Decision will be entered under Rule 50.
Held: 1. Proceeds of a fire insurance policy paid on account of a fire, where the lessee paid the premiums covering machinery and equipment placed upon the property by the lessee, belonged to the lessor where the lease gave the lessor ownership of the machinery and equipment and the proceeds are taxable to the lessor at capital gains rates. Owen Meredith, 12 T.C. 344 (1949), followed.
2. Certain of the proceeds in the amount of $ 34,740.92 were not proceeds collected by the lessor for his property and this amount represented a constructive dividend to petitioner-lessor from the lessee where petitioner was controlling stockholder of the lessee.
3. Proceeds from the sale of the machinery and equipment after the fire were additional long-term capital gains to petitioner wherein petitioner had a zero basis in the machinery and equipment.
4. Future Realty Corporation was a collapsible corporation within the meaning of section 341, I.R.C. 1954, and the gains realized by petitioner on the sale of his stock in that corporation were taxable as gains from the sale of property which is not a capital asset.
*84 Respondent determined deficiencies in the income tax of petitioners for the years 1954, 1955, and 1956 in the respective amounts of $ 135,377.43, $ 26,008.39, and $ 24,969.66. Most of these deficiencies are in dispute. Petitioners contest the adjustments by appropriate assignments of error and in doing so the following issues are raised:
*85 (1) Whether certain machinery and equipment were the property of petitioner when destroyed by fire so that the fire insurance proceeds are taxable as capital gains to petitioners or whether the machinery and equipment were the property of J. T. Gibbons, Inc., a corporation in which petitioner was controlling stockholder, so that the insurance proceeds collected by petitioner constituted a constructive dividend from the corporation to him and was therefore ordinary income.
(2) Whether or not the proceeds from the sale of certain machinery and equipment after the fire represented additional capital gains to petitioners or whether the proceeds from the sale properly belong to J. T. Gibbons, Inc.
(3) Whether or not Future Realty Corp. was a collapsible corporation.
Respondent by *149 affirmative pleading by an "Amendment to Answer" and an "Amendment to Amendment to Answer" pleads in the alternative that if petitioners did not realize ordinary income in 1954 they realized capital gain in 1954 in the amount of $ 207,706.77 by the receipt of insurance proceeds because of destroyed machinery and equipment; that petitioners realized additional capital gains in 1954, 1955, and 1956 from the sale of machinery and equipment in the amounts of $ 1,675, $ 35,086.37, and $ 25,187.33, respectively; and that petitioners understated capital gain realized on the sale of Future Realty Corp. stock for 1955 in the amount of $ 47,346.52, in the event that we should determine that such gain is capital gain rather than ordinary income.
FINDINGS OF FACT
A stipulation of facts and a supplemental stipulation of facts, together with exhibits attached thereto, were filed by the parties and are incorporated herein by this reference.
Petitioners Max N. Tobias and Mildred G. Tobias are husband and wife residing in New Orleans, La. They filed their joint income tax returns with the district director of internal revenue at New Orleans for the calendar years 1954, 1955, and 1956. Hereinafter Max *150 N. Tobias will be referred to as petitioner.
Issue 1J. T. Gibbons, Inc., hereinafter referred to as Gibbons, is a corporation organized under the laws of the State of Louisiana on February 1, 1949. Petitioner was president of Gibbons. The issued and outstanding common stock of Gibbons was owned as follows:
| Common | |
| Name | stock |
| Max N. Tobias (petitioner) | 254 |
| Morris E. Burka (petitioner's nephew) | 245 |
| Ralpha H. Fishman | 1 |
*86 Gibbons acquired the assets of a going business which was located at 2700 Howard Avenue, New Orleans. The land and buildings located there were acquired by petitioner individually on February 1, 1949, for a total consideration of $ 185,000, which cost was allocated on petitioner's records as follows:
| Machinery and equipment | $ 52,578 |
| Building | 99,222 |
| Land | 33,200 |
| Total | $ 185,000 |
On February 1, 1949, petitioner leased the buildings to Gibbons for a period of 10 years commencing February 1, 1949, for an annual rental of $ 22,500. In addition to the cash rental, the lessee agreed to assign to petitioner machinery and equipment that it had acquired in the buildings and the lessee agreed to pay for all repairs and pay for all insurance that was considered necessary to insure adequately all the *151 property, including the buildings and the machinery and equipment located in the buildings.
The lease, inter alia, contained the following provisions:
NET LEASE
This Agreement made and entered into this first day of February, 1949 by and between Max N. Tobias, hereinafter called "Lessor" and J. T. Gibbons, Inc., hereinafter called "Lessee" * * *
* * * *
I
Lessor hereby leases to Lessee the following described property situated in the City of New Orleans to wit:
ONE CERTAIN SQUARE OF GROUND, together with all the buildings and improvements thereon, and all the rights ways, privileges, servitudes, appurtenances and advantages thereunto belonging or in any wise appertaining * * *
* * * *
Together with all engines, machines and machinery, appurtenances, appliances, tools, implements, equipment and all other property of similar nature located upon or used in connection with the hereinabove described property and/or located and used in connection with the plant and buildings thereon erected wheresoever located; also all tracks, switches, switch tracks, switching privileges, ways, roads, pipes, pipe lines and all similar rights or privileges.
