*277 Decision will be entered under Rule 50.
The petitioner made payments to a bank, the purpose being to use the money, if necessary, to pay depositors in liquidation proceedings. The arrangement was to be effective until in the opinion of the state superintendent of banks the financial condition of the bank increased sufficiently to protect the depositors. Subsequently the funds were by petitioner's authority used as collateral for payment of debenture bonds of the bank and such security was to continue until released by the bondholder. Subsequently, in a recapitalization of the bank, the rights of petitioner to a return of her payments were exchanged for "B" preferred stock of the bank. Held, that the cost basis of the stock for determining gain or loss upon the sale thereof in the taxable years was its fair market value when acquired in the exchange.
*376 The respondent determined deficiencies of $ 8,178.57 and $ 4,498.95 in income tax against the petitioner for the years 1940 and 1941, respectively, resulting, in part, from disallowing each year*278 a deduction of $ 14,996.50 claimed as a loss sustained on sales of stock of the Bank of Waterford. The disallowance of the losses is the question at issue. Questions relating to credits for Canadian taxes and an overstatement of income in 1940 were settled by concessions of the respondent and will be reflected in recomputations under Rule 50. The income tax returns of the petitioner for the taxable years were filed with the collector for the fourteenth district of New York.
FINDINGS OF FACT.
The Bank of Waterford, hereinafter referred to as the bank, was organized in 1917 under the laws of New York, with a capital stock consisting of 4,000 shares of common, having a par value of $ 25 each, of which 1,586 shares were owned by the petitioner on August 20, 1931, and thereafter until December 18, 1934, when she ceased to be a stockholder until she became so again in 1939. The petitioner's husband, Leonard C. Feathers, has been a director of the bank since April 1931.
In August 1931 and January 1932 the assets of the bank were less than $ 2,000,000, of which in excess of $ 1,000,000 was in the bond account. Within such period the value of the bond account had decreased in value in*279 amounts ranging from $ 260,000 to $ 330,000, and as a result the Superintendent of Banks of New York insisted that *377 the bank raise additional capital. The petitioner knew in the spring of 1931 that the bond account of the bank was very materially impaired. From 1931 to 1937 the assets of the bank were written down about $ 400,000, an amount at least ten times the earnings of any year.
On August 20, 1931, the petitioner and 11 other stockholders, holding a total of 2,531 shares of the 4,000 outstanding shares of stock of the bank, executed agreements with the bank, in which they agreed to "deposit" with the bank cash or securities in the amount specified in the instrument by each stockholder, the total being $ 104,000, "the same to be held by the Bank of Waterford for the better security of the depositors of said Bank of Waterford." For convenience, the individual parties to the agreement are sometimes referred to herein as "contributors," and their "deposits" as "contributions." The instrument also provided that the agreement was to continue in effect until the securities of the bank increased in value sufficiently, in the opinion of the New York State Banking Department, *280 to protect the depositors, at which time the contributors were to be released from the terms of the agreement and the cash and securities restored to their "respective owners." It further provided that in the event of liquidation of the bank the cash and securities "deposited" under the terms of the agreement should be applied, if necessary, to the payment of depositors of the bank. Cash and notes in the total amount of $ 104,000 were delivered to the bank in accordance with the terms of the agreement. The petitioner contributed $ 25,000 in cash under the agreement. The amount was paid by a check, which was charged to petitioner's checking account at the bank on August 21, 1931. The petitioner had a balance of $ 47,245.48 in the checking account when the check was signed. The balance in the account in October 1931 was $ 39,602.81.
On about January 22, 1932, the contributors delivered a total of $ 62,500 in cash and securities to the bank under instruments signed by them, but not the bank, containing terms like the agreements executed on August 20, 1931. The petitioner's contribution was $ 30,000, which she made in cash.
The cash and notes and other securities received by the*281 bank under each of the agreements were entered on the books of the bank by first charging cash for the cash received and loans receivable for the amount of the securities received and crediting profit and loss, and then closing out the entry in the profit and loss account by a credit to surplus.
