*143 Decisions will be entered under Rule 50.
Installment Sales of Mortgaged Real Property Under Sec. 44 (b), I. R. C. 1939. -- Under terms of agreement of sale, buyer from petitioners of real property that had a mortgage on it did not assume the mortgage or take the property subject to the mortgage within the meaning of respondent's regulation relating to the determination of the percentage of taxable income to be returned on the installment basis.
*659 The Commissioner determined the following deficiencies against the petitioners:
| Stonecrest Corporation | |||
| Declared value | |||
| Year | Income tax | excess-profits | Excess profits |
| tax | tax | ||
| 1942 | $ 3,766.08 | $ 29,678.26 | $ 158,359.56 |
| 1943 | 3,883.19 | 42,331.60 | |
| 1945 | 12,176.55 | 414.62 | 8,115.87 |
| Brookfield Corporation | |||
| Declared value | |||
| Year | Income tax | excess-profits | Excess profits |
| tax | tax | ||
| 1942 | $ 2,116.32 | $ 6,514.86 | $ 37,918.40 |
| 1943 | 21,803.05 | 61,998.28 | 309,345.48 |
| 1944 | 1,679.71 | 3,287.51 | 19,278.31 |
| 1945 | 17,686.81 | 1,061.54 |
*660 Upon motion of petitioners the cases have been consolidated for hearing and decision.
The question we have to decide concerns the amount of income to be reported by petitioners on the installment basis from the sale of mortgaged real property.
Most of the facts have been stipulated. Since the methods of operation of both petitioners were essentially the same, to the extent possible circumstances relating only to petitioner Stonecrest's operations will be stated in detail in our Findings of Fact and are to be understood as being identical to the circumstances of Brookfield's operations. Stonecrest will hereafter be called petitioner.
FINDINGS OF FACT.
The stipulated facts are found accordingly, and are incorporated herein by this reference.
Petitioner is a California corporation with its principal office in San Francisco. Its income and excess profits tax returns for the years in question, 1942 through 1945, were*145 filed with the collector of internal revenue for the first district of California. Insofar as the sales in question here, petitioner kept its books and records and reported its profits on the installment basis.
During the taxable years petitioner's principal business was the construction of housing developments consisting of individual residences.
Petitioner's method of operation was as follows: It first purchased land from a partnership whose members were also shareholders of petitioner. The partnership had previously purchased an unimproved tract of land, the purchase price being financed partially by partnership funds but principally by a loan from a San Francisco bank. The loan was evidenced by a promissory note executed by the partners and their wives and secured by a blanket deed of trust covering the entire tract in favor of the lending bank. Petitioner then submitted its plans for building individual residences to the Federal Housing Administration to obtain the latter's commitment to insure loans on the property. Having obtained the general approval of the F. H. A., petitioner applied to a bank for loans for the construction of individual housing units, which were made*146 after an F. H. A. commitment to insure each loan had been received. In connection with the loan petitioner executed a deed of trust note and a deed of trust on each unit, which was recorded by the bank. The original blanket deed of trust on the entire tract was released on individual lots as loans for the construction of housing units on these lots were made. An agreed release price was paid to the mortgagee out of the construction loan. When all of the lots in the subdivisions developed by petitioner were subject to individual deeds of trust, the stockholders of petitioner and their wives, who had personally signed the original *661 note and blanket deed of trust, were released from their personal liability thereon, so that only the petitioner was liable to the lending bank on the deed of trust notes with respect to houses covered by installment contracts that had not been closed. In the case of Brookfield, the shareholders and their wives were required personally to guarantee each individual note secured by individual deeds of trust on the houses constructed and sold, and they were never relieved of their secondary liability on such loans until the loans were either paid*147 in full or, as in a few cases not in issue here, assumed by the purchasers.
Among the documents executed by a purchaser from petitioner was a "Mortgagor's Statement" contained in a "Mortgagee's Application For Mortgage Insurance," which was filed by the lending bank with the F. H. A. together with a "Consent to Substitution of Mortgagors Under Title VI." The Mortgagor's Statement contained information regarding the financial status of the mortgagor for the guidance of the F. H. A. in determining whether to insure a mortgage loan on the property being purchased by the mortgagor. When a house was ready for occupancy, a "Uniform Agreement of Sale" was executed by the purchaser and petitioner, and the purchaser also executed that portion of the Consent to Substitution of Mortgagors Under Title VI designated "Purchaser's Certificate," which acknowledged his receipt of the property and contained his agreement to pay the mortgage debt. The purchaser also executed a guarantee to the mortgagee bank of petitioner's obligation on the mortgage loan, and a quitclaim deed to the property in favor of petitioner. Neither the bank nor the F. H. A. retained an executed copy of the Purchaser's Certificate*148 or the purchaser's guarantee of the loan made to petitioner.