* * * *
II
This lease is made for a term of ten (10) years *152 commencing on the first day of February, 1949 and ending on the thirty-first (31st) day of January, 1959.
III
The property herein leased constitutes, and shall be leased as a plant, office and place of business for the manufacture, storing, sale and distribution of mixed feeds, hay, grain and similar products.
*87 IV
This lease is made for and in consideration of an annual net rental to be paid by Lessee to Lessor of TWENTY-TWO THOUSAND FIVE HUNDRED ($ 22,500.00) DOLLARS, payable monthly in advance at the rate of ONE THOUSAND EIGHT HUNDRED AND SEVENTY-FIVE ($ 1,875.00) DOLLARS per month.
As further consideration for this lease, Lessor and Lessee agree as follows:
Lessor and Lessee take cognizance of the fact that under a prior lease between J. T. Gibbons, Inc. (now Louisiana Grain Corporation) (the predecessor of the present J. T. Gibbons, Inc.) and Gibbons Realty Company, certain machinery, appliances and equipment in the leased premises became the property of the Lessee, which said machinery, appliances and equipment were sold by said Lessee to the present J. T. Gibbons, Inc.; that the balance of said machinery, equipment and appliances in said premises were acquired by the said Max N. Tobias *153 by purchase of the realty from Gibbons Realty Company. The parties hereto declare that the ownership of said machinery, equipment and appliances is impossible to determine as between the Lessor and Lessee, and, as further consideration for this lease, the said Lessee does hereby transfer to said Lessor all of its right, title, interest and ownership in and to the said machinery, equipment and appliances which is hereby declared to now form part of the premises herein leased.
V
Lessee assumes to the complete release and discharge of the Lessor the following charges:
* * * *
(c) The cost of all replacements, repairs and maintenance of the machinery, equipment and appliances, such repairs and maintenance to be done according to the standards by which such machinery, equipment and appliances are usually maintained; all replacements shall be at least of equivalent type and value and such replacements shall become and remain the property of the Lessor. Should Lessee desire to install additional machinery, equipment and appliances, such additions shall also become and remain the property of the Lessor.
* * * *
(f) Lessee agrees at all times during the term of this lease to keep the buildings and *154 improvements insured to their full insurable replacement value, but not in excess of $ 200,000.00. Lessee further agrees, during the term of this lease, to keep the machinery, equipment and appliances insured against fire and extended coverage in the sum of $ 150,000.00 and to insure the Lessor against loss of rental for the period of one year up to the sum of $ 28,000.00. Lessee further agrees to insure Lessor at its own expense, against any other perils that Lessor may from time to time require.
In consideration of the mutual agreements and undertakings by the said parties, they do now agree to hold each the other harmless for any damage to or destruction of one anothers property caused by the negligence of either party, their agents, servants, or employees, when such damage is attributable to and covered by any of the perils insured against and which could result from human fault, particularly fire; and each of the parties does hereby expressly waive the right of subrogation under said insurance policies, provided said policies grant permission to waive rights of subrogation prior to loss.
* * * *
*88 VI
Lessee shall not make any additions, alterations or improvements to the leased premises *155 without the written consent of the Lessor. All additions, alterations and improvements made by Lessee, with or without the consent of Lessor, shall become and remain the property of Lessor, Lessee hereby expressly waiving all right to compensation therefor.
VII
Lessee shall have the right to sublease the premises and to assign this lease but shall first obtain the written consent of the Lessor, who shall have the right to reject any assignee or sublessee at his own discretion with proper cause.
The lease was first amended on July 19, 1949, and provided in material part as follows:
Whereas, the said parties desire to amend the said lease;
Now Therefore, in consideration of their mutual agreements, the said parties do hereby amend the said lease in the following respects and no others, the remaining provisions of said lease to continue in full force and effect. Article V (f) is hereby amended so as to read as follows:
(f) Lessee agrees at all times during the term of this lease to keep the buildings and improvements insured to their full insurable replacement value, but not in excess of $ 400,000.00. Lessee further agrees, during the term of this lease, to keep the machinery, equipment *156 and appliances insured against fire and extended coverage in the sum of $ 150,000.00 and to insure the lessor against loss of rental for the period of one year up to the sum of $ 28,000.00. Lessee further agrees to insure lessor at its own expense, against any other perils that lessor may from time to time require.
The second amendment was made and entered into on January 8, 1951, and provided in material part as follows:
Article II of said lease is hereby amended so as to read, as follows:
II
This lease is made for a term of twenty (20) years, commencing on the first day of February, 1949, and ending on the 31st day of January, 1969.