The petitioner regarded her contributions to the bank as loans for the protection of depositors. When making the contributions she was aware that the capital of the bank was impaired on account of a decline in value of bonds held by the bank. The bank paid interest *378 to petitioner on her contributions at the rate it paid on special deposits. The bank did not reflect the contributions on its balance sheet until about 1935, when it commenced to show the amounts as a contingent liability on published statements. Deposits of the bank have been insured by the Federal Deposit Insurance Corporation since about 1934.
On January 3, 1934, the Reconstruction Finance Corporation purchased $ 100,000 of the bank's debenture bonds, maturing August 1, 1953, and bearing interest at the rate of 5 per cent per annum. Thereafter the Reconstruction Finance Corporation agreed to reduce the interest*282 rate on the bonds upon the condition, among other things, that the contributors agree to extend, until released by it in writing, the provisions of the agreements of August 20, 1931, and January 22, 1932, to the protection of the debenture bonds after paying liability of the bank to depositors, as set forth in the agreements. The agreement of petitioner to obtain the lower interest rate was given to the bank on August 30, 1935.
About 1935 the Superintendent of Banks of New York requested the bank to adjust its capital and write down its assets, and for at least two years prior to 1939 negotiations were conducted to recapitalize the bank. In April 1938 the bank did not have sufficient funds to absorb the decrease in value of its bond account.
On October 14, 1938, the petitioner subscribed, in writing, for 1,549 shares of "B" preferred stock, par value $ 8.875 each. The instrument recited that the price was to be $ 35.50 a share, payable in cash, under a proposed recapitalization of the bank, to which the Reconstruction Finance Corporation had given its conditional consent, and that petitioner agreed to give to the bank, upon demand, authority to apply her contributions against the*283 purchase price. The petitioner had a definite understanding with the bank that such application would be made. Others subscribed for 2,451 additional shares on the same terms. The subscriptions were subject to a release by the Superintendent of Banks of New York of the liability of the subscribers under the agreements of August 20, 1931, and January 22, 1932. Such a release was given. All of the stockholders of the bank were asked to purchase the "B" preferred stock, but, other than directors, none of them agreed to acquire any of it. The plan of recapitalization was adopted for the purpose of transferring funds from capital stock to surplus to write down depreciated assets, and to exchange whatever liability the bank had under the agreements of August 20, 1931, and January 22, 1932, for capital stock.
A plan of recapitalization of the bank was approved by the Superintendent of Banks of New York on February 6, 1939. Pursuant thereto, on April 18, 1939, the par value of the common stock of the bank *379 was reduced from $ 25 to $ 6.25 a share; 7,960 shares of "A" preferred stock, par value $ 6.25 a share and subject to retirement at $ 12.50 a share, were issued to the Reconstruction*284 Finance Corporation in exchange for the debenture bonds then held by it in the amount of $ 99,500; and 4,000 shares of "B" preferred stock, par value $ 8.875 each and subject to retirement at $ 35.50 a share after retirement of the "A" preferred stock, were issued to petitioner and other contributors for the cancellation of the liability of the bank to them under the agreements of August 20, 1931, and January 22, 1932.
The petitioner received 1,549 shares of the "B" preferred stock and cash in the amount of $ 10.50 for the difference between the callable value of the stock and $ 55,000, the amount of her contributions.
Four of the contributors did not acquire "B" preferred stock under the plan of recapitalization. Of these, three executed guaranty agreements for the protection of depositors and other creditors of the bank and the "A" preferred stock, in the aggregate amount of $ 16,000, and the security pledged by the other individual in the amount of $ 8,500 was returned to his estate.
The bank never levied an assessment against its stockholders, never closed for business, except during holidays, and has never been liquidated. None of the contributions was used to pay depositors*285 of the bank. The Superintendent of Banks of New York did not at any time, prior to the recapitalization of the bank, authorize a return of the funds to the contributors.
Dividends of 6 and 8 per cent have been paid on the par value of the "A" and "B" preferred stock, respectively, since the date of issue.
In 1939 the Federal Deposit Insurance Corporation declined to allow any value for the "B" preferred stock of the bank for use as collateral.
