*737 An insolvent corporation which purchases stock of a building and loan association at less than its face value and applies such stock at its face value in part payment of its debt to the association and which is still insolvent after the transaction, realizes no taxable gain from such purchase and payment.
*1445 This proceeding was brought to redetermine a deficiency in the income tax of the petitioner for the year 1933 in the sum of $1,451.93, with an added penalty of $362.98, and also a deficiency of $527.98 in its excess profits tax, plus a penalty of $132 thereon.
The sole issue is whether or not the petitioner realized taxable income when it repaid its loan of $50,000, assigned by the mortgagee to a building and loan association, by the payment of $10,000 in cash and $40,000 in the stock of that association, purchased by the petitioner at a cost of $24,000.
FINDINGS OF FACT.
The petitioner is an Ohio corporation organized in August 1927, and is the owner of and operates an office building located in Springfield, *738 Ohio, the ground floor of which is occupied by the First Morris Plan Industrial Bank, Springfield, Ohio, hereinafter called the Bank.
During the year 1927 the Bank desired to purchase a building in which it had its banking quarters, known as the Kelly Building, located at 120 South Limestone Street in the city of Springfield, Ohio, from its owner, Edwin S. Kelly (now deceased). However, due to the banking laws of the State of Ohio, the Bank was prevented *1446 from having more than 60 percent of its capital and surplus invested in real estate. The Bank was capitalized for only $50,000, while the best price obtainable from the owner of the building was $110,500.
Accordingly, the petitioner was organized for the sole purpose of acquiring the Kelly Building. Common capital stock of $100,000 was authorized, of which $50,500 was subscribed and paid for by the Bank. Two shares were issued for qualifying shares for directors, the remainder being unissued. It then proceeded to purchase the said real estate, paying therefor the sum of $110,500, the amount of $50,500 being available by the sale of its capital stock to the Bank. The balance of $60,000 was borrowed by placing*739 a real estate mortgage upon the premises being purchased, the mortgagee being the Merchants & Mechanics Savings & Loan Association (now Merchants & Mechanics Federal Savings & Loan Association), hereinafter called the Loan Association.
On October 22, 1927, the petitioner borrowed the sum of $60,000 from the First National Bank & Trust Co. of Springfield, Ohio, hereinafter called the Trust Co., and with the proceeds of that loan paid off the loan from the Loan Association. For that purpose the petitioner executed a note and mortgage on the same premises to the Trust Co. There was paid on that note on the 7th day of May 1928, the sum of $17,000. The loan was later increased by the amount of $27,000, which sum was used to remodel the building.
On December 29, 1928, the Trust Co. sold and assigned all its interest in the note and mortgage to the Loan Association. The principal of the note and mortgage was then $70,000. On April 7, 1932, that sum was reduced to $50,000 by the payment of $20,000 by the petitioner to the Loan Association.
During the year 1933, the Loan Association encountered financial difficulties then prevalent among banking institutions. Accordingly, it*740 made demand upon the petitioner to pay its mortgage note amounting to $50,000. The petitioner was unable to meet that demand since substantially all of its assets were represented by the bank building which it owned.
When the Loan Association was informed by the petitioner that it could not pay its mortgage indebtedness of $50,000, various negotiations were entered into between the petitioner and the Loan Association, the latter finally agreeing to accept $10,000 in cash and $40,000 par value of the Loan Association stock in payment of the petitioner's indebtedness of $50,000. The Loan Association thereupon served notice upon the petitioner that if the petitioner could not satisfy that requirement, foreclosure proceedings would be instituted at once. At that time, the stock of the Loan Association was selling at approximately 60 percent of par. The petitioner had no available *1447 cash with which to comply with the demand of the Loan Association and was forced to make a temporary loan of $35,000 in order to purchase the stock and to pay the additional $10,000, plus $1,074.57 accrued interest. Immediately upon the cancellation of the Loan Association mortgage a new note*741 and mortgage in the sum of $35,000 was executed by the petitioner to take up such temporary loan.