The Uniform Agreement of Sale provided in part as follows:
That said Seller hereby agrees to sell and convey to the Purchaser, and Purchaser hereby agrees to purchase, that certain real property situated in the City and County of San Francisco, State of California, described as follows:
[description of property]
The purchase price for said property which Purchaser agrees to pay and Seller agrees to accept therefor, is the sum of $ 4,450.00, payable as follows:
$ 100.00 in cash, receipt of which is hereby acknowledged;
$ 47.40 per month, payable on the 1st day of each and every month hereafter for a period of 27 months, (first period), and thereafter $ 33.50 per month, payable on same day of each month until purchase price and interest are paid in full (second period). Seller heretofore executed a promissory note to The San Francisco Bank in the principal sum of $ 4,000.00, and a trust deed conveying said real property to E. T. Kruse and Parker S. Maddux, as trustees, to secure the payment of said note (pursuant to the provisions of Title 6, F. H. A.) Reference is hereby made to the record of *149 said trust deed in the office of the Recorder of the City and County of San Francisco, and the same is hereby incorporated herein. Said installments payable during the first and second periods include interest and charges at the rate and as provided for in said *662 note and trust deed upon that portion of purchase price represented thereby. Installments payable during the first period include interest at the rate of 6% per annum on balance of purchase price. Said installments shall be applied by the Seller to the requirements of said F. H. A. loan and to the payment of balance of purchase price and interest thereon. Monthly installments payable pursuant to said F. H. A. loan are subject to increase or decrease as provided for in said note and trust deed representing the same, and in the event of such increase or decrease, installments payable hereunder shall be increased or decreased accordingly. Seller shall deliver and Purchaser shall accept conveyance of said property upon first period installments being paid in full at any time thereafter within five years therefrom at option of Seller, and Purchaser shall thereupon assume the performance of Seller's unperformed obligations*150 under the terms of said note and trust deed, and Purchaser hereby consents to Seller being then released therefrom. For this purpose, Purchaser executes an assumption concurrently herewith, delivers the same to Seller, and the Seller is authorized to deliver said assumption to The San Francisco Bank upon delivery of said conveyance. Thereafter balance of purchase price shall consist of monthly payments required by said note and trust deed provided in the event Seller cannot secure said release of liability from said note and trust deed, Seller may withhold delivery of conveyance and parties shall function under this agreement until such release is obtained or Seller may deliver conveyance at any time sooner if Seller so elects.
* * * *
Purchaser concurrently herewith executes and delivers to Seller a quitclaim deed to said property. Seller may at any time after default by the Purchaser in the performance of the obligations herein provided for, record said quitclaim deed. Said quitclaim deed shall be returned to Purchaser upon Purchaser's becoming entitled to a conveyance hereunder.
Other provisions related to taxes on the property, title, and possession. Some of the sales agreements*151 used by petitioner varied from the form set out above; instead of the requirement that the seller deliver and the buyer accept conveyance of the property within 5 years after the first period installments had been made, the option is given to the buyer to require a conveyance of the property after 8 (in some agreements, 12) years from the agreement date.
Although the agreement called for the concurrent execution of an assumption of the mortgage by the purchaser, to be used when property was conveyed to a purchaser, the document actually signed was the purchaser's guarantee of petitioner's mortgage loan. Even if title had passed before complete performance by the purchaser, the petitioner would have remained primarily liable to the bank for the unpaid amount of the mortgage.
Petitioners reported the following number of sales between 1942 and 1945 on the installment basis:
| Year | Stonecrest | Brookfield |
| 1942 | 349 | 103 |
| 1943 | 88 | 605 |
| 1944 | 9 | |
| 1945 | 91 | |
| Total | 537 | 708 |
*663 The level of payments that the purchaser was required to make during the first 27 months was greater than the level of payments during the remaining period of the installment contract, the difference*152 in level representing the excess of purchase price (less downpayment) over the original amount of the mortgage loan plus interest on the excess.
