*236 Decision will be entered under Rule 50.
1. Deductions. -- Held, petitioner did not sustain his burden of proving distributions or advances to wholly owned corporation to enable it to pay certain indebtednesses and real estate taxes were allowable as business bad debts or losses incurred in transactions entered into for profit. Held, further, respondent did not sustain burden of proving affirmative allegation that advances were contributions to capital.
2. Basis. -- Held, on the facts, basis of petitioner's interest in trust was original amount of investment therein.
*1593 The respondent, in his deficiency notice, determined income tax deficiencies in the amounts of $ 1,616.93, $ 1,098.92, and $ 627.91, for the calendar years 1943, 1944, and 1945, respectively. By affirmative pleading respondent makes claim for increased deficiencies in the amounts of $ 2,036.94, $ 1,606.10, and $ 757.06, for the years 1943, 1944, and 1945, respectively, and, in the alternative, for a further increased deficiency in the amount of $ 1,164.32 for the year 1945. The petitioners contest the asserted deficiencies and claim an overpayment of $ 1,953.76 for the year 1945.
Petitioners assign error in the respondent's determination: (1) that disbursements made by petitioners in each of*238 the taxable years to a wholly owned corporation for payment of interest on its indebtedness and real estate taxes, were not deductible in full as claimed, but only as nonbusiness bad debts; and (2) that in connection with investments *1594 in participating fractional interests in bonds and mortgages held by a trust company which subsequently foreclosed the mortgages and bid in the properties and thereafter in 1945 sold the properties and made distributions of the proceeds in liquidation of the fractional interests, petitioners sustained ordinary losses in the amount of $ 1,043.88 in 1945, instead of $ 7,134.61 as now claimed. With respect to both issues respondent affirmatively pleads error in allowing any amounts as deductions.
Part of the facts have been stipulated.
FINDINGS OF FACT.
The stipulated facts are so found.
The petitioners are husband and wife residing at Hazleton, Pennsylvania. They filed joint income tax returns for each of the years in question with the collector of internal revenue for the twelfth collection district of Pennsylvania. The petitioner, George B. Markle, Jr. will be hereinafter referred to as petitioner.
The Hazleton Auto Sales Company, hereinafter*239 referred to as the Sales Company, was incorporated in the early 1920's at which time petitioner paid $ 50,000 for its entire capital stock. From the time of that company's organization to and including the taxable years, petitioner was its sole stockholder and president and directed its business affairs. From 1930 on petitioner received no dividends or salary from the Sales Company.
The Sales Company engaged in business as a retail Ford dealer until 1930 when it disposed of various assets pertaining to that business but retained certain improved real estate. The Sales Company's balance sheet of December 31, 1930, disclosed that it had a deficit of $ 21,119.54. The Company's liabilities included inter alia, a first mortgage on its real estate of $ 40,000 held by the Hazleton National Bank; two judgment notes in the aggregate unpaid principal balance of $ 27,750 due that same bank; and also a judgment note in the unpaid principal balance of $ 9,750 due the Markle Banking and Trust Company. Those banks periodically revived the judgments entered on the notes and the liens of the judgments were kept alive throughout the taxable years. Subsequent to 1930 and at all times material*240 here the Sales Company used its real estate only as a rental and storage garage and its only business activity consisted of collecting rents and paying expenses, interest, and taxes.
On April 19, 1932, the petitioner executed under seal an agreement of "Suretyship" to the Hazleton National Bank for the payment in full of the Sales Company's two judgment notes aggregating an unpaid principal amount of $ 27,750, together with interest thereon. The instrument provided that so long as petitioner, his executors, or administrators *1595 remain the owner of the majority of the stock of the Sales Company and the latter retains ownership of its real estate, "this agreement of Suretyship shall not be enforceable, unless default is made on payment of interest of above notes."
On January 17, 1933, the petitioner executed a similar agreement of suretyship to the Markle Banking and Trust Company for the payment in full of the Sales Company's judgment note in the then unpaid principal amount of $ 8,900, together with interest thereon.
