*1748 The fact that petitioner originally reported income from the sale of real estate on the installment basis does not preclude it from changing to the deferred payment basis where the installment basis does not correctly reflect income.
*1008 The respondent determined a deficiency in income tax in the amount of $1,280.66 for the year 1925. The petitioner in reporting a sale of real estate in 1925 on the installment method included in the contract price the amount of a first mortgage assumed by the purchaser. This amount was excluded by the respondent in determining the percentage of profit realized, and this difference, together with an adjustment for taxes, gave rise to the deficiency asserted.
Petitioner alleges that the respondent erred in denying to it the right to file an amended return changing from the installment basis of returning income to the deferred payment plan not on the installment basis, and in determining the amount of taxable profit.
FINDINGS OF FACT.
Petitioner is a corporation organized*1749 in the year 1925. In that year it purchased a tract of land containing 82.86 acres on Key Largo in Monroe County, Florida, for $89,860, of which it paid within the year $18,860 as an initial payment, and $17,750 to apply on the mortgage given to secure the balance of the purchase price, making a total of $36,610 paid in 1925 and leaving a balance of $53,250 secured by a first mortgage.
In September, 1925, petitioner sold the tract of land to the Atlantic and Gulf Shores, Inc., for an agreed price of $5,000 per acre, or a total of $414,300. Under the sale agreement the purchaser was to pay $82,860 in cash, assume the first mortgage of $53,250, and give a second mortgage for the balance. The purchaser did not have sufficient cash to meet the down payment, and it proceeded to raise the amount needed partly by sales of lots from the tract and by borrowing money. Within the year it made the agreed initial payment of $82,860, plus a tax adjustment of $368.15, making a total amount of $83,228.15 paid in 1925.
The Key Largo tract here involved was unimproved land on an island which was not connected by road to the mainland. In view of its location the contract price was greatly*1750 in excess of the actual value *1009 of the land. The purchaser defaulted on the interest payment due on the first mortgage in November of 1925. The purchaser was financially irresponsible and the second mortgage given by it had no value in 1925. Before the close of the year it was evident that the purchaser would not be able to make any further payment on its indebtedness to the petitioner. The land covered by the two mortgages was not worth more than the amount of the first mortgage.
On March 15, 1926, petitioner filed a tentative income-tax return for 1925 reporting an estimated tax of $8,000. On May 10, 1926, it filed its completed return for 1925 reporting a net income of $60,849.38. In this return, which was prepared for petitioner by a firm of auditors, the income was computed on the installment basis as follows:
| Sales price | $414,300.00 | ||
| Cash | $82,860.00 | ||
| First mortgage assumed | 53,250.00 | ||
| Second mortgage taken back | 278,190.00 | ||
| Cost | 89,860.00 | ||
| Cash | 36,610.00 | ||
| First mortgage | 53,250.00 | ||
| Cash collected 1925 | $82,860.00 | ||
| Realized profit 1925 78.31% of | 82,860.00 | 64,887.67 |
An explanatory note as follows was attached*1751 to the computation:
Inasmuch as the taxpayer still is held on the mortgage which has been assumed by the purchaser in the amount of $53,250.00 and has not been relieved of the liability, this mortgage is an evidence of indebtedness under the provision of the 1926 law, and is not property which has a cash value and therefore is not realized profit until paid, at which time the profit will be reported as income to the taxpayer.
In the respondent's notice of deficiency he computed the income as shown by the following computation:
| Sale price | $414,300.00 |
| First mortgage assumed | 53,250.00 |
| Total contract price | $361,050.00 |
| Initial payment excluding evidence of indebtedness | 83,228.15 |
| Real estate sold for | 414,300.00 |
| Cost | 89,860.00 |
| Profit to be realized | $324,440.00 |
| Realized profit in 1925: | |
| $324,440.00/$361,050.00 = .898 X $83,228.15 = | 74,738.88 |
| Profit reported, original return | 64,887.67 |
| Additional realized profit | $9,851.21 |
*1010 At a meeting of the directors of petitioner on April 1, 1926, it was reported that the purchaser of the Key Largo land had defaulted in payment of taxes and interest and principal on the mortgages. The president of petitioner*1752 was thereupon authorized to place the matter in the hands of attorneys for foreclosure. Due to the fact that some lots had been sold, considerable time was required to locate all the parties, and foreclosure proceedings were not instituted until August of 1926. They were concluded in September, 1927, when the tract was bid in by some one other than the petitioner for $1,000. The Atlantic and Gulf Shores, Inc., never made any payment other than the initial payment in 1925.
The building in which petitioner's office was located was wrecked in a hurricane in the fall of 1926, which necessitated moving to other quarters. Upon moving, petitioner's president rearranged the company's files and in so doing he came across a copy of the 1925 return. Upon examining it be concluded that an error had been made in reporting a profit on the sale of the Key Largo tract, whereupon he took up the matter with the firm that had prepared the return, and that firm then prepared an amended return in which it showed a loss for the year 1925, the Key Largo transaction being set up as follows:
| Sale price | $414,300.00 | |
| Cash | $82,860.00 | |
| 1st Mtg. assumed | 53,250.00 | |
| 2nd Mtg. taken | 278,190.00 | |
| 414,300.00 | ||
| Cost | 89,860.00 | |
| Cash collected | 82,860.00 | |
| Uncollected Cost | 7,000.00 |
*1753 Attached to the computation was a note reading:
Second mortgage had no fair market value when received and could not have been sold at any fair price. Taxpayer was not relieved of its obligation assumed on the first mortgage hence no profit was returnable as cost had not been collected. If collection is ever made on either of above mortgages taxpayer will return for taxation any profit in such collection.
