*23 Decision will be entered under Rule 50.
T corporation owned real estate which it leased to an affiliate and in which the affiliate conducted its business operations. In order to expand its plant the affiliate subsequently leased an adjoining building from an unrelated third party. Thereafter, threats of "legal action" for violations of a municipal building code in respect of such adjoining building made it economically impractical to continue using that building, and the needs of T's affiliate required it to seek other space. The only feasible alternative was to construct a new plant elsewhere; and financing therefor was obtainable only from the Small Business Administration (SBA) which required as a condition to the loan that T's real estate be sold and the proceeds applied towards repayment of the loan. T in fact sold its property and realized a gain. Held, the nonrecognition provisions of sec. 1033(a), I.R.C. 1954, do not apply, because (1) T had no property interest in the adjacent real estate threatened by the proposed legal action, and (2) the threat did not relate to any "involuntary conversion" by the way of "requisition or condemnation." Held, further, neither*24 the conditions of the SBA loan nor the general provisions of sec. 21 of the Small Business Act repealing all "inconsistent" laws require nonrecognition of the gain realized by T.
*300 The Commissioner determined the following deficiencies in petitioner's income tax:
| FYE July 31 -- | Deficiency |
| 1963 | $ 6,913.86 |
| 1964 | 1,061.00 |
| 1965 | 294.58 |
The sole question is whether petitioner is entitled to nonrecognition of gain realized upon sale of its property; the answer turns upon whether there was an involuntary*25 conversion of the property within section 1033(a) of the 1954 Code.
FINDINGS OF FACT
Most of the facts have been stipulated and are found accordingly. They are incorporated herein by reference.
Petitioner filed its Federal income tax returns for its fiscal years ended July 31, 1963 through 1965, with the district director of internal revenue at Los Angeles, Calif. Its address at the time of filing the petition in this case was 10800 Cantara Street, Sun Valley, Calif.
Dorothy C. Thorpe, Inc. (hereinafter Thorpe), was a corporation engaged in the business of decorating glassware and lighting fixtures. *301 Petitioner, Dorothy C. Thorpe Glass Mfg. Corp., was organized as a California corporation in 1950 as an "affiliate" of Thorpe to manufacture glassware products by a glassblowing process. Its original shareholders were the same as the shareholders of Thorpe, except that some of petitioner's stock was held by the glassblower employees. By 1956 the glassblowing business was discontinued since it had become unprofitable, and Mrs. Dorothy C. Thorpe, petitioner's founder, repurchased the stock of the glassblowers. Since that time petitioner and Thorpe have had substantially the*26 same shareholders and directors. Both corporations have at all times operated as separate business entities, each keeping separate books and filing separate corporate tax returns.
Petitioner had carried on its business in a building at 902 Thompson Ave., Glendale, Calif., which it had leased as its factory. In 1957, that property became available for purchase, and petitioner purchased it from its lessor. It thereupon leased the property to its affiliate Thorpe for use in the latter's glassware-decorating business. From that time until sale of the property in 1963, as hereinafter set forth, petitioner's only business activity was the leasing of this property to Thorpe.
In 1959, Thorpe needed additional operating space. Accordingly, it leased the land and building adjoining the property leased from petitioner. The new facilities were located at 912 Thompson Avenue, Glendale, Calif. The lessor was the Fortner Engineering Co., a third party unrelated to either petitioner or Thorpe. Petitioner does not appear to have been a party to this lease. As part of the consideration for the lease, the lessor constructed a mezzanine in the building at 912 Thompson Avenue which contained *27 approximately 4,000 square feet of storage space, about 40 percent of the usable floor space of the building. Once the mezzanine was constructed this building and the building at 902 Thompson Avenue were used by Thorpe as a single unit with conveyors, passages, and doorways connecting the two buildings. The building at 912 Thompson Avenue was used primarily for the storage and shipping of goods produced at 902 Thompson Avenue.
The mezzanine as constructed was not in accordance with the standards as required by the Building and Safety Code of the City of Glendale, nor had a permit ever been obtained for its construction as required by that code.