In no single case under the Uniform Agreement of Sale did the petitioner exercise its option to deed property to a purchaser. In no single case under any agreement of sale did a purchaser exercise an option to receive a deed prior to full payment of the total purchase price.
All monthly payments on contracts were made directly to the petitioner by the purchaser, and all monthly payments due on loans were made directly by the petitioner to the bank until the property was deeded to the purchaser, at which time the purchaser's contract account was closed and the unrealized profit applicable thereto was reported as income for that year. There was no intended synchronization between the time fixed for payments due from purchasers on homes sold under installment contracts and the time fixed for payments by petitioner to the bank on its loans secured by deeds of trust on the properties sold on the installment plan.
The lending bank (mortgagee) carried all loans on its books and records as loans due from the petitioner from the date each individual*153 loan was granted until the closing out of the installment contract pertaining to the property on which petitioner had executed a deed of trust as security for the loan.
Every installment sales contract reflected on petitioner's books was closed by petitioner at the time the property covered by the contract was deeded to the purchaser. In substantially all cases the property covered by an installment sales contract was not deeded to the purchaser until the purchaser paid the amount remaining due on the installment sales contract, and, concurrently with the receipt of such sum, petitioner paid the bank the amount due on the loan which was secured by a deed of trust on the property covered by the installment sales contract. In a few cases, by special arrangement between the petitioner and purchaser, the petitioner has nevertheless deeded property to a purchaser without requiring payment of the purchase price in full. In each of such cases, which in the aggregate represent only a small percentage of the total number of contracts, the deed was issued for individual and personal reasons and not as a matter of right on the part of either party. In such cases the party receiving the deed*154 made arrangements with the bank to assume the mortgage on the property in question and paid petitioner any amount due on the installment sales contract in excess of the amount due on the deed *664 of trust note. In every instance in which a deed was issued to a purchaser, such purchaser's installment sales contract was closed, and petitioner reported as income in that year the entire amount of the unrealized profit on the installment sale. None of the transactions described in this paragraph involved the exercise of any option given to either party under any of the agreements of sale.
The petitioners reported as income from the sales in question here that proportion of the installment payments actually received which the gross profit to be realized on the sale bore to the total contract price. "Total contract price" was considered to be the amount for which a property sold, without any deduction for the amount of the mortgage.
In determining the percentage of each installment to be returned as income in the taxable years the respondent, following the regulation, included the amount of the mortgage in the "selling price" but excluded it from the total contract price to the *155 extent that it did not exceed the seller's basis in the property. Since in each of the sales made by petitioners the mortgage on the property exceeded the seller's basis, the respondent added the excess to the basis to determine total contract price. Included in "initial payments" were the buyer's downpayment, payments on the purchase price during the taxable period when the sale was made, and the excess of the mortgage over the seller's basis. Using this method respondent determined that 100 per cent of the installment payments received by petitioners during the years in question should be reported as profit for those years, with the exception of the year 1945 as to Stonecrest, for which the percentage is 83.5.
OPINION.
Where property is sold on the installment plan the seller may return as income from the sale in any taxable year the proportion of the installment payments actually received in that year which the gross profit on the sale bears to the total contract price. Sec. 44, I. R. C. 1939. 1*158 This provision, enacted in the Revenue Act *665 of 1926, 2 relieved a seller from having to pay an income tax in the year of sale based on the full amount of anticipated profits*156 when in fact only a small portion of the sales price had been received. Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496 (1948). It permitted him to distribute the profit on an installment sale over the years during which the purchase money would be actually received, by dividing the payments into parts representing a return of capital and profit. In the case of real property sold on the installment plan where there was a mortgage on the property which the buyer either assumed or took the property subject to, the statutory scheme of returning a portion of each payment as income in the year received did not reach all of the seller's profit, since the total amount of the selling price was not paid over by the buyer to the seller; that portion of the selling price represented by the mortgage was paid by the buyer directly to the mortgagee. To remedy this, regulations were issued by the Commissioner and approved by the Secretary of the Treasury to provide that the amount of the mortgage, to the extent that it did not exceed the seller's basis in the property sold, was not to be considered a part of the "initial payments" or of the "total contract*157 price." Treasury Regulations 69, article 44, promulgated August 28, 1926; amended by Treasury Decision 4255, VIII-1 C. B. 165 (1929). The reduction in the total contract price had the effect of increasing the percentage of each installment payment to be returned as income, thereby reaching the entire profit on the sale. The amount by which the mortgage exceeded the seller's basis in the property was treated as a part of the initial payments and was added to the seller's basis in computing total contract price. The regulation was upheld in a case involving the sale of mortgaged property where the buyer unequivocally "assumed" the mortgage, as a fair attempt to carry out the intent of Congress. Burnet v. S. & L. Bldg. Corp., 288 U.S. 406">288 U.S. 406 (1933).
