*2322 1. MORTGAGE FEES. - Commissions and fees for securing loans on mortgages are not deductible in full in the year when paid or incurred, but should be spread proportionately over the life of the mortgages and when the mortgages are paid off or the property sold and the mortgage assumed by a third person, the unamortized portion of such mortgage fees may be charged off and deduction taken from gross income.
2. INSTALLMENT SALE - MORTGAGE. - In the case of an installment sale of mortgaged realty the amount of the mortgage must be deducted from the original agreed consideration to arrive at the total contract price in order to fix the basis for computation of the percentage of profit.
3. ACCOUNTING. - Where petitioner reported certain contract adjustments as income for 1924, and this was in accordance with its method of accounting and respondent made no change relative thereto, no change will now be made on petitioner's claim that they should have been reported for a previous year.
*789 Petitioner seeks redetermination of deficiencies of $394.69*2323 for the calendar year 1924 and $33,947.39 for the year 1925. Respondent determined an overassessment for 1923 in the amount of $5,255.31. Respondent amended his pleadings and is claiming increased deficiencies for the years 1924 and 1925. The calendar year 1923 is involved herein on account of the respective claims of the parties in respect of a statutory net loss for the year 1923 deductible in computing taxable net income for the succeeding years.
The matters in controversy relate to the following:
(a) The proper treatment in computing income for the calendar years 1923, 1924, and 1925 of certain expenditures incurred by the petitioner in obtaining loans as hereinafter set forth.
(b) The proper computation of installment sales income on account of the sale of the petitioner's property at 82nd Street and Broadway.
(c) The proper computation of installment sales income on account of the sale of the petitioner's property at 83rd Street and Broadway.
(d) Whether an item of $3,336.81 or any part thereof, referred to in the petitioner should be eliminated from income for the year 1924.
Part of the facts in this proceeding were developed at the hearing and part were*2324 stipulated by the parties.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal office at 2382 Grand Concourse, New York City.
During all times material hereto the business of the petitioner consisted of the acquisition, improvement, rental, operation and sale of real estate. Its income consisted principally of interest on investments, rentals from properties so rented and operated, and profits on the sale of improved real estate. During 1923, 1924, and 1925 and prior thereto, the petitioner, in order to finance the conduct of its business, including the construction of improvements on its real estate, obtained a number of loans, securing the same by mortgages upon its real estate and by pledging purchase money mortgages receivable on other real estate already sold. In order to obtain such loans the petitioner incurred and paid certain fees, bonuses or commissions, which were accrued on its books under the designation of "prepaid raising mortgage expense," and which will be hereinafter referred to for convenience as "mortgage fees." The purposes of said loans were to pay off existing mortgages on properties, to pay *790 current obligations*2325 in the form of notes and open accounts to contractors for construction work, to purchase additional properties, and to pay general operating expenses of the company. The cash received from these loans was merged with other cash received from rental income, sale of properties, and other sundry income, and out of the entire cash funds withdrawals were made from time to time for the above mentioned purposes.
At all times material hereto petitioner employed the accrual method of accounting in keeping its books and records, and in making its Federal income-tax returns. On its books and in its returns the above-mentioned mortgage fees were capitalized as prepaid expense, and amortized by way of deductions from income over the lives of the respective loans; and in the case of the sale and disposition of any of the mortgaged property the unamortized portion of the mortgage fees relating thereto was written off at the time of such sale. The unamortized amount of said mortgage fees as of December 31, 1922, as shown by the petitioner's books, was $44,500.84.
During the years 1923, 1924, and 1925 the petitioner obtained the following described loans and incurred mortgage fees as follows: *2326
| Amount of loan | Term of loan | Mortgage fees incurred in obtaining loan | |
| 1923 | |||
| 2665 Grand Concourse | $175,000.00 | 5 years | $30,000.00 |
| 180th St. & Boston Road: | |||
| 1st mortgage | 220,000.00 | 10 years | 7,750.00 |
| 2nd mortgage | 60,000.00 | 5 years | 13,000.00 |
| 184th St. & Grand Concourse: | |||
| 1st mortgage | 45,000.00 | do | 4,614.54 |
| 2nd mortgage | 50,000.00 | 6 years | 10,485.00 |
| 82nd St. & Broadway: | |||
| 1st mortgage | 1,100,000.00 | 10 years | 56,167.50 |
| 2nd mortgage | 200,000.00 | 7 years | 41,460.00 |
| Total | $163,477.04 | ||
| 1924 | |||
| 1325 Grand Concourse | 260,000.00 | 10 years | 10,525.00 |
| 83rd St. & Broadway: | |||
| 1st mortgage | 1,100,000.00 | do | 54,250.00 |
| 2nd mortgage | 500,000.00 | do | 125,250.00 |
| Total | 190,025.00 | ||
| 1925 | |||
| S. E. Corner of 101st St. & Broadway | 1,900,000.00 | On demand | 63,593.50 |
| 205 W. 100th St | 35,000.00 | 1 year | 932.49 |
| 206 W. 101st St | 90,000.00 | do | 2,143.26 |
| General loan | 125,000.00 | 2 years | 13,750.00 |
| General loan | 100,000.00 | 1 year | 5,157.00 |
| General loan | 50,000.00 | 2 years | 2,500.00 |
| Total | 88,076.25 |
If it be held as a matter of law that such mortgage fees are deductible in computing taxable income entirely in the year in which incurred, the parties are*2327 agreed that the amounts hereinabove set *791 forth are the correct amounts to be used in computing the deductions on that account.