The above-mentioned agreements of suretyship were executed by petitioner at the request of the banks, respectively, because the Sales Company's real estate had*241 greatly depreciated in value during 1932 and 1933 and petitioner acceded to protect his position in the community, his relationship with the banks, and his business interests. Petitioner's grandfather founded the Markle Banking and Trust Company, but petitioner's only connection therewith was as a depositor and customer. Petitioner was a director of the Hazleton National Bank.
In or about 1924 petitioner organized the Markle Hotel Company and throughout all subsequent years material here, was the president and owner of 80 per cent of the stock thereof. In April 1932 that Company was indebted to the Hazleton National Bank in an amount in excess of $ 91,000, and was in poor financial condition. In 1933 the Hotel Company was reorganized under the name of the Altamont Hotel and the Hazleton National Bank received a third mortgage on the hotel property for $ 91,600, the amount of the debt due the bank at that time.
In 1935 petitioner organized the Freeland Spool and Bobbin Corporation which engaged in the manufacture of special processes for textile mills. From that time and during the taxable years petitioner owned a majority of the stock of that Company which received various loans*242 and a line of credit from the Markle Banking and Trust Company.
From time to time petitioner made advances to the Hotel Company and the Spool and Bobbin Company, to provide necessary working capital. The petitioner was not in the business of organizing, promoting, or financing corporations, nor of making loans to other persons or guaranteeing indebtedness of other persons.
During each of the taxable years petitioner made disbursements to the Sales Company from his own funds in the total amounts of $ 5,058.39 for 1943, $ 3,226.60 for 1944, and $ 2,879.31 for 1945, which moneys were used by the Sales Company to pay taxes on its real estate and interest on its mortgage and three judgment notes. During each of the taxable years the Sales Company's principal asset was real estate and its income was insufficient to meet its obligations as they arose. The petitioner's disbursements to the Sales Company in *1596 those years were made for the purpose of enabling the Company to meet its obligations thereby preventing any default on its mortgage or notes and thus avoiding the possibility of petitioner's becoming liable for the principal amount of the judgment notes under his agreements*243 of suretyship to the two banks and, further, for the general purpose of protecting his business interests. At the time those disbursements were made in each of the taxable years there was no reasonable expectation that they would ever be repaid and they were worthless as claims against the Sales Company.
On his return for 1943, petitioner claimed deductions of $ 3,225.17 for interest and $ 1,832.22 for taxes paid as guarantor of the Sales Company. On his returns for 1944 and 1945, petitioner claimed deductions of $ 3,226.60 and $ 2,879.31, respectively, as bad debt losses representing interest and taxes paid as guarantor of the Sales Company. For each of the taxable years respondent disallowed the claimed deductions and held that the amounts represented nonbusiness bad debts deductible as short term capital losses.