The wording of the regulation, insofar as it relates to the question here, is as follows:
Regulations 111:
Sec. 29.44-2. Sale of Real Property Involving Deferred Payments. -- * * *
* * * *
In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the "selling price," but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or of the "total contract price," as those terms are used in section 44, in sections 29.44-1 and 29.44-3, and in this section.
*666 The above form of the regulation is the same as that approved by the Supreme Court in Burnet v. S. & L. Bldg. Corp., supra.
In determining the deficiencies here involved the respondent followed the procedure described in our Findings of Fact and applied the regulation to the sales made by petitioners, claiming that *159 according to the terms of the agreement of sale a buyer, in effect, assumed the mortgage obligation, or at least that the property was taken subject to the mortgage.
Whether respondent has properly determined the amount of reportable income received by petitioners turns on whether a buyer from petitioners either assumed the mortgage on the property or took the property subject to the mortgage within the meaning of the regulation.
While the regulation first refers broadly to "the sale of mortgaged property," the language following this broad reference describes the two types of sales of mortgaged property to which the regulation applies: (a) Where a buyer takes property subject to mortgage, or (b) assumes the mortgage. These expressions we take to have the meaning customarily attributed to them in transactions concerned with the transfer of mortgaged property. Crane v. Commissioner, 331 U.S. 1">331 U.S. 1, 6 (1947). Taking property subject to a mortgage means that the buyer pays the seller for the latter's redemption interest, i. e., the difference between the amount of the mortgage debt and the total amount for which the property is being sold, but the buyer*160 does not assume a personal obligation to pay the mortgage debt. The buyer agrees that as between him and the seller, the latter has no obligation to satisfy the mortgage debt, and that the debt is to be satisfied out of the property. Although he is not obliged to, the buyer will ordinarily make the payments on the mortgage debt in order to protect his interest in the property. Where a buyer assumes a mortgage on property, he pays the seller for the latter's redemption interest, and in addition promises the seller to pay off the mortgage debt. This promise of the buyer can ordinarily be enforced by the mortgagee. 5 Tiffany, The Law of Real Property, secs. 1435, 1436 (3d ed. 1939); IV American Law of Property, secs. 16.125, 16.127, 16.128-16.132 (1952).
The typical agreement of sale used by petitioners, as set out fully in our Findings of Fact, first specified the purchase price of the property and then provided the manner of payment: A downpayment of $ 100, monthly payments of $ 47.40 for 27 months (first period), and then of $ 33.50 until the purchase price and interest were paid in full (second period). Mention is then made of a deed of trust (mortgage) conveying the property*161 to trustees to secure payment of a promissory note executed by the seller. The agreement states that the installment payments include interest and charges at the same rate and as provided in the promissory note secured by the deed of trust, and the seller is *667 required to apply the installment payments to the loan and to the rest of the purchase price and interest thereon. Provision is then made that the seller shall deliver and the buyer accept conveyance of the property within 5 years (8 and 12 years in some agreements) after the first period installment payments have been made. The option is given to the buyer to determine when in the 5- (sometimes 8- and 12-) year period the conveyance will be made. In some agreements an option is given to the buyer to require conveyance of the property within a period of years after the agreement date. Upon conveyance the buyer is to assume payment of the promissory note secured by the deed of trust. After assumption the buyer's payments on the purchase price were to be the monthly payments required by the promissory note, but in the event the seller could not obtain a release from its obligation on the promissory note from the *162 lending bank, the seller could withhold conveyance of the property until a release of its liability was obtained, or could make the conveyance at any time sooner.