The petitioner was able, during the period September 14 to 29, 1933, to purchase on the open market $40,000 of the par value of the stock of the Loan Association in miscellaneous odd lots for the aggregate sum of $24,000. It thereupon tendered to the mortgagee $10,000 in cash and $40,000 par value of the Loan Association's stock, receiving in return therefor its paid note and canceled mortgage. That transaction occurred on September 29, 1933. On that date the fair market value of the stock of the Loan Association was 60 percent of its par value.
For the calendar year 1933 the petitioner filed a delinquent Federal income tax return on May 8, 1935, showing an operating net loss of $5,440.48. The balance sheet incorporated in that return shows the cost of buildings at the beginning of the taxable year as $141,606.25, while at the end of the year, December 31, 1933, the building cost is shown as $125,606.25. The following statement appears at the foot of the balance sheets:
Reduction in building cost was due to final settlement for building which was purchased finally for $16,000.00*742 less than originally bargained for.
Attached to the return is an affidavit sworn to on May 8, 1935, by the petitioner's treasurer, Frank J. Braun, in which he states that the delay in filing the return was due to:
Unintentional negligence on the part of this corporation. We discontinued our State Franchise Tax and due to the fact that our operations showed no tax we did not file this return.
On May 8, 1935, the petitioner filed a capital stock tax return for the year ended June 30, 1933 (form 707), and declared a value of "none" for its entire capital stock. The petitioner was engaged in the business of owning and operating a building during the entire year 1933.
The record discloses the following additional facts:
On September 29, 1933, prior to the transaction of that date, the petitioner owed $50,000 to the Loan Association, $20,000 to the McGregor heirs, $17,000 to the Bank, and accrued interest on such debts amounting to $1,074.57, $1,500, and $1,001.12, respectively, or a total indebtedness of $90,575.69. Immediately after the transaction the petitioner owed the McGregor heirs $20,000, with $1,500 accrued interest thereon, and the Bank, $17,000, with $1,001.12*743 accrued interest thereon, and it also owed the Bank $35,000 (shortly thereafter borrowing *1448 from M. G. Stimmell the same amount and repaying the Bank).
On September 29, 1933, the petitioner's only asset was the Kelly Building, which it carried on its books at its actual cost to the petitioner. The gross rentals from the building in 1933 were $7,034.
The petitioner's profits and losses from the operation of the building were as follows:
| Period | Profit | Loss |
| 1927 (4 months) | $41.98 | |
| 1928 | 336.02 | |
| 1929 | $113.84 | |
| 1930 | 1,867.18 | |
| 1931 | 1 194.25 | |
| 1932 | 1,723.34 | |
| 1933 | 2 5,440.48 |
The Kelly Building is a four-story brick and stone building and is approximately 40 years old. It is situated about 400 feet from the main business block of Springfield, around which the business activities of the city are centered and concentrated. The building has a composition roof and a cellar under only a small part of it. It contains two elevators, a sprinkler system, and a small amount of plumbing. It fronts 80.5 feet on Limestone Street and extends back 169 feet. There*744 is a one-story shed 31 feet wide extending across the rear of the lot.
The rear three-fourths of the building is the factory type of construction, with no ceiling or plastering. The front part of the upper floors is used for offices and an electrician's shop. The rear part of the building was rented by a printing establishment which in 1931 began to be delinquent in rent and later went into bankruptcy. The Bank and a cafeteria occupy the ground floor, which is four steps up from the pavement. These rooms extend back 109 feet. The bank quarters are well appointed and attractive. In 1928 they were remodeled at a cost of $45,000. The improvements in the Bank rooms were of no value to the petitioner unless the successor to the Bank would need them for similar purposes. In the same neighborhood, bank vaults had been a liability to the owners of a like building. The cafeteria room is in fairly good condition. The remainder of the building is in poor condition.