During the period from February 1, 1949, to May 11, 1953, Gibbons purchased machinery and equipment that were used in its business operated in the buildings. The cost of such machinery and equipment in the amount of $ 115,011.87 was entered in a plant improvement account on the Gibbons books. The machinery and equipment were shown as either buildings or buildings and leasehold improvements in its balance sheets.
A fire occurred on May 11, 1953, that damaged one of the buildings and damaged and destroyed machinery and equipment that had been placed and installed *157 in that building. All payments made by the insurers of the property were made during the months of January and February 1954 and all checks in payment of said proceeds were issued to petitioner and Gibbons "as their interest may appear." These checks were endorsed by Gibbons and by petitioner and were *89 deposited in the individual bank account of petitioner. The insurance policy on the machinery and equipment contained a loss payable clause to "Max N. Tobias and J. T. Gibbons, Inc., as their interest may appear."
The insurance companies' appraisal of all machinery and equipments in the buildings as of May 11, 1953, and the amount of fire loss were determined as follows:
| Total sound value of all machinery and equipment | $ 502,167.58 |
| Machinery and equipment loss | $ 208,400.47 |
| Add: | |
| 6% engineering fee | 12,504.02 |
| Loss of tools, supplies, and spare parts | 20,000.00 |
| Difference in salvage scrap and dismantling and removal | |
| of debris | 6,097.00 |
| Total loss | $ 247,001.49 |
| Amount paid after applying coinsurance clause: | |
| 90% x $ 247,001.49 | 1 $ 213,790.32 |
For machinery and equipment damaged or destroyed in said fire, the insurers paid the total *158 sum of $ 213,790.32, of which amount Gibbons reported the sum of $ 6,083.55 in its original 1953 income tax return. In his 1955 tax return, petitioner reported the receipt of $ 207,706.77 as insurance proceeds paid for the loss of machinery and equipment. Later, petitioner agreed that 1954 was the proper year for reporting the insurance proceeds and he does now so concede.
For the purpose of ascertaining the amount of loss to be paid for the damaged and destroyed machinery and equipment the insurance companies employed an appraiser. He determined the sound value of each item of machinery and equipment in the buildings, described each item, and determined the amount of loss with respect to each item.
Petitioner reported as a capital gain the proceeds of the fire insurance policies in 1955, rather than in 1954, the amount of $ 186,237.42 computed as follows:
| Total payments received | $ 213,790.32 | |
| Less: | ||
| (a) Amount voluntarily given to Gibbons | $ 6,083.55 | |
| (b) Remaining cost | 21,469.35 | 27,552.90 |
| $ 186,237.42 |
After the fire Gibbons desired to have the lease between petitioner and Gibbons canceled because Gibbons was losing a great deal of money. The lease was canceled as of January 1, 1955, pursuant *159 to an agreement made sometime in 1954. Gibbons continued to rent the *90 office and a small warehouse but the remainder of the buildings were not leased again until 1961. Gibbons' earned surplus as of December 31, 1953, and December 31, 1954, was $ 338,228.67 and $ 141,918.71, respectively.
Issue 2Petitioner informed Gibbons that it could sell all of the machinery and equipment it had purchased since February 1, 1949, and retain the sales proceeds. After the fire, Gibbons sold all of the machinery and equipment, whether destroyed, damaged, or undamaged, for which payments were received in the years 1954, 1955, and 1956 in the respective amounts of $ 1,675, $ 37,166.65, and $ 35,710.55. It had spent $ 2,080.28 and $ 3,501.13 in 1955 and 1956, respectively, reconditioning the damaged equipment. Gibbons, on its income tax returns, accounted for the receipt of those sales except for amounts that were credited to petitioner's account in the respective amounts of $ 432.79, $ 1,325, and $ 8,260.25 for the years 1954, 1955, and 1956. Petitioner did not report as income any of the proceeds received from those sales except the amount of $ 7,022.09 which he reported as long-term capital gain *160 for the year 1956.
No entries were made in Gibbons' books which showed either that there was an agreement between the parties as to the sale of petitioner's property or that petitioner made a contribution of capital in any form whatever that would either indicate or show he had contributed this machinery to it. Except for the sale of certain small items of equipment and parts which were not leasehold improvements, the machinery and equipment sold by Gibbons were actually the property of petitioner for which he should have reported the following amounts as long-term capital gains:
| Year | Amount |
| 1954 | $ 1,675.00 |
| 1955 | 30,027.62 |
| 1956 | 18,711.23 |
Petitioner reported $ 7,022.09 of the total amount collected in 1956, leaving a balance of $ 11,689.14 which was unreported additional long-term capital gain in that year. The additional capital gains which petitioner should have reported for 1954, 1955, and 1956 are arrived at as follows:
| 1954 | 1955 | 1956 | |
| Proceeds from sale of equipment | $ 1,675 | $ 37,166.65 | $ 35,710.55 |
| Cost of reconditioning | 0 | 2,080.28 | 3,501.13 |
| 1,675 | 35,086.37 | 32,209.42 | |
| Sale of property belonging to Gibbons | 0 | 5,058.75 | 13,498.19 |
| Additional long-term capital gains | 1,675 | 30,027.62 | 18,711.23 |
| Previously reported by petitioner | 0 | 0 | 7,022.09 |
| Additional long-term capital gains to | |||
| petitioner | 1,675 | 30,027.62 | 11,689.14 |
Future Realty Corp., hereinafter referred to as Future, was organized under the laws of the State of Louisiana on June 23, 1953. Future was licensed and authorized to purchase, acquire, own, and sell real estate. Future's authorized capital stock was 150 shares of $ 100 par value per share. All of the authorized stock was issued and paid for. From June 23, 1953, to September 21, 1954, petitioner owned 25 percent of Future's authorized and issued capital stock, all of which was held and recorded in the names of nominees.
Marvin Realty Corp., hereinafter referred to as Marvin, was incorporated under the laws of the State of Louisiana on July 14, 1953. It was authorized to purchase, acquire, own, and sell real estate. Marvin had authorized and issued 2,500 shares of capital stock. Future's and Marvin's capital stock was owned at all material times by the same persons and in the same proportions.
On June 22, 1953, Future acquired an option to purchase, from the estate of William Mason Smith, 563 acres of land in Jefferson Parish, La., for $ 600,000 with a cash payment of $ 150,000 and 10 annual payments of $ 45,000 each. On July 17, 1953, Marvin acquired, by agreement, the right to *162 purchase 136 acres of land that was part of the 563-acre tract. The securing of the option by Marvin was accomplished by canceling the option Future acquired on June 22, 1953, and by Future securing an option to acquire 427 acres and Marvin acquiring an option to acquire the 136 acres.
Prior to the date Future was incorporated its stockholders had information that indicated that the Veterans' Memorial Highway would be constructed and would either intersect or pass along the 563-acre tract that Future and Marvin acquired from the estate of W. M. Smith. This highway was later constructed and did intersect such tract and its construction materially enhanced the value of the property.
Magnolia Park, Inc., hereinafter referred to as Magnolia, was incorporated under the laws of the State of Louisiana on July 16, 1953, for the purpose of operating a harness racing track in Jefferson Parish, La. The State of Louisiana granted Magnolia a racing permit on July 24, 1953, while petitioner was racing commissioner for the State of Louisiana.
On July 24, 1953, Future and an agent acting for Magnolia entered into an agreement wherein Future agreed to lease to Magnolia the 427 acres of land that Future *163 had acquired the option to purchase. Between the dates of July 24, 1953, and September 10, 1953, Magnolia's agent secured from Future's stockholders an option to purchase all of Future's authorized and outstanding stock. It was the decision of the Future stockholders to sell all of their Future stock prior to the date Future acquired the property from the estate of W. M. Smith.
*92 On September 21, 1953, Future exercised its option to purchase and acquired the land. Future agreed to pay the amount of $ 350,000 for the tract. The purchaser agreed to make a downpayment in the amount of $ 87,500 and pay the balance in 10 equal annual payments.
On September 21, 1953, Future and Magnolia entered into a lease agreement which provided in part: The lease was for a period of 10 years; the annual rent payable was the amount of $ 45,000 for the first 3 years and the amount of $ 48,750 for the remaining years; the lessee agreed to construct and complete a number of improvements during the first years of the lease; and in the event the lessee failed to complete the improvements on the premises of a cost of $ 500,000 or more prior to the expiration of the first year of the lease, the lessor had the *164 right and option to cancel the lease upon written notice to the lessee 15 days prior to the expiration of the first year's term. Improvements were made by the lessee pursuant to the lease.
On September 21, 1953, all of Future's stockholders granted to Magnolia an option to purchase all of the Future authorized and issued capital stock.
On September 21, 1953, Marvin exercised the option it had acquired on July 17, 1953, and purchased 136 acres of land from the estate of W. M. Smith. Future loaned Marvin $ 25,000 to be used to purchase the 136 acres. Marvin was liquidated on November 20, 1953, and its assets were distributed to its stockholders in kind.
On September 21, 1954, Magnolia exercised its option and purchased all of Future's outstanding capital stock for which it paid the amount of $ 625,500. Payments received and the gain realized by petitioner on the sale of Future capital stock were as follows:
| 1954 | 1955 | |
| Payments received | $ 9,272.41 | $ 50,525.59 |
| Cost | 583.42 | 3,179.07 |
| Gain realized | $ 8,688.99 | $ 47,346.52 |
The only improvements made on the 427 acres Future leased to Magnolia were made by the lessee pursuant to the lease of September 21, 1953.
