1935 BTA LEXIS 838">*838 1. Certain second mortgage notes received by the petitioner as part of the consideration for the sale of an apartment house are held, upon the entire evidence, including opinion testimony, to have had a fair market value, at the time of their receipt, equal to 60 percent of their face value.
2. A taxpayer who receives notes as part of the consideration for the sale of property is not required to report their face value, but only their fair market value.
3. A charge of fraudulent intent to evade tax, by understating the value of notes received as part consideration for the sale of property and by failing to indicate the face value of the notes, can not be sustained, where it appears that the taxpayer had made reasonable efforts to discover the fair market value of the notes, that it disclosed in its return that notes had been received, and that it reported them at what it believed to be their fair market value.
32 B.T.A. 1187">*1188 This is a proceeding for the redetermination of a deficiency in income tax for the year 1924 in the amount1935 BTA LEXIS 838">*839 of $21,734.38, and a fraud penalty of 50 percent, in the amount of $10,867.19. The questions presented are (1) the fair market value of certain second mortgage notes received by the petitioner in 1924 upon the sale of certain real estate; and (2) whether any part of the deficiency was due to fraud with intent to evade tax.
FINDINGS OF FACT.
The petitioner, Doric Apartment Co. (hereinafter referred to as Doric), is a corporation of Kentucky, with its office at Louisville. It was organized in 1922 and, until May 29, 1924, it had an outstanding capital stock of $200,300, consisting of 2,003 shares of the par value of $100 each.
In 1922 Doric purchased several lots in Louisville, at a cost of $32,500, and it commenced the construction thereon of an apartment house and garage, known as the Willow Terrace Apartments. In February 1923 it procured a construction loan of $225,000 from the Louisville Title Co., secured by a first mortgage on the property. The building was completed in June 1923. The total cost of the property, to April 1924, was $490,411.38, consisting of the following items:
| Land | $32,500.00 |
| Buildings | 417,553.39 |
| Furniture and Fixtures | 32,176.99 |
| Trustees' commissions, on first mortgage | 8,181.00 |
| $499,411.38 |
1935 BTA LEXIS 838">*840 On April 18, 1924, Doric sold and conveyed the apartment house, together with the furniture and equipment therein, to the Matz Realty Co., a Kentucky corporation, of which Samuel L. Matz, was the president and principal stockholder. The Matz Realty Co. paid $175,000 in cash, assumed the then existing first mortgage of $225,000, and executed and delivered to Doric 147 promissory notes of varying 32 B.T.A. 1187">*1189 amounts, of the aggregate face value of $312,500, secured by a second mortgage on the property. The notes were executed by the Matz Realty Co. and Samuel L. Matz, as joint makers. The dates of maturity and the aggregate face value of the notes maturing on each date were as follows:
| Date of maturity | Face value |
| May 1, 1927 | $ 37,500 |
| May 1, 1928 | 15,625 |
| May 1, 1929 | 15,625 |
| May 1, 1930 | 15,625 |
| May 1, 1931 | 15,625 |
| May 1, 1932 | $ 15,625 |
| Feb. 1, 1933 | 196,875 |
| Total | 312,500 |
In its income tax return for the year 1924 Doric reported a profit of $3,338.62 from the sale of the apartment house, computed as follows:
| Payment for apartment: | |
| Cash | $134,642.01 |
| Notes | 93,750.00 |
| Assumption of first mortgage | 225,000.00 |
| 453,392.01 | |
| Cost | 450,053.39 |
| Net profit | 3,338.62 |
1935 BTA LEXIS 838">*841 In determining the deficiency the Commissioner computed the profit on the sale as follows:
| Sale price: | ||
| Cash | $175,000.00 | |
| Assumption of first mortgage | 225,000.00 | |
| Second mortgage notes, 85% of face value | 265,625.00 | |
| 665,625.00 | ||
| Cost: | ||
| Land | $32,500.00 | |
| Buildings | 417,553.39 | |
| Furniture & equipment | 32,176.99 | |
| Trustee service | 8,181.00 | |
| 490,411.38 | ||
| Net profit | 175,213.62 | |
| Profit returned in 1924 | 3,338.62 | |
| Additional profit | 171,875.00 |
He increased the net income reported by the amount of $171,875, determined a deficiency of $21,734.38, and imposed a penalty of 50 percent.
32 B.T.A. 1187">*1190 The total fair market value of the second mortgage notes received by the petitioner upon the sale of the apartment house, at the time of their receipt, was $187,500.