In 1933 rents in Springfield were exceedingly low. There were many vacant store rooms in the vicinity of the Kelly Building and others were occupied at only a nominal rental. One and one-fourth percent is a fair rate*745 of depreciation on the building.
On September 29, 1933, the fair market value of the Kelly Building was $70,000. On December 31, 1933, the petitioner had a credit *1449 of $352.87 on prepaid insurance and owed an overdraft of $4.41. Immediately before and immediately after the transaction of September 29, 1933, the petitioner was insolvent.
OPINION.
VAN FOSSAN: The matter at issue in this case is the taxability of the petitioner's alleged gain of $16,000 arising from its discharge of an obligation of $50,000 by the payment of $10,000 in cash and the transfer of capital stock of its creditor, having a face value of $40,000 but purchased by the petitioner for $24,000.
If the petitioner had been solvent at the time of the transaction the gain would be taxable. In , we said:
* * * the present state of authority seems to be that where a solvent debtor is under direct obligation to make payments for physical property purchased by him or by his assignor, which is still held by him, and satisfies this obligation by paying less than the amounts called for by the obligation, the property continuing to be of a value*746 sufficient to pay the indebtedness, the transaction will result in taxable income to the debtor in the amount by which the face value of the obligation exceeds the amount paid by him for its satisfaction.
Conversely, no taxable gain would result from such a transaction provided that, both immediately before and immediately after the transaction, the debtor was insolvent. In , we said:
* * * It seems clear that where an insolvent debtor turns over all of his property to his creditors in full or partial satisfaction of his debts the debtor realizes no taxable gain. Cf. ; ; ; ; . It is equally clear, we think, that where an insolvent debtor satisfies a portion of his debts without thereby becoming solvent he has likewise realized no taxable income. He had not by such satisfaction of his debt realized "something*747 of exchangeable value," something "for his separate use, benefit and disposal." * * *
The petitioner's purchase and retirement of its own bonds during the taxable years simply reduced its outstanding liabilities. A reduction in outstanding liabilities which does not make a taxpayer solvent does not result in taxable gain. .
See ; cf. .
The only question for us to decide therefore is the fact of the petitioner's insolvency. We have found as a fact that the petitioner was insolvent, immediately before and immediately after September 29, 1933. The record reveals that the petitioner owed $90,575.69 just before the settlement with the Loan Association and $74,501.12 immediately thereafter. In addition, the petitioner had a *1450 liability of $50,500 in outstanding capital stock, and, despite a generous rental paid by the Bank, its books at the end of 1933 showed an operating loss of $2,648.36 (which did not include a depreciation allowance of $2,792.12).
Its only asset was the*748 Kelly Building, whose fair market value we have found to be $70,000. At the end of 1933 it had an additional asset of $352.87 in prepaid insurance, minus the liability of an overdraft of $4.41. Thus, it is obvious that the petitioner could not pay its debts on September 29, 1933, or immediately theretofore or thereafter.
It is unnecessary to discuss at length the factors which combined to produce the September 29, 1933, valuation of the Kelly Building. However, it is pertinent to say that the Kelly Building was about 40 years old, of primarily a factory type of construction, with the Bank and cafeteria quarters on the lower floor and some office rooms finished off on the upper floors of the front part of the building. The ground floor was not level with the pavement. The building was not in good condition except the remodeled banking rooms and the cafeteria. Its location was not in the best business location of Springfield, a "one-street" city. Rents in this vicinity were very low in 1933 and there were many vacant rooms and buildings.
We had the benefit of the testimony of expert witnesses who were well acquainted with real estate values and were familiar with the general*749 business and economic situation in Springfield. On the facts as presented, we feel that $70,000 is a liberal valuation of the Kelly Building on September 29, 1933.
Thus, due to its insolvent condition, the petitioner realized no taxable gain in 1933 and, consequently, is chargeable with neither the tax nor the penalty set forth in the respondent's notice of deficiency.
Decision will be entered for the petitioner.