On November 22, 1954, Future was liquidated.
OPINION
Issue *165 1Involuntary Conversion of PropertyPetitioner received $ 213,790.32 in 1954 as reimbursement under a fire insurance policy paid because of damaged and destroyed machinery and equipment located in a building owned by him. Petitioner purchased the building on or about February 1, 1949, and he *93 leased it to Gibbons, a corporation in which he is controlling stockholder, for a term of 10 years on February 1, 1949, later changed to 20 years. Petitioner retained $ 207,706.77 of the insurance proceeds and paid Gibbons the amount of $ 6,083.55.
From February 1, 1949, to May 11, 1953, Gibbons purchased machinery and equipment for which it paid the amount of $ 115,011.87. The fire which caused a loss of approximately 40 percent of the machinery and equipment occurred on May 11, 1953. Fire insurance premiums were paid for by the lessee insuring jointly the interests of the lessor and lessee in the machinery and equipment.
Petitioner contends that under the terms of the lease between petitioner and Gibbons all the machinery and equipment placed in the building by the corporate lessee became petitioner's property at the time it was installed, that he is entitled to all of the insurance proceeds, *166 and that any gain to him is taxable at capital gain rates. Respondent contends that petitioner should report as a dividend taxable at ordinary income tax rates the proceeds he received in 1954 in the amount of $ 207,706.77 on the ground that the destroyed and damaged machinery and equipment in fact belonged to the lessee.
Petitioner reported the insurance payments as long-term capital gains in 1955 but now concedes that they are reportable in the year received, 1954. There is now no dispute as to the amount or year of payment or that petitioner personally received all of the proceeds except for $ 6,083.55. There is no dispute as to the payments collected by petitioner on his loss on the building itself. Petitioner has not replaced the damaged or destroyed machinery and equipment.
The questions presented are whether the additions of machinery and equipment made by the lessee during the term of the lease were the property of the lessor when they were destroyed by fire and, if so, what amount of the insurance proceeds collected by petitioner represented a reimbursement for his property. If the machinery and equipment added by the lessee to the building were not the property of the *167 lessor but were in fact the property of the lessee, as respondent contends, then the insurance proceeds collected by petitioner, respondent contends, represent a constructive dividend to petitioner.
In 1938 the Supreme Court held that a lessor does not realize taxable income when a lessee makes improvements to the leasehold, M. E. Blatt Co. v. United States, 305 U.S. 267">305 U.S. 267 (1938). In that case the Supreme Court concluded that:
It may be assumed that, subject to the lease, lessor became owner of the improvements at the time they were made. But it had no right to use or dispose of them during the term. Mere acquisition of that sort did not amount to contemporaneous realization of gain within the meaning of the statute.
Two years later in Helvering v. Bruun, 309 U.S. 461">309 U.S. 461 (1940), the Supreme Court modified the Blatt decision and determined that the *94 lessor could derive income due to the improvements made during the lease at the termination of the lease. Congress, however, soon thereafter amended the law to exclude from the gross income of the lessor income attributable to the improvements made by the lessee. The congressional reports make it clear that section 115 of the Revenue Act of 1942 *168 was designed to overrule the Bruun decision. 1 Section 115 of the Revenue Act of 1942 became section 22(b)(11) of the 1939 Code, as amended, and section 1092*169 of the 1954 Code is substantially identical with section 22(b)(11). Accordingly, if we find that the machinery and equipment constitute "other improvements" as that phrase is used in section 109 of the 1954 Code and that they became the lessor's property under the lease, then the value of the improvements is not included in the gross income of the lessor and fire insurance proceeds paid on account of the involuntary conversion of that property belong to him. The terms of the lease set forth in our Findings of Fact make it clear, we think, that the machinery and equipment became the property of the lessor.
It seems apparent to us that the phrase "other improvements" as it is used in section 109 has application to permanent additions of value to real property. The additions of machinery and equipment made by the lessee in this case seem to fall within that definition. Most of the equipment was heavy and large and it appears that most of it was physically attached to the realty. The equipment was also necessary for the manufacturing process carried on in the building. As a general rule, under the law of fixtures, manufacturing equipment becomes part of the real property if the lessor and lessee so intend and where the equipment is needed in the manufacturing process carried on on the leasehold. 3
We conclude that the machinery and equipment installed by the lessee constituted "other improvements" within the meaning of section 109 of the 1954 Code. Therefore, it appears that section 109 is applicable here.