The foregoing provisions of the agreement make it clear that there was no assumption of the mortgage when a property was sold by petitioners. As is clearly stated, the buyer agreed to assume the mortgage upon conveyance of the property by the seller at some time from 5 to 12 years after the first period installments had been made. The regulation has no application until there is an actual assumption. The fact that the seller was to use the installment payments to pay off the mortgage debt does not constitute an assumption of the mortgage by the buyer. As we have pointed out, assumption of a mortgage means that the buyer takes over the seller's obligation to the mortgagee and incurs an obligation generally enforceable by the mortgagee. Here, as the parties have stipulated, the buyer was under no present obligation to the mortgagee.
Nor was any sale made by petitioner "subject to" a mortgage in the ordinary usage of that expression. The expression means that the buyer has no personal obligation to pay the mortgage debt; *163 that, as between seller and buyer, the seller has no obligation to pay the debt; and that the debt is to be satisfied from the property. Here there was no understanding that the debt was to be satisfied out of the property; instead it was explicitly provided in the agreement of the parties that the seller was to make the payments on the mortgage debt until there was a conveyance of the property. It has been stated that in determining whether or not a transfer is subject to a mortgage,
A circumstance which is usually of controlling importance in this regard is whether the mortgage was considered in adjusting the purchase price. If the price was reduced by reason of the mortgage, it is a reasonable conclusion that it was intended that the debt, either in whole or in part, should be imposed on the land in the hands of the transferee rather than on the tranferor, while if *668 the full agreed value of the land was paid, it may be concluded that the parties intended the grantor to pay the mortgage debt out of the proceeds of the sale. [Tiffany, sec. 1435, p. 365.]
In this case there was no reduction in selling price because of the mortgage and it seems clear that the seller *164 was intended to pay the mortgage debt out of the proceeds of the sale. By his interpretation respondent would extend the application of the regulation to every sale of property that has a mortgage on it. While in a sense every sale of mortgaged property is subject to a mortgage since the property remains liable to have the mortgage debt satisfied from it, we think the expression was used in the regulation in its customary meaning, to define the obligations of the parties to a sale of property with respect to the mortgage debt. See Tiffany, supra, sec. 1435.
The position taken by respondent here appears contrary to G. C. M. 3048, VII-1 C. B. 60 (1928), where it was ruled that the regulation in question was inapplicable. The form of the regulation there involved contained language identical to that before us (viz, "In the sale of mortgaged property * * *, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser"). The situation dealt with in the ruling was one where real estate against which there was a "reducing mortgage" was sold on installments. The purchaser did not assume the mortgage but*165 made monthly payments to the vendor who in turn made the mortgage payments, similarly to the case here. It was held that the rule prescribed in the regulations for the determination of the percentage of profit returnable each year in the case of mortgaged property sold on the installment plan was inapplicable.
The cases relied on by respondent -- Burnet v. S. & L. Bldg. Corp., supra;Dalriada Realty Co., Inc., 5 B. T. A. 905; Pacheco Creek Orchard Co., 12 B. T. A. 1358; Katherine H. Watson, 20 B. T. A. 270; and Fifty-Three West Seventy-Second Street, Inc., 23 B. T. A. 164 -- are distinguishable. In all of those cases, with the exception of Pacheco Creek Orchard Co., the mortgage was assumed by the vendee. In the Pacheco case payment of the mortgage was made by the vendee to the mortgagee and it was held that while the mortgage was not "assumed," the property was "purchased subject to the mortgage," and the regulation applied.
In summary, we think that the type of transaction entered into by petitioner with a purchaser*166 is apparent from the face of the agreement of sale. It was an agreement by the parties that the purchaser was to make payments on the purchase price for a period of time, after which petitioner was to pass title to the property and the purchaser was to take over the remaining mortgage payments. There was no present assumption of the mortgage nor was the property taken subject to the mortgage, as those expressions are customarily used. Respondent *669 therefore erred in subtracting the amount of the mortgage from the total contract price in determining the percentage of income from installment sales to be returned by petitioners during the taxable years in question, and also erred in including the excess of the mortage over the seller's basis in initial payments.
In the event we decide this issue for petitioners, which we do, the parties have stipulated the figures to be used in determining how much installment income should be reported in the taxable years.
In view of other concessions,
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 44. INSTALLMENT BASIS.
(a) Dealers in Personal Property. -- Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price.
(b) Sales of Realty and Casual Sales of Personalty. -- In the case * * * of a sale or other disposition of real property, if * * * the initial payments do not exceed 30 per centum of the selling price * * *, the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this section. As used in this section the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.↩
2. Sec. 212 (d), 44 Stat. 23.↩