If, as a matter of law, said mortgage fees should properly be capitalized and amortized over the lives of the loans, and the unamortized portion written off at the time the mortgaged property is disposed of, the parties are agreed that the correct amounts so deductible in computing taxable income for the years 1923, 1924, and 1925 (including the amounts deductible in said years on account of mortgage fees incurred prior to 1923, as set forth in the second preceding paragraph) are as follows:
| 1923 | 1924 | 1925 | |
| 2665 Grand Concourse | $9,338.50 | $11,838.50 | $11,838.50 |
| 180th St. & Boston Road | 1,668.00 | 3,375.00 | 15,707.00 |
| 184th St. & Grand Concourse | 928.33 | 2,652.00 | 2,652.00 |
| Kingsbridge & Fordham | 733.34 | ||
| 2055-2065 Creston Ave | 12,747.21 | ||
| 82nd St. & Broadway | 6,618.75 | 91,008.75 | |
| 1325 Grand Concourse | 1,052.50 | 1,052.50 | |
| 83rd St. & Broadway | 17,950.00 | 161,550.00 | |
| S. E. Corner 101st St. & Broadway | 63,593.50 | ||
| 205 W. 100th St | 932.49 | ||
| 206 W. 101st St | 2,143.26 | ||
| Three general loans described in preceding paragraph | 5,223.08 | ||
| Total | 32,034.13 | 127,876.75 | 264,692.33 |
*2328 During the year 1924 the petitioner sold and disposed of the premises at 82nd Street and Broadway. The sales price was $2,100,000, made up as follows:
| Cash | $300,000 |
| First mortgage assumed | 1,100,000 |
| Purchase-money mortgage given by purchaser | 700,000 |
| Total | 2,100,000 |
Said property was acquired by the taxpayer after March 1, 1913. Its depreciated cost at the time of sale (without adjustment on account of unamortized mortgage fees) was $1,541,323.48, leaving a profit to be reported (without adjustment on account of said mortgage fees) in the amount of $558,676.52. The respondent contends that in computing the profit on the sale of these premises an adjustment to cost should be made on account of unamortized mortgage fees incurred in 1923 in respect of said property. The parties are agreed that the correct amount of such unamortized mortgage fees in the year of sale is $91,008.75, if it be held that such mortgage fees should not have been deducted in their entirety in the year 1923. If such adjustment be proper, the net depreciated cost was $1,632,332.23, leaving a profit to be reported on account of said sale in the amount of $467,667.77. If it be held that*2329 said mortgage fees are deductible in the year 1923 when incurred, or if it be held that said unamortized portion thereof is deductible as expense in the year *792 of sale (rather than being taken into consideration as an adjustment of the profit on the sale) then the parties are agreed that the correct profit would be $558,676.52 as above stated. In addition to the cash of $300,000 received at the time of sale, the taxpayer received during the year 1924 the amount of $30,000 as installments on the purchasemoney mortgage. During the year 1925 the petitioner received payments on said purchase-money mortgage in the amount of $36,250. The mortgage of $1,100,000 assumed by the purchaser provided that the principal sum thereof was payable in installments of $22,000 on December 1, 1924, and $22,000 every six months thereafter until April 9, 1933, when the entire balance should become due and payable. In accordance with the agreement of sale the purchaser paid to the holders of said mortgage in 1924 the amount of $22,000, and in 1925 the amount of $44,000.
During the year 1925 the petitioner sold and disposed of the premises at 83rd Street and Broadway. The sale price was $2,165,000, *2330 made up as follows:
| Cash | $300,000.00 |
| First mortgage assumed | 1,100,000.00 |
| Second mortgage assumed | 500,000.00 |
| Purchase-money mortgage given by purchaser | 265,000.00 |
| Total | 2,165,000.00 |
Said property was acquired by the taxpayer after March 1, 1913. Its depreciated cost at the time of sale (without adjustment on account of unamortized mortgage fees) was $1,522,033, leaving a profit to be reported (without adjustment on account of said mortgage fees) in the amount of $642,967. In addition to the cash payment of $300,000, the petitioner received on the purchase-money mortgage during the year 1925 the sum of $2,000. If no adjustment be made in the year of sale on account of unamortized mortgage fees, the first and second mortgages assumed by the purchaser exceeded the basis of such property to the taxpayer in the amount of $77,967. In connection with this sale the respondent makes the same contention, in regard to an adjustment to cost in respect to unamortized mortgage fees incurred in 1924 as set forth in the preceding paragraph, in connection with the sale of the premises at 82nd Street and Broadway. If an adjustment on account of unamortized mortgage fees*2331 be proper in computing profit from the sale of said property, the parties are agreed that the correct amount to be used in said adjustment is $161,550, which would result in a net depreciated cost of $1,683,583, leaving a profit to be realized in the amount of $481,417. The loan secured by the first mortgage on said property in the amount of $1,100,000 was obtained by the petitioner in the year 1924, the terms thereof providing that the principal sum *793 should be payable in installments of $16,500, payable May 1, 1926, and $16,500 every six months thereafter until April 9, 1933, when the entire balance should become due and payable. The loan secured by the second mortgage on said property in the amount of $500,000 was obtained by the petitioner during the year 1924, and provided that the principal sum should be payable in installments of $7,500 on May 7, 1925, and $7,500 every three months thereafter until November 7, 1934, when the entire balance should become due and payable. In the year 1925 the purchaser paid to the holders of the second mortgage the amount of $22,500 in respect to said installments.
In determining the deficiencies the respondent included in the*2332 petitioner's income for the year 1924 a realized profit on the sale of the property at 82nd Street and Broadway in the amount of $184,363.25, computed on the installment basis as follows:
| Profit to be realized | $558,676.52 |
| Contract price | $1,000,000.00 |
| Percentage of profit | 55.867652 |
| Cash payment plus installments received on purchase-money mortgage | $330,000.00 |
| 55.867652% times $330,000 equals | $184,365.25 |
In determining the deficiencies the respondent included in the petitioner's income for the year 1925 realized profit on account of the sale in 1924 of said property at 82nd Street and Broadway i n the amount of $20,252.02, computed by multiplying the installment payments received during 1925 in the amount of $36,250 by 55.867652 per cent.
In computing the deficiencies the respondent included in the petitioner's income for the year 1925 profits realized on the sale during the year 1925 of said property at 83rd Street and Broadway in the amount of $379,967, computed on the installment basis as follows:
| Profit to be realized | $642,967.00 |
| Contract price (without adjustment on account of excess of mortgages assumed over the basis) | $565,000.00 |
| Percentage of profit | 100 plus |
| Initial payment | $300,000.00 |
| Installments received on purchase-money mortgage | $2,000.00 |
| Liability on bond and mortgage canceled (being the excess of the mortgages assumed over the basis of the property to the taxpayer) | $77,967.00 |
| Profit to be reported 1925 | $379,967.00 |
*2333 On petitioner's income-tax return for the year 1924 there was reported as income an item reading as follows:
| Premises No. 2608 Creston Ave., sundry allowances received from contractor after sale of premises | $3,336.81 |
*794 In determining the deficiencies the respondent made no adjustment in respect to this item and did not eliminate the amount from the petitioner's income for the year 1924.
This item is in connection with a building which petitioner constructed at No. 2608 Creston Avenue during 1922, which was completed in December of that year. Final settlement was not made with a number of contractors and material men until 1924, when certain allowances were made to petitioner by the contractors for excess material returned, omission of work or inferior work or material, or other causes. These allowances aggregated $3,336.81 and were credited to profit and loss by petitioner and returned by it as income for 1924. This was in accordance with the regular method and practice of petitioner in keeping its accounts, up to that time, viz., these adjustments were set up after the building was completed and sold, and were entered as of the time whem made.
*2334 In determining the deficiencies the respondent allowed as a deduction in computing taxable net income for the year 1924 a statutory net loss sustained in 1923 computed as follows:
| Net loss (before adjustment for nontaxable item) | $3,035.87 |
| Nontaxable interest | 510.61 |
| Statutory net loss | 2,525.26 |
It is agreed that the correct amounts of nontaxable interest to be taken into consideration in computations of statutory net losses are $510.61 for 1923 and $637.54 for 1924, respectively.
OPINION.
BLACK: In the recent case of , we held that fees, commissions, and expenses in obtaining a loan on a mortgage were in the nature of capital expensitures and were not deductible in full in the year when paid or incurred, but should be spread proportionately over the term of the mortgage. That case is controlling here and the contention of petitioner that the mortgage fees should be deducted in the year when paid is denied in so far as such mortgage fees were paid in securing loans extending beyond the period of one year.
But the further question arises in this proceeding: How should the unamortized portion of these*2335 mortgage fees be treated in the year when the mortgaged property is sold and the mortgage is assumed by the purchaser? Should such unamortized portion of such fees be fully charged off in the year in which the sale is made, or should it at the time of sale be added to the capital cost of the property and in that manner be recovered tax-free by the seller in reducing his profits on the sale?
*795 There would be no difference in either method so far as the taxpayer's net income is concerned, if the sale is one where all the profit must be reported in the year of sale; but if the transaction is an installment sale under the statute, so that the period of reporting the profit on the sale may be spread over a period of years, then the practical effect of including unamortized mortgage fees as a capital adjustment is to spread the deduction over the period during which the taxpayer is receiving the deferred payments and reporting the income from them. Now which is the correct method? The Commissioner contends that the unamortized mortgage fees should be added to the cost of the property and in that way be recovered tax free by the seller in the sale.
Mortgage fees paid to*2336 secure loans such as those involved in this proceeding do not represent cost of property, but represent cost of the use of money borrowed. The purposes of the loans involved in this proceeding were to pay off existing mortgages on properties, to pay current obligations in the form of notes and open accounts to contractors for construction work, to purchase additional properties, and to pay general operating expenses of the company. The cash received from these loans was merged with other cash received from rental income, sale of properties and other sundry income and out of the entire cash funds withdrawals were made from time to time for the above mentioned purposes. Under such circumstances we think it would be altogether improper to say that the mortgage fees paid to secure such loans represented a part of the cost of the property mortgaged.
If A owns an apartment house worth $100,000 and needs some money and borrows $50,000 due in ten years, and puts his apartment house up as security, and in addition to the regular rate of interest pays a $5,000 mortgage fee to get the money, under such circumstances we have held that he can not take the $5,000 as a deduction in the year*2337 that the loan is made and the mortgage fee is paid but the deduction must be spread over the life of the loan. Cf. ; . But when A comes to sell his apartment house the year following the year in which the loan was made and the purchaser agrees to assume the mortgage, A does not add the $5,000 mortgage fee to the cost of his house. It has nothing to do with the cost of his house. He, having shifted the burden of his mortgage to other shoulders, stands in the same situation as if he had paid it off and therefore should be allowed to deduct the remaining portion of his unamortized mortgage fees.
In the instant case it is shown by stipulation of the parties that the petitioner accrued these items of mortgage fees on its books as *796 "prepaid raising mortgage expense" and capitalized them thus and amortized them by way of deductions from income at rates which were properly related to the langth of the loan.
It is further shown by stipulation of the parties that in the case of sale of any of the mortgaged property, the unamortized portion of*2338 the mortgage fees relating thereto was written off at the time of such sale. We think that is the proper accounting method and the Commissioner should use it in computing the net income of the taxpayer for the respective years involved in this proceeding.
Petitioner alleges that respondent erred in his computation of profit on the installment sale basis on the two properties located at 82nd Street and Broadway and at 83rd Street and Broadway, and relies on the case of Schneider, Trustee of Bagby-Howe Drug Co.v. Lucas, decided August 3, 1929, Western District of Kentucky. This Board, in , and , had before it the construction of section 212(d) of the Revenue Act of 1926, and Regulations 69, articles 42-46, made in pursuance thereof, and we there held that the total contract price is the consideration named in the original agreement less the mortgage on the property, and that the sum thus found is to be used as the basis for the computation of percentage of profit. We think that is a correct interpretation of the statute, and we approve the action of the Commissioner*2339 in so treating it.
Relative to the claim for deduction of the sum of $3,336.81 from income for 1924, petitioner claims that this item should properly have been included in its income for 1922 and should therefore be excluded from income for 1924. It claims that this was an error or neglect of its own accounting and should now be corrected.
It returned this sum as income for 1924, and it was so accepted by the respondent. It has not been shown that this was erroneous or unfair or that it did not clearly reflect petitioner's income. As petitioner made its return on the basis of its own system of accounting, we are of opinion that the respondent was correct in not eliminating this item. A similar principle was involved in , where the railway company had accrued wages in one year, and which when unclaimed were credited to profit and loss in a later year, it was held to constitute income in the year when credited to profit and loss.
Reviewed by the Board.
Judgment will be entered under Rule 50.