Finding that the lease between petitioner and his corporation was a bona fide lease arrived at at arm's length, our decision in Owen Meredith, 12 T.C. 344">12 T.C. 344 (1949), is of particular note. In that case *170 we held that the proceeds of fire insurance policies paid for by the lessee, covering improvements placed on the property by the lessee under a lease agreement which gave the lessor ownership of the improvements, were taxable to the lessor at capital gains rates. The following portions of that opinion are particularly relevant here:
*95 *171 There can be no question but that under the lease agreement the petitioner became the owner of the improvements at the time they were placed on the property. The only interest which the lessee had in them was the right to their use during the term of the lease. The cancellation of the lease immediately cut off that interest. At best, the lessee's interest in the insurance proceeds gave it no more than a bargaining power in the negotiations for cancellation of the lease. It could forego its right under the lease agreement to the use of the insurance proceeds to replace the improvements in consideration for release from its obligation to pay rent for the remainder of the lease term. * * * We can not find on the evidence before us that the insurance proceeds were in fact received by petitioner, to any extent, as consideration for cancellation of the lease.
Even if the lessee had continued the lease and had been permitted to use the funds to replace the improvements, the converted fund in the form of new improvements would still have been the property of the lessor. Thus, it would seem that the petitioner was actually the equitable, as well as the legal, owner of the improvements and *172 the insurance proceeds.
* * * *
The petitioner did not receive the insurance money as rent. He received it as compensation for his loss of the improvements which had already become his property. * * *
It might be noted that under section 112(f), Internal Revenue Code, the petitioner would not have been taxable on the receipt of the insurance proceeds if he had permitted their use for replacing the improvements; nor under section 22(b)(11), Internal Revenue Code, would he have been taxable on any gain from the acquisition of the improvements if they had not been destroyed and had remained on the premises until the termination of the lease. His gain would have been taxable when he sold or otherwise disposed of the property, presumably at the capital gain rates.
We reach the same conclusion here under the 1954 Code as was reached above and find that the insurance payments for the destroyed and damaged improvements are taxable as long-term capital gain to petitioner.
A portion of the fire insurance proceeds collected by petitioner, however, was not reimbursements for the loss of petitioner's property. The record shows that petitioner received some of the insurance payments that should have *173 gone, we think, to Gibbons under the policy. These payments were for (1) engineering fees, (2) tools, supplies, and spare parts, and (3) difference in salvage, scrap, and dismantling and removal of debris in the respective amounts of $ 12,504.02, $ 20,000, and $ 6,097, less 10 percent for the coinsurance provision. The insurance payments made for these items were, we think, clearly not for improvements owned by the lessor. Accordingly, they should have been collected by Gibbons and the amount of $ 34,740.92 constituted a constructive dividend to petitioner in 1954, taxable at ordinary rates. Gibbons' earnings and profits were more than sufficient to cover this dividend. The remainder ($ 207,706.77 less $ 34,740.92, or $ 172,965.85) represents a payment to petitioner for his property. Since both the damaged and undamaged machinery and equipment owned by petitioner *96 were subsequently sold, we can assume that petitioner first recovered his entire adjusted basis of $ 21,469.35 from the fire insurance payments and his capital gain in 1954 was $ 151,496.50, giving him a zero basis in all the remaining machinery and equipment.
Issue 2Additional Long-term Capital GainsAfter the fire and *174 after the parties agreed to cancel the lease, petitioner claims that he entered into an oral agreement with Gibbons whereby Gibbons would sell all the machinery and equipment owned by petitioner, whether damaged by fire or not, and Gibbons would keep the proceeds from the sale of the machinery and equipment it had purchased. We do not believe there is sufficient evidence to find that a valid agreement was made between petitioner and Gibbons to that effect. Petitioner has previously shown that this was his property and he now takes an inconsistent position. Accordingly, we find that the proceeds of the sale of petitioner's machinery and equipment should have been reported by him as his gain.
We have set forth in detail in our Findings of Fact the amount of proceeds from these sales which should have been reported by petitioner in the years 1954, 1955, and 1956 as additional long-term capital gains and we do not feel it necessary to review those findings here. As we noted earlier, petitioner recouped his entire adjusted basis in this machinery and equipment from the insurance payments so his adjusted basis in this machinery and equipment was zero and the total sales proceeds are additional *175 long-term capital gains to him.
Issue 3Collapsible CorporationThis issue involves the question of whether the Future Realty Corp. was a collapsible corporation within the meaning of section 341 of the 1954 Code. 4*176 *177 *178
*97 Petitioner contends that Future was not a collapsible corporation because (1) the stockholders did not have the required "view," (2) the property was not a section 341 asset, and (3) if the corporation is collapsible, the decision in United States v. Ivey, 294 F. 2d 799 (C.A. 5, 1961), petition for rehearing denied 303 F. 2d 109 (1962), is applicable.
Respondent contends that Future was a collapsible corporation and also contends that there is a statutory presumption that Future was a collapsible corporation. As to the statutory presumption, the facts show that the asset involved, real estate, was far in excess of 50 percent of *179 the fair market value of Future's total assets. The adjusted cost basis of the land was $ 350,250 and the amount paid for all of the Future capital stock on September 21, 1954, was $ 625,500. The value of the land and improvements was more than 120 percent of the adjusted basis of $ 350,250. It appears, therefore, that the provisions of *98 section 341 (c)5*180 have been met. There was also a sale of stock since it is stipulated that the option to purchase Future's stock was exercised on September 21, 1954.