On or about December 22, 1961, both properties were inspected by personnel of the building department of the City of Glendale. Violations in respect of the mezzanine, as well as certain other violations, were set forth in a letter dated December 27, 1961, which was sent on behalf of the Glendale Superintendent of Building to Thorpe. *302 The letter stated that "legal action" would be started if the violations were not corrected within 30 days. The parties have stipulated that the "legal action" referred to is of the following nature:
*28 If the stated violations are not corrected within the 30-day period, the case would be referred by the Building Superintendent to the City Attorney of the City of Glendale. The City Attorney, pursuant to Section 205 of the Glendale Building and Safety Code, would bring action in the Municipal Court of the Glendale Judicial District, County of Los Angeles, State of California, for violation of the applicable sections of the Building and Safety Code. Such a violation constitutes a misdemeanor and upon conviction therefor carries a maximum sentence of a $ 500.00 fine and six months imprisonment in the County Jail. This procedure would have been followed, and repeated until the violations were corrected, and in this instance, correction of the violation with respect to the mezzanine would have required that the mezzanine be demolished since it could not have been brought up to standards without destruction and reconstruction of the entire building.
The record contains no explanation as to why the notice of violations was sent to Thorpe rather than to Fortner Engineering Co., the lessor and owner of the building which constructed the mezzanine.
The violations other than those relating*29 to the mezzanine were susceptible of correction and were in fact corrected; they do not play any part in the controversy herein. Reconstruction of the mezzanine so as to comply with the City Code was not economically feasible, for it in effect required the destruction of the old building and the erection of an entirely new one. The only practical alternative was to remove the entire mezzanine, since failure to do so would result in charges of continuous violations in the action that would have been instituted by the city attorney. But the removal of the mezzanine, while possible, would have so reduced the usable space in the building as to have had a substantial adverse effect on Thorpe's business. Faced with these alternatives, Thorpe sought comparable space in the surrounding area, but no such space was available. Accordingly, it was decided by Thorpe and petitioner to build a comparable new plant at another location in which to house the existing business operation.
Petitioner and its affiliate, Thorpe, attempted to secure financing for the new plant from several private lenders. Because of the "tight money" situation then existing, however, the needed financing was unobtainable*30 from private sources. A loan was then sought from the Small Business Administration (hereinafter SBA), a public agency of the United States created to help finance small businesses.
On January 26, 1962, a loan in the amount of $ 110,000 was obtained from SBA for a new plant on condition, however, that the petitioner sell its property located at 902 Thompson Avenue in Glendale and apply the net proceeds from that sale to the SBA loan "in the inverse order of payments." Petitioner, Thorpe, and another affiliate (Dorothy C. Thorpe Sales Co., Inc.) were parties to the loan agreement. In *303 accordance with the agreement, the property at 902 Thompson Avenue was sold during petitioner's taxable year ending July 31, 1963, and the new plant was completed and occupied by Thorpe during the same year. The new plant is located at 10800 Cantara Street, Sun Valley, Calif.Thorpe is using the new plant as it did the property located on Thompson Avenue in Glendale.
Petitioner did not report the gain which it realized on the sale of the property at 902 Thompson Avenue, but instead "transferred" the basis of that property to the new property at 10800 Cantara Street, Sun Valley, Calif. Its*31 fiscal 1963 tax return reported a net operating loss for that year. This loss was carried forward in petitioner's tax return for 1964. The Commissioner determined that petitioner realized a long-term capital gain on the sale of the property at 902 Thompson Avenue amounting to $ 35,445.29. The Commissioner now concedes that this amount may be reduced by $ 5,690.40, representing selling costs incurred by the petitioners. The Commissioner included this long-term capital gain in petitioner's income for the year 1963, eliminating the loss carried forward by the petitioner in its 1964 return. The Commissioner also disallowed an investment credit carried over to years 1964 and 1965 in the petitioner's returns since the entire credit became usable in 1963 as a result of the recognition of the long-term capital gain on the above sale.
OPINION
Petitioner's primary argument is that the gain realized on the sale of the property located at 902 Thompson Avenue was nonrecognizable since it arose out of an involuntary conversion of its property within the terms of section 1033(a) of the 1954 Code. 1 Although there is no dispute that the proceeds of sale of petitioner's property at 902 Thompson*32 Avenue were invested in "similar" property within the meaning of section 1033(a)(1), the Government challenges petitioner's position on two principal grounds, (1) that petitioner did not possess a property interest in any land or building subject to the threat of destruction, requisition, or condemnation within section 1033(a), and (2) that, in any event, there was no "involuntary conversion" of the nature required by the statute. We think that these grounds are sound.
Insofar as the actions by the City of Glendale are concerned, it is clear that even if there had been a destruction, requisition, or condemnation *304 *33 of property or the threat thereof within the meaning of section 1033(a), it related solely to the property at 912 Thompson Avenue in which petitioner had no interest, and that there was therefore no involuntary conversion of petitioner's property at 902 Thompson Avenue. Only Fortner Engineering Co., as owner, and Thorpe, petitioner's affiliate, as lessee, had any interest in the threatened property. And while Thorpe's interest as lessee was sufficient to bring it within the coverage of section 1033 in respect of that leasehold interest, assuming that all other requirements were satisfied, cf. Davis Regulator Co., 36 B.T.A. 437">36 B.T.A. 437, the blunt fact remains that petitioner had no interest whatever in the property at 912 Thompson Avenue which alone was the target of the City's threats.
We are aware that in appropriate circumstances the threat of condemnation of one of two properties where both are owned and operated as an economic unit by the same taxpayer, may furnish the basis for applying the nonrecognition provisions of section 1033 in respect of the sale of both properties. Cf. Harry G. Masser, 30 T.C. 741">30 T.C. 741. In such *34 circumstances, the application of the statute to the owner's interest in the condemned property was merely extended to cover the same owner's interest in the second parcel. In the present case, however, petitioner had no interest in the threatened building at 912 Thompson Avenue, and therefore had no property covered by the statute with which its property at 902 Thompson Avenue could be associated.
Nor is petitioner's position in this respect strengthened by the fact that its affiliate, Thorpe, had a leasehold interest in 912 Thompson Avenue that might have furnished the basis for the application of section 1033. Cf. Davis Regulator Co., supra. In the first place, the record does not disclose any sale of that leasehold interest which might have brought section 1033 into play. And in the second place, Thorpe's leasehold interest may not be attributed to petitioner. Both were separate, viable corporate entities, one engaged in the business of decorating glassware, and the other in the business of owning and renting real estate. The persons who controlled these business operations elected to do so by using two separate corporate entities. That election*35 cannot now be repudiated in order to receive more favorable tax treatment under section 1033. Cf. Vim Securities Corp. v. Commissioner, 130 F. 2d 106 (C.A. 2), affirming 43 B.T.A. 759">43 B.T.A. 759, certiorari denied 317 U.S. 686">317 U.S. 686; Moline Properties v. Commissioner, 319 U.S. 436">319 U.S. 436, 438-439.
Moreover, even if we were to accept petitioner's argument that it had an interest in the property at 912 Thompson Avenue, the evidence does not establish that the City of Glendale caused the involuntary conversion of the petitioner's property within the terms of section *305 1033. Section 1033(a) clearly limits the nonrecognition of gain to situations where property is involuntarily converted "as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof." Since destruction, theft, or seizure is not involved, the principal issue is whether there was a "requisition or condemnation" of the petitioner's property, or a threat thereof.
The only action threatened with respect to the defective mezzanine was a legal action *36 which could have resulted in a misdemeanor conviction, carrying with it a possible jail sentence for a maximum period of 6 months and a $ 500 fine. The City did not threaten condemnation or taking of the building. Granted the threat of criminal conviction is coercive, it does not constitute a threat of "requisition or condemnation" of petitioner's property.
The inapplicability of the statute to this type of situation was made clear in American Natural Gas Co. v. United States, 279 F. 2d 220 (Ct. Cl.), certiorari denied 364 U.S. 900">364 U.S. 900, where the court spelled out the limitations of the term "requisition or condemnation" (as used in the comparable provisions of sections 117(j) and 112(f) of the 1939 Code), as follows (p. 225):
Plaintiffs say that the term "requisition or condemnation" as used in the Act means something more than the exercise of the power of eminent domain. We do not think it does. It seems clear to us that the words mean the taking or the threat of taking property by some public or quasi-public corporation -- by some instrumentality that has the power to do so against the will of the owner, and for the use*37 of the taker. That is the common, well-recognized meaning of those words and there is nothing to indicate that Congress used them in any other sense. Plaintiffs were required to dispose of their property, but the United States did not take it, nor did it prevent plaintiffs from getting for it its full market value at the time of the taking.
The same meaning was given to this phrase in Dear Publication & Radio, Inc. v. Commissioner, 31 T.C. 1168">31 T.C. 1168, affirmed 274 F. 2d 656 (C.A. 3). See Rev. Rul. 57-314, 2 C.B. 523">1957-2 C.B. 523.
The petitioner also argues that there was a governmental "requisition" since the Small Business Administration loan was conditioned upon the sale of the property and the application of the proceeds against the loan. Admittedly, this contractual condition created pressures which ultimately resulted in the sale of the property. Nonetheless, there was no governmental taking or threat of taking of petitioner's property. Petitioner entered into its contractual relationship with the agency of its own volition. No governmental authority forced petitioner to secure its*38 financing from the Small Business Administration. Any compulsion upon it to deal with the Small Business Administration was the result of business expedience, not the exercise of the governmental power of eminent domain. This type of compulsion *306 cannot form the basis of an involuntary conversion within the terms of section 1033. Cf. C. G. Willis, Inc., 41 T.C. 468">41 T.C. 468, affirmed 342 F. 2d 996 (C.A. 3); Dear Publication & Radio, Inc., 31 T.C. 1168">31 T.C. 1168; George S. Robins, 15 B.T.A. 1068">15 B.T.A. 1068; Philip F. Tirrell, 14 B.T.A. 1399">14 B.T.A. 1399; The Davis Company, 6 B.T.A. 281">6 B.T.A. 281.
Finally, the petitioner argues that it need not recognize gain on the sale because section 21 of the Small Business Act provides that all laws or parts of laws inconsistent with that Act "are hereby repealed to the extent of such inconsistency" 72 Stat. 384. Thus, goes the argument, if the capital gains are taxed in this type of situation small businessmen will not benefit fully from the assistance provided by the Small Business Act. This argument does*39 not rely on the relief provisions of section 1033, 2 but is rather a general broadside against any taxation under the Code occasioned by contracts made with the Small Business Administration. There is, however, nothing in the legislative history of the Small Business Act, much less in its provisions, which evidences an intent to insulate small businesses from general taxation in transactions such as the one here. Indeed, if petitioner's argument were carried to its logical conclusion, any taxation, including income taxation -- or for that matter any regulation of business under Federal statutes of general application such as those administered by the Federal Trade Commission or the Securities and Exchange Commission which might have an adverse financial effect upon a particular company aided by the SBA -- would be improper as a result of the general repealer of section 21. The argument proves too much. Such was hardly the intent of Congress.
*40 Decision will be entered under Rule 50.
Footnotes
1. SEC. 1033. INVOLUNTARY CONVERSIONS.
(a) General Rule. -- If property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted --
(1) Conversion into similar property. -- Into property similar or related in service or use to the property so converted, no gain shall be recognized.↩
2. Indeed, if there should be any "repeal" of sec. 1033 as a result of sec. 21 of the Small Business Act, the nonrecognition or relief provisions of sec. 1033 would of necessity be eliminated, thereby defeating petitioner's claim to be free of tax under the provisions of sec. 1033↩. The argument would thus be self-destructive.