The amended return was executed by petitioner on January 28, 1927, and filed with the collector on February 3, 1927. The respondent refused to accept the computation set out in petitioner's amended return on the ground, as stated in the deficiency notice, "that your corporation having elected the installment plan in reporting the profit from such sale, is estopped from changing to the deferred payment method, merely because subsequent events make it to its interest to do so."
*1011 OPINION.
ARUNDELL: Petitioner having filed a return for the year 1925 in which it reported income from the sale of real estate according to the installment method provided for by section 212(d) of the Revenue Act of 1926, now seeks to report the sale in a manner so as to first recover*1754 its capital outlay and, in fact, so as to show a loss. The respondent in auditing petitioner's return accepted the installment method of accounting for the sale of the Key Largo tract, but used a percentage different from that of petitioner in determining the portion of the initial payment to be reported as income, and thereby increased the tax. There is no issue as to the figures used by the respondent.
The respondent contends that, the petitioner having elected a particular method of reporting income, the election is binding and it can not afterward choose a different basis. As authority for this position he cites ; , and other cases in which taxpayers were denied the right to change the basis of reporting income.
The cited cases either presume or decide that the method first employed by the taxpayer served to reflect the true income and proceed on the theory that in such cases it is in the interest of administrative expediency to require adherence to the method first elected. There is no doubt considerable to be said in favor of the argument made because to permit taxpayers to change*1755 at will the basis of reporting income merely because subsequent events might produce a lower tax under one method than under another would result in an ever widening circle of confusion in the computation of taxes, with consequent delay in closing out tax cases.
The chief foundation of the rule applied in the above cases, namely that the first elected method correctly reflected income, does not exist in the present case, as a glance at the facts will clearly show. In the instant case, under the installment method the petitioner is being taxed on 89.8 per cent of all the money it received in the taxable year, on the theory that the contract price of $361.050 would be paid which would result in a profit of $324,440. But before the close of the year it was clearly evident that some of the factors used in making such a computation were erroneous by reason of the fact that the second mortgage which was included in the contract price was of no value. The purchasers were financially irresponsible, and before the year was out they were unable to meet their first interest payment. The land itself was of insufficient value to afford any security for the debt covered by the second mortgage. *1756 The evidence establishes, contrary to the contention of the respondent, that it was *1012 reasonably certain within the year 1925 that the second mortgage was worthless and that the purchaser of the land would make no further payment on its indebtedness. The entire transaction was initiated and completed within a short period and was one of the typical land exploitation schemes that flourished during the Florida land boom. Land prices, which had mounted dizzily in the early part of the year, were skidding rapidly downward before the year was out. November found the purchaser of petitioner's tract unable to meet the interest payment due and with no prospect of selling lots at any price, because of the deflation that by that time was under full swing. While the petitioner took no formal action toward foreclosure until the early part of 1926, it is established that its officers were fully aware of the situation before the close of that year. In view of the situation that existed in the latter part of 1925, it is obvious that the second mortgage should be entirely excluded from any computation of the profit realized or to be realized on the transaction. Under the facts here, *1757 to presume that the contract price less cost represented the profit to be realized and to determine the tax on that basis would be to completely ignore the facts known at the end of the tax year.
Under the Revenue Acts various method of reporting income may be adopted by taxpayers, but all are designed to correctly reflect the true income in order that a just tax may be levied and collected. If a method used by a taxpayer does not clearly reflect income, the respondent may determine the income according to a method which in his opinion does clearly reflect it. Section 212, Revenue Act of 1926. This in itself is sufficient to demonstrate that it was not intended that taxpayers should be irrevocably bound by the election of a method of reporting when that method is erroneous. The effect in this case of requiring adherence to the basis originally adopted by the taxpayer would be to set up and tax, as income, an amount which in fact is not income. Neither administrative rules nor the forceful arguments in favor of administrative expediency can create income where in fact where is none, and, after all, it is only income that is to be taxed. In our opinion the installment basis*1758 when applied to the facts in the present case does not reflect the taxpayer's income.
Excluding the second mortgage from consideration, the essence of what occurred here is that the taxpayer purchased land, paying in cash $36,610 and giving a first mortgage for $53,250. Within the year it sold the land, receiving $82,860 in cash and the purchaser assumed the mortgage of $53,250. In this view of the transaction it is clear that it is improper to attempt to apply the installment sales method of computing income. The net result of the transaction *1013 was petitioner made a profit of the difference between $36,610 and $82,860, or $46,250, and this in our opinion should be included in gross income for the year.
Petitioner contends that it was not relieved of its obligation on the first mortgage and for that reason it has not recovered its cost. It is pointed out that on foreclosure sale the property was purchased for $1,000. However, it is not shown that the purchaser on foreclosure did not assume the existing mortgage, which is usually the case. Moreover, it is not shown that the land itself was not of sufficient value to be security for the mortgage. It is true that*1759 there is a statement in the record made by petitioner's president that the land was not worth as much as the first mortgage, but we do not feel warranted, after considering the entire record, in going that far.
In our opinion the application of the installment sales method is improper in this case as it does not correctly reflect income. We are further of the opinion that petitioner's gross income from the Key Largo transaction in 1925 was $46,250.
Reviewed by the Board.
Decision will be entered under Rule 50.
STERNHAGEN, TRAMMELL, and MURDOCK concur in the result only.