The property involved would be a "section 341 asset" if it was either held by Future primarily for sale to customers in the ordinary course of business, section 341(b)(3)(B), supra, or if the property falls within the description set forth in section 1231(b), 6*181 section 341(b) (3)(D), supra. It seems apparent that the property in question is property described in section 1231(b) since it was real estate used in Future's trade or business of renting real estate.
The next question is whether the stockholders sold their stock before Future realized a substantial part of the taxable income to be derived from the property. Future had realized $ 45,000 in rentals when the stock option was exercised by Magnolia. Under the 10-year lease with Magnolia it would have realized $ 476,250 in rentals. We find that it was reasonable to expect that Future would realize at least $ 476,250 from the real estate through rentals. Consequently, it is apparent that the amount of realized income at the time of the sale was not substantial so as to take the transaction outside the scope of section 341(b)(1)(A), supra; cf. Heft v. Commissioner, 294 F. 2d 795 (C.A. 5, 1961), affirming 34 T.C. 86">34 T.C. 86 (1960), and Rose Sidney, 30 T.C. 1155">30 T.C. 1155 (1958), affd. 273 F. 2d 928 (C.A. 2, 1960).
The next question is whether *182 Future was formed or availed of with a view to sell the stock before the realization of a substantial part of the taxable income to be derived therefrom.
*99 In June 1953 the Future stockholders were considering leasing property and giving an option to sell their stock. The group that became the Future stockholders at that time caused Marvin to be created to secure an option on the 136 acres that Magnolia did not want. The facts show that Future intended to lease 427 acres to Magnolia and became bound to do so on July 24, 1953. Magnolia could not have entered into any agreement prior to July 16, 1953, the date it was incorporated.
The Future stockholders knew exactly what was going to be done sometime in June or July of 1953. If they had not intended to sell their stock at that time there would have been no need for creating Marvin since Future could have acquired the 563 acres and leased all or any part of the tract. Future did not exercise its option to purchase the real property until the same date that it entered into the lease agreement with Magnolia and the Future stockholders granted an option to purchase all of the Future stock. Doubtless Magnolia would not have leased the 427 *183 acres had it not acquired an option to purchase the property or all of the Future stock. We believe the conclusion is inescapable that Future stockholders knew that either the property or their stock would be sold at the time Future purchased the property. This evidence clearly shows that Future was formed or availed of with the "view" on the part of the stockholders to sell their stock before Future realized a substantial part of the income to be derived from the property, cf. Raymond G. Burge, 28 T.C. 246">28 T.C. 246 (1957), affd. 253 F. 2d 765 (C.A. 4, 1958); Elizabeth M. August, 30 T.C. 969">30 T.C. 969 (1958), affd. 267 F. 2d 829 (C.A. 3, 1959); and C. D. Spangler, 32 T.C. 782">32 T.C. 782 (1959), affd. 278 F. 2d 665 (C.A. 4, 1960), certiorari denied 364 U.S. 825">364 U.S. 825 (1960).
It is further stipulated that petitioner owned 25 percent of the Future capital stock at all times from the date Future was formed until the stockholders sold their stock to Magnolia on September 21, 1954. The evidence also shows that the entire gain involved in this issue was attributable to the real estate acquired on September 21, 1953. Therefore, the requirements of section 341(d), supra, have been met.
Our analysis set forth above, we think, *184 shows that the corporation was collapsible under all the tests within section 341.
Petitioner contends, however, that another reason remains why petitioner is entitled to capital gain treatment on the sale of his stock. Petitioner argues that under the Fifth Circuit's decision in United States v. Ivey, supra, collapsible corporation treatment should not apply to tax a shareholder's gain as ordinary income where such gain would have been taxed as capital gain if the corporate form had not been utilized. If we assume, without deciding, that the facts in the instant case fall into that exception, we would still feel compelled to refuse to follow that decision. The Tax Court has expressly refused *100 to adopt the principles of United States v. Ivey, supra; see Sproul Realty Co., 38 T.C. 844">38 T.C. 844 (1962). The argument was also rejected by the Second Circuit in Braunstein v. Commissioner, 305 F. 2d 949 (C.A. 2, 1962), affirming 36 T.C. 22">36 T.C. 22 (1961), certiorari granted December 10, 1962, and that case is now before the Supreme Court. We follow our decision in Sproul Realty Co., supra, in the instant case with all due respect to the Fifth Circuit in United States v. Ivey, supra.
We conclude, therefore, *185 that Future was a collapsible corporation and that petitioner's gains in 1954 and 1955 from the sale of his stock in Future, as stipulated, should be considered as gains from the sale of property which is not a capital asset. On this issue we hold for the respondent.
Decision will be entered under Rule 50.
Footnotes
1. 90% of $ 247,001.49 is $ 222,301.34. No explanation is given in the stipulation.↩
1. H. Rept. No. 2333, 77th Cong., 2d Sess., p. 69 (1942), 2 C.B. 425">1942-2 C.B. 425; S. Rept. No. 1631, 77th Cong., 2d Sess., p. 79 (1942), 2 C.B. 564">1942-2 C.B. 564↩.
2. SEC. 109. IMPROVEMENTS BY LESSEE ON LESSOR'S PROPERTY.
Gross income does not include income (other than rent) derived by a lessor of real property on the termination of a lease, representing the value of such property attributable to buildings erected or other improvements made by the lessee.
3. V American Law of Property, secs. 19.1-19.8, 19.13, and 19.14 (1952).↩
4. SEC. 341. COLLAPSIBLE CORPORATIONS.
(a) Treatment of Gain to Shareholders. -- Gain from --
(1) the sale or exchange of stock of a collapsible corporation,
* * * *
to the extent that it would be considered (but for the provisions of this section) as gain from the sale or exchange of a capital asset held for more than 6 months shall, except as provided in subsection (d), be considered as gain from the sale or exchange of property which is not a capital asset.(b) Definitions. --
(1) Collapsible corporation. -- For purposes of this section, the term "collapsible corporation" means a corporation formed or availed of principally for the manufacture, construction, or production of property, for the purchase of property which (in the hands of the corporation) is property described in paragraph (3), or for the holding of stock in a corporation so formed or availed of, with a view to --
(A) the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, before the realization by the corporation manufacturing, constructing, producing, or purchasing the property of a substantial part of the taxable income to be derived from such property, and
(B) the realization by such shareholders of gain attributable to such property.
(2) Production or purchase of property. -- For purposes of paragraph (1), a corporation shall be deemed to have manufactured, constructed, produced, or purchased property if --
(A) it engaged in the manufacture, construction, or production of such property to any extent.
(B) it holds property having a basis determined, in whole or in part, by reference to the cost of such property in the hands of a person who manufactured, constructed, produced, or purchased the property, or
(C) it holds property having a basis determined, in whole or in part, by reference to the cost of property manufactured, constructed, produced, or purchased by the corporation.
(3) Section 341 assets. -- For purposes of this section, the term "section 341 assets" means property held for a period of less than 3 years which is --
(A) stock in trade of the corporation, or other property of a kind which would properly be included in the inventory of the corporation if on hand at the close of the taxable year;
(B) property held by the corporation primarily for sale to customers in the ordinary course of its trade or business;
(C) unrealized receivables or fees, except receivables from sales of property other than property described in this paragraph; or
(D) property described in section 1231 (b) (without regard to any holding period therein provided), except such property which is or has been used in connection with the manufacture, construction, production, or sale of property described in subparagraph (A) or (B).
In determining whether the 3-year holding period specified in this paragraph has been satisfied, section 1223 shall apply, but no such period shall be deemed to begin before the completion of the manufacture, construction, production, or purchase.
* * * *
(d) Limitations on Application of Section. -- In the case of gain realized by a shareholder with respect to his stock in a collapsible corporation, this section shall not apply --
(1) unless, at any time after the commencement of the manufacture, construction, or production of the property, or at the time of the purchase of the property described in subsection (b)(3) or at any time thereafter, such shareholder (A) owned (or was considered as owning) more than 5 percent in value of the outstanding stock of the corporation, or (B) owned stock which was considered as owned at such time by another shareholder who then owned (or was considered as owning) more than 5 percent in value of the outstanding stock of the corporation;
(2) to the gain recognized during a taxable year, unless more than 70 percent of such gain is attributable to the property so manufactured, constructed, produced, or purchased; * * *↩
5. (c) Presumption in Certain Cases. --
(1) In general. -- For purposes of this section, a corporation shall, unless shown to the contrary, be deemed to be a collapsible corporation if (at the time of the sale or exchange, or the distribution, described in subsection (a)) the fair market value of its section 341 assets (as defined in subsection (b)(3)) is --
(A) 50 percent or more of the fair market value of its total assets, and
(B) 120 percent or more of the adjusted basis of such section 341 assets.
Absence of the conditions described in subparagraphs (A) and (B) shall not give rise to a presumption that the corporation was not a collapsible corporation.
(2) Determination of total assets. -- In determining the fair market value of the total assets of a corporation for purposes of paragraph (1)(A), there shall not be taken into account --
(A) cash,
(B) obligations which are capital assets in the hands of the corporation (and governmental obligations described in section 1221(5)), and
(C) stock in any other corporation.↩
6. SEC. 1231. PROPERTY USED IN THE TRADE OR BUSINESS AND INVOLUNTARY CONVERSIONS.
(b) Definition of Property Used in the Trade or Business. -- For purposes of this section --
(1) General rule. -- The term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 167, held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not --
(A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year,
(B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * *↩