The surplus account of the bank at the close of the years 1935 to 1941, inclusive, as reflected in its income tax returns for such years, shows the following increases and decreases in the amount thereof:
| Year | Increase | Decrease |
| 1935 | $ 6,498.92 | |
| 1936 | $ 14,410.48 | |
| 1937 | 22,076.92 | |
| 1938 | 412.73 | |
| 1939 | 1 29,478.14 | |
| 1940 | 2,589.23 | |
| 1941 | 4,425.65 |
The "B" preferred stock had a book value a share, as follows, at the close of 1939, 1940, and 1941: 1939, $ 17.08; 1940, $ 18.37, and 1941, $ 20.74.
*380 In December 1940 and January 1941 the petitioner sold for $ 5,000 774 and 775 shares, respectively, *286 of the "B" preferred stock she acquired on April 18, 1939. In her return for the taxable years the petitioner claimed a long term capital loss of $ 14,996.50 on each sale. The respondent in the deficiency notice disallowed each deduction upon the ground that the "loss was worthless prior" to the taxable year, in each instance.
OPINION.
The point of difference now between the parties is the cost basis of the "B" preferred stock sold by the petitioner in each of the taxable years. The petitioner contends, in effect, that she acquired the stock for cash at $ 35.50 a share in connection with the recapitalization of the bank. The respondent's position is that the petitioner exchanged her rights in the contribution of $ 55,000 she made to the bank for the stock in a taxable transaction and, that accordingly, the petitioner's basis is the fair market value of the stock at the time of the exchange.
The parties are not in agreement on the status of petitioner with respect to contribution she made to the bank. Neither contends on brief that it was a contribution of capital. Petitioner says that the money was deposited with the bank as security for depositors and was held in escrow until*287 the occurrence of conditions subsequent. The respondent argues that petitioner was a contingent creditor of the bank. The correct answer to the question will point to the solution of the primary issue.
In August 1931 and January 1932 the financial condition of the bank was not good because of decreases in the value of bonds held as assets of the institution. The Superintendent of Banks of New York insisted that the loss in value be made good by an increase of capital. In lieu thereof the bank called upon some of its stockholders, including the petitioner, for financial assistance. The objective was to obtain additional protection for the funds of depositors of the bank. Petitioner and other stockholders agreed to put up certain specified amounts upon terms set forth in instruments they executed. These documents contain the understanding of the parties on their rights to the money.
The instruments provided that the money was "for the better security of the depositors of" the bank; that the agreement was to be effective until such time as in the opinion of the Superintendent of Banks of New York the securities of the bank had increased sufficiently to protect the depositors; *288 and that in the event of liquidation of the bank the money and securities were to be used, if necessary, to pay depositors in full, any excess to be repaid to the contributors. The fact that the bank credited the amounts first to profit and loss and *381 then transferred the amounts to surplus, and paid petitioner interest on the amount of her participation in the plan, was outside the scope of the agreements, for nothing therein suggests a contribution to surplus, or an obligation to pay interest. All of petitioner's rights to a return of all or part of the money depended upon the need of the funds to pay depositors in possible liquidation proceedings of the bank, and, in the absence of such proceedings, upon the judgment of the Superintendent of Banks of New York on whether the depositors were otherwise fully protected. Under another instrument she extended the protection to $ 97,500 of debenture bonds, subject to claims of depositors, until released in writing by the Reconstruction Finance Corporation, the holder of the bonds.
The Superintendent of Banks of New York never authorized the bank to relinquish the amounts except in connection with the plan of recapitalization*289 of the bank. In the absence of proof, we must assume that the Reconstruction Finance Corporation never gave its consent to repayment of the contributions. The inference from what occurred is that such consent as it gave was limited to an exchange of the contribution of petitioner for "B" preferred stock. Even if the Reconstruction Finance Corporation had given its consent, that of the Superintendent of Banks was still necessary. Thus, petitioner was never in a position to enforce a claim for payment of the bank's obligation in cash. She agreed to the application of her contributions, except for the cash payment of $ 10.50 representing the difference between her subscription for "B" preferred stock and her contributions, for "B" preferred stock of the bank. The effect of the transaction was an exchange of her rights against the bank, a property right, for shares of its stock.