After the petitioner had sold the apartment house it decided to sell the second mortgage notes as quickly as possible, reduce its capital stock to a nominal amount, and discontinue its business activities. Its officers tried unsuccessfully to sell the notes. The only offer received was one of $30,000. The directors and stockholders on May 28, 1924, after receiving reports from those who1935 BTA LEXIS 838">*842 had tried to sell the notes, passed a resolution appraising the notes at 30 percent of their face value. The officers were authorized to sell the notes as soon as possible on the basis of this appraised value or for any price obtainable. The articles of incorporation were amended on May 29, 1924, reducing the outstanding stock to $1,000 par value, divided into 100 shares, and authorizing the retirement at par of the remainder of the outstanding capital stock. On June 24, 1924, the petitioner endorsed and transferred the notes to a partnership and two corporations, which then distributed the notes to the petitioner's stockholders in proportion to their stockholdings. The petitioner received from the partnership and the two corporations checks in the total amount of $93,750. The petitioner in retiring its capital stock during the year 1924 distributed $112,000 in cash on April 26, 1924, out of the $175,000 in cash received upon the sale of the apartment house and distributed $93,750 in cash on June 24, 1924, being the amount received from the partnership and the two corporations to whom it endorsed and transferred the second trust notes.
No part of the deficiency for 1924 was1935 BTA LEXIS 838">*843 due to fraud with intent to evade tax.
OPINION.
MURDOCK: Each party to this proceeding called a number of witnesses to express opinions as to the total fair market value of the second mortgage notes which the petitioner received from the sale of the Willow Terrace Apartments property. The values given by the witnesses called by the petitioner ranged downward from 30 percent of the face value of the notes. One witness for the respondent stated that in his opinion the notes were worth 80 percent of their face value. Another stated that in his opinion the notes maturing within the first five years were worth 80 percent of their face value while those maturing thereafter were worth 70 percent of their face value. There was other evidence bearing upon the question of the value of these notes. The evidence clearly shows that the notes had some fair market value, but that it was not as much as 85 percent of their face value. Since the determination of the Commissioner 32 B.T.A. 1187">*1191 was incorrect the Board must determine, as best it can from the evidence, the total fair market value of the notes. Cf. 1935 BTA LEXIS 838">*844 ; . This has been done. The decision on this question of fact is set forth in the findings of fact above.
The Commissioner determined that the petitioner is liable for a penalty under section 275(b) of the Revenue Act of 1924, which provides, "if any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected and paid * * *." The burden of proof on this issue is by statute placed upon the Commissioner. Section 601 of the Revenue Act of 1928, amending section 907(a) of the Revenue Act of 1924, as amended. The Commissioner, in determining the deficiency, increased the amount of cash and the value of the notes over the figures used by the petitioner in reporting its profit from the sale of the apartment house and included in the basis the cost of furniture and fixtures and trustees' services. The deficiency is due to the fact that the Commissioner increased the value of the second trust notes from $93,750, as reported by the petitioner, to $265,625, 1935 BTA LEXIS 838">*845 and he contends that the deficiency is due to fraud with intent to evade tax.
The petitioner was required by statute to report the gain from the sale of the apartment house. That gain was the excess of the amount realized over the basis. The amount realized is "the sum of any money received plus the fair market value of the property (other than money) received." Sec. 202. The Commissioner contends that the petitioner understated the value of the notes received and misled him by failing to indicate the face value of the notes. There is nothing in the statute requiring the petitioner to report the face value of the notes. It was only required to report their fair market value. The petitioner indicated on its return that "notes" were part of the consideration. Not only was the Commissioner thus put on notice that it was fair market value rather than face value which was being reported, but his action in investigating the fact and determining the deficiency belies his statement that he was in any way misled. The petitioner made at least a reasonable effort to discover the fair market value of the notes and reported what it believed to be their fair market value. This was a1935 BTA LEXIS 838">*846 question of fact upon which opinions vary widely, as evidenced by the opinions of the witnesses in this case. The fact that the petitioner used $93,750 as the value of the notes on its return certainly does not show a fraudulent intent to evade tax.
The Commissioner also argues that fraud with intent to evade tax in connection with the amount reported as the fair market value of 32 B.T.A. 1187">*1192 these notes is shown by all the surrounding circumstances. He calls particular attention to the way in which the notes were divided into series and amounts, to the transfer of the notes to the partnership and the two corporations, and to the distribution of the notes to the petitioner's stockholders in proportion to their stockholdings. There is, however, a plausible explanation of these transactions unrelated to the matter of income tax. There was no reason for the continued operation of Doric after the sale of the apartment. It therefore retired at par all but a relatively small amount of its capital stock. In order to do this it used most of the cash received from the sale of the apartment house and $93,750 obtained through the disposition of the notes. The evidence as a whole is not1935 BTA LEXIS 838">*847 sufficient to sustain the burden of proof cast by statute upon the Commissioner, and, therefore, that no part of the deficiency was due to fraud with intent to evade tax has been found as a fact.
Decision will be entered under Rule 50.