The petitioner's father died in 1914 and his will established a trust (hereinafter referred to as the testamentary trust), under the terms of which the income thereof was payable to petitioner for 21 years and thereafter the principal thereof was distributable to petitioner. The trustee, an individual, made three separate investments of principal funds of the testamentary*244 trust, each one being an undivided participating fractional interest in the bond and mortgage on improved real estate situated in Philadelphia, Pennsylvania, which mortgages were subsequently foreclosed, as follows:
| Principal | ||
| Date of investment | Amount | amount of |
| invested | bond and | |
| mortgage | ||
| June 19, 1926 | $ 5,000 | $ 100,000 |
| June 26, 1926 | 5,000 | 200,000 |
| January 11, 1929 | 1,600 | 65,000 |
| Date of investment | Property covered by mortgage | Date of |
| foreclosure | ||
| June 19, 1926 | 251-3 No. 18th St | May 3, 1937 |
| June 26, 1926 | 1324 Walnut St | Feb. 5, 1934 |
| January 11, 1929 | 822-4 No. Broad St | June 6, 1932 |
The above-mentioned bonds and mortgages were acquired by the Fidelity-Philadelphia Trust Company or its predecessor, (hereinafter referred to collectively as the Trust Company) either from the mortgagor or by assignment from the mortgagee or intermediate assignee. The Trust Company was designated as "Trustee For Various Trusts" in the first two mortgages and as "Trustee" in the third one. In connection with each of the first two investments the Trust Company issued a registered "Certificate of Interest in Mortgage" on the face of which it was stated, in part, *245 that "This is to Certify, That the Philadelphia Trust Company, Agent for Charles B. Adamson Trustee under the Will of George B. Markle, 2nd, is the owner of an undivided interest amounting to Five Thousand Dollars in a *1597 certain Bond and Mortgage" appropriately described. In connection with the third investment the Trust Company issued a registered "Fractional Mortgage Certificate" on the face of which it was stated, in part, that the Trust Company "Hereby Certifies that Fidelity-Philadelphia Trust Company, Attorney for Charles B. Adamson Trustee under the Will of George B. Markle, 2nd, Deceased, has invested the sum of One Thousand Six Hundred Dollars belonging to the said Estate in a fractional part to the extent of said Bond and Mortgage" appropriately described. On the back of each of the three mortgage certificates appeared a printed form for the assignment thereof.
The Trust Company maintained ledger sheets as "agent" for the account of the testamentary trust showing various investments of its funds, including the investments in question.
Upon the foreclosure of the mortgages on the above-mentioned dates and at each foreclosure sale, the Trust Company bid in the mortgaged*246 premises and received a sheriff's deed for each property, either as "trustee for various trusts" or as "trustee." The stipulation herein sets forth the fair market value of each property on the foreclosure date, which value was substantially less than the amount of the mortgage, and also the depreciation claimed and allowed from that date to the date of sale of each property by the Trust Company in 1945.
Pursuant to the terms of the testamentary trust all the assets thereof, including its undivided participating fractional interests derived from its above-mentioned investments, were distributed to petitioner in 1936. Upon the sales of the three properties by the Trust Company in 1945, the petitioner received pro rata distributions in liquidation of his participating fractional interests in the proceeds of the sales, in the amounts of $ 2,618.74 on the N. 18th St. property, $ 1,182.05 on the Walnut St. property, and $ 664.60 on the N. Broad St. property, or a total of $ 4,465.39.
In his return for 1945 petitioner included an attached statement of account by the Trust Company as "Agent for" petitioner. That statement reported the sale of each of the above-mentioned properties in 1945; *247 the dates of acquisition as the dates of the foreclosure sales; the amounts realized as the sums distributed to petitioner in liquidation of his interests in 1945; certain amounts as cost or other basis; and a total "net real estate loss $ 6,675.62." The latter figure was reported on petitioner's 1945 return as a long term capital loss and one-half thereof taken into account (together with one-half of a reported capital loss on a sale of shares of stock), and he claimed a capital loss deduction of $ 1,000. In his deficiency notice respondent determined and allowed for 1945, an additional deduction of $ 1,043.88 as an ordinary "loss on sale of properties."
*1598 OPINION.
The first issue, which is common to all three taxable years, involves the question of whether petitioner is entitled to deductions for all or any part of his disbursements to the Sales Company in the amounts of $ 5,058.39 in 1943, $ 3,226.60 in 1944, and $ 2,879.31 in 1945. Petitioner's primary contention is that those amounts were paid by him as a guarantor and constituted business bad debts deductible in full under section 23 (k) (1), Internal Revenue Code. On the other hand, respondent contends that the *248 disbursements were not made by the petitioner as a guarantor; that they were worthless as claims, when made; and that they did not constitute bad debts, either business or nonbusiness, under section 23 (k) (1) or (4). 1 Respondent further contends, under his affirmative plea, that the disbursements constituted capital contributions to petitioner's wholly owned corporation and that he erred in allowing any amounts as deductions on account thereof in his deficiency notice.
