in real property.
Section 112(f), supra, and its prototype in other revenue acts, "was designed to prevent an inequitable incidence of taxation", , and its provisions "are relief provisions by which a taxpayer may postpone the taxation of so much of the gain derived from an involuntary conversion as it uses in replacement." . Being relief provisions, they are "to be liberally construed to effectuate their purposes"; *726 ; .
The section must be read and considered in its entirety; and, while it is true, as respondent points out upon brief, that a taxpayer seeking to avail itself of an exemption from tax must come clearly within the terms of the statute allowing the exemption, we are of the opinion that this petitioner has done so. It is sufficient answer to respondent's argument that there was merely a sale to point out that the section does not, by its terms, preclude a sale. On the contrary, it refers specifically to a conversion of property "into money" - the simplest form of a sale. Whether the leasehold which it gave up was, as contended by respondent, merely personal property or not, is probably unimportant, but it was a "chattel real", an interest in the land, *443 and "it is treated (by the courts of Illinois) in many respects as real estate." ; . If the statute required that the money derived from the sale or conversion be invested in "similar" property and stopped there, there would be more substance*727 to respondent's argument; but it goes further, and, as pointed out by this Board in , the word "similar" is "followed immediately by the phrase 'or related', which * * * considerably broadens the scope of the statute and gives the taxpayer more latitude in making an investment * * *." As we view the facts before us, the petitioner had an interest in real estate, capable of and being used by it in connection with its business. This interest was sold and the money received was invested by it in another interest in real estate "similar or related in service or use to the property so converted." That, we believe, is all that is required to entitle petitioner to the benefits of the section under consideration; and we do not agree with respondent's contention that the amount received from a sale of a leasehold must be reinvested in another leasehold. The test, as was stated in , is "whether there is a replacement in the character of the service or use." Here there was such replacement. Petitioner used the new building for the identical purpose that the old one was used - carrying on its manufacturing business. *728 Under the circumstances it must be held that it is entitled to the benefit of section 112(f), though in passing it may be remarked that the "benefit" to petitioner may, in the long run be small; for the property which it acquired, has the same "basis", under section 113(a)(10) of the Revenue Act of 1928 as the property converted.
But, says respondent, a possible threat of condemnation is not a threat and "the fact that the railroad company threatened to bring condemnation proceedings is not proof that it would have been successful." It is stipulated that the railway company "is a public utility corporation authorized by law to exercise the power of eminent domain in the State of Illinois." A cursory inspection of the statutes of the state bears out such conclusion. We must assume that the railway company would have been successful if it had instituted appropriate proceedings to condemn petitioner's property. But there need not be an actual condemnation. If the property were conveyed, as a result of "the threat or imminence" of condemnation the statute is satisfied. The letter from the agent of the railway company, set out in full above, if not sufficient to show that condemnation*729 was imminent, does nevertheless contain a distinct threat that condemnation proceedings would be resorted to, if necessary. Under the circumstances we have no hesitancy in concluding that the sale was made because of "the threat or imminence" of condemnation. , cited *444 by respondent is not in point, nor is the conclusion the therein reached contrary to the views herein expressed. In that case a fertilizer company sold its property to a sugar company and invested the proceeds elsewhere. It was not contended that the sugar company had the power of eminent domain, nor was it shown that any official action had been taken or was seriously contemplated by the authorities to condemn the property. The Board merely held that the evidence was insufficient to warrant the conclusion that the petitioner sold its property because of the imminence of condemnation proceedings.
No evidence was presented by petitioner as to the cost (or other basis) of the leasehold to it. We must assume therefore that the entire $95,000 received from the railway company represented gain. We have found that it expended $82,574.55 of the amount*730 received in the acquisition of other property similar or related in service or use to the leasehold formerly owned by it. Under the provisions of section 112(f), supra, petitioner's gain is not to be recognized to the extent of this expenditure, but is to be recognized in an amount not in excess of the $12,425.45 which petitioner did not use in the acquisition of the new building. It follows that respondent erred in including the $82,574.55 in petitioner's income for the taxable year.
As to the negligence penalty, counsel for the respondent admitted at the hearing, and the exhibits show, that a disclosure of the receipt of the income involved was made by the petitioner in its income tax return for the taxable year. It has been held that where full disclosure is made and the taxpayer has "reasonable grounds to differ from the conclusion" of the Commissioner that a tax is due, the negligence penalty should not be imposed. ; ; affd., *731 . A similar holding is made here and no penalty will be imposed.
Judgment will be entered under Rule 50.
Footnotes
1. SEC. 112. (f) Involuntary conversions.↩ - If property (as a result of * * * an exercise of the power of * * * condemnation, or the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, expended in the acquisition of other property similar or related in service or use to the property so converted, * * * no gain or loss shall be recognized. If any part of the money is not so expended, the gain, if any, shall be recognized, but in an amount not in excess of the money which is not so expended.