The petitioner, however, points to the subscription agreement, in which she agreed to pay cash for the stock at the rate of $ 35.50 a share. Another provision obligated petitioner to authorize the bank, upon its demand, to apply against her subscription the amount of her contributions. Such an application*290 was made, and what occurred, rather than what might have happened, is controlling. The superintendent of banks never authorized the payment of cash to petitioner, other than $ 10.50, and petitioner never had a right to cash. As the transaction was consummated, there was an exchange of the bank's obligation for shares of stock, not a payment of cash with an agreement to invest the cash in stock. There is no proof that the petitioner's cash position was such that she could have paid $ 35.50 in cash. In any event, petitioner disposed of her rights against the bank for stock, an event with tax consequences. At that time petitioner realized taxable gain or sustained a loss measured by her outlay of $ 55,000 and the fair market value of the stock, plus the cash. ; , affirming ; , affirming ; ;*291 .
The deduction of $ 14,996.50 (two-thirds of $ 22,494.75) claimed by the petitioner each year as a long term capital loss, was based upon cost of $ 35.50 a share. The stock was acquired in a transaction resulting in gain or loss to petitioner and, as a result, the basis of the stock to her was its fair market value at the time acquired. ; ; .
The respondent disallowed the deductions upon the ground that the loss was sustained in a prior year. The basis for his conclusion that the loss did not occur in the years in which shares of the stock were sold does not appear in the record. His present position, made clear at the hearing, is that the loss, if any, occurred when the sales were made, but that none was sustained since the fair market value of the stock when acquired was no more than the selling price of about $ 6.50 a share.
The petitioner also contends that, *292 under the theory of respondent, she could have claimed a bad debt deduction for such part of her contribution as was worthless in 1939, or postpone the deduction until 1940 and 1941, when the transaction was closed. The basis for the argument is that a debtor and creditor relationship existed. There was no unconditional promise on the part of the bank to pay the contribution or any part of it at any time in the future. It never agreed to do more than exchange its contingent obligation for stock. Clearly there is no basis here for a bad debt deduction. ; affd., ; ; .
Petitioner had the burden of proving a deductible loss and the amount thereof. .
While the petitioner relies primarily upon the theory that she purchased the stock for $ 35.50 a share, she contends under respondent's theory that the stock had a value of $ 35.50 a share when issued, and in support thereof points to the*293 subscriptions at that price and two alleged sales of the stock at the same figure.
The subscription agreements were executed under the plan adopted for recapitalizing the bank and do not represent arm's length negotiations on the value of the stock. The effect of the subscription was to enable the subscribers to obtain stock for the contingent liability of the bank to repay the contributions. The stock, at most, had no value in excess of the rights exchanged therefor, and, considering the financial *383 condition of the bank at that time, it is obvious that the value was not $ 35.50 a share.
One of the alleged sales was made in May 1939 of 169 shares by the president of the bank. The testimony shows that the president gave his note for $ 6,000 to the bank in the 1931 and 1932 transactions. In February 1938 the alleged buyer loaned the president money to pay the note in consideration of 400 shares of common stock of the bank and the president's rights to subscribe for stock when the recapitalization, then being considered, was adopted and made effective. Thus, the alleged buyer was, in effect, a subscriber to "B" preferred stock, as petitioner was. The deal was consummated*294 about 15 months before the stock was issued and at a time when it was not known what the plan of recapitalization would be. There is nothing in the transaction to shed light on the value of the stock in April 1939. The other transaction involved a transfer of four shares, being unallotted shares in the recapitalization, in May 1939 by the president to a stockholder of the bank since 1919, and an officer and a director since about January 1938. The buyer had declined to participate in the purchase of the stock in connection with the recapitalization. The transaction has all of the appearance of an accommodation purchase without regard to the actual value of the stock.
We are unable to find from the evidence that the stock had a fair market value when acquired by petitioner in excess of the selling price in the taxable years. Accordingly, we hold that the respondent did not err in disallowing the loss deductions in question.
Decision will be entered under Rule 50.
Footnotes
1. After reducing surplus at the beginning of the year in the amount of $ 6,675.53 to set up a reserve to retire "A" preferred stock.↩