*249 Accepting the rule of Shiman v. Commissioner, 60 F. 2d 65, (See also Daniel Gimbel, 36 B. T. A. 539, and D. W. Pierce, 41 B. T. A. 1261), it still becomes necessary for petitioner to satisfy us that, if not when the sums were paid by him, at least when the debtor corporation's obligations were originally guaranteed, the corporation was sufficiently solvent to justify some hope that these gratuitous acts would ultimately be compensated by repayment. Hoyt v. Commissioner, 145 F.2d 634">145 F. 2d 634. On that factual issue, the evidence is so meager as to make it impossible to reach the necessary conclusion. All the evidence we have is that while in 1930 the guaranteed corporation had a surplus deficit of $ 21,000, by 1932 and 1933, when the guarantees were made, the value of the corporation's assets had declined. We are accordingly unable to conclude that petitioner has proved that the corporation was solvent at the time of the original guarantees. Indeed, petitioner does not give the hope of salvage as his reason for guaranteeing the corporation's debts, but rather*250 his personal standing in the community. That being so, it cannot be said, as it was in Shiman, that petitioner's guarantee of a solvent debtor's obligations *1599 left him no choice when subsequently the debtor became unable to perform and the taxpayer, on the one hand, was required to make good in its place, and, on the other, acquired in exchange only a worthless obligation of an insolvent debtor. This would normally eliminate even the assumption that this was a nonbusiness bad debt, making it comparable to a loan to a debtor so insolvent that the debt was worthless when acquired. Cf. Hoyt v. Commissioner, supra;Fred A. Bihlmaier, 17 T. C. 620; E. J. Ellisberg, 9 T.C. 463">9 T. C. 463.
Similarly, the facts outlined prevent the conclusion that the advances were business bad debts, Omaha National Bank v. Commissioner, 183 F.2d 899">183 F. 2d 899; A. Kingsley Ferguson, 16 T. C. 1248; Jan G. J. Boissevain, 17 T. C. 325, or losses incurred in a trade or business under section 23 (e) (1), Burnet v. Clark, 287 U.S. 410">287 U.S. 410,*251 or in a transaction entered into for profit under section 23 (e) (2), Clark v. Kavanagh, 152 F. 2d 49; Harold Kushel, 15 T. C. 958, the circumstances of the original guarantee eliminating any possibility that the purpose was to embark upon a profitable venture. Nor do we see how in the light of petitioner's occupation they can be treated as business expenses incurred for the production of income under section 23 (a) (2), assuming as we must that there was no possibility at any time that income would result. Deputy v. du Pont, 308 U.S. 488">308 U.S. 488; Low v. Nunan, 154 F.2d 261">154 F. 2d 261.
When we come, however, to considering disposition of the nonbusiness bad debt issue, we are met with the condition of the pleadings. The original deficiency was determined on the theory that the claim was allowable as a nonbusiness bad debt, and it was only by affirmative answer that respondent raised the contention that no deduction whatever could be granted. To that extent, the burden of proving the necessary facts was upon respondent, 2 particularly the fact that the corporation*252 was so insolvent in 1931 and 1932, when the guarantees were entered into, that petitioner was dealing with a worthless debtor. On this point, he has no more nearly sustained his burden than has the petitioner sustained his. We are accordingly required to approve the deficiency as initially determined and find that the amounts in question were deductible as nonbusiness bad debts and hence are subject to treatment as short term capital losses. Internal Revenue Code, section 23 (k) (4).
As the case is presented, the second issue is narrowly limited. There is no question as to the character of petitioner's loss. It is conceded by respondent that when petitioner, as a result of the sale of the foreclosed *1600 property, received the proceeds originally invested in *253 the participating interest in the mortgage, his loss was ordinary and not capital.
The sole question is the amount of the loss which, in turn, depends on what was petitioner's basis. This, again, requires only that we select between the amount originally invested in the participating mortgage interest and the value (less subsequent depreciation) of the property at the time of foreclosure.
It seems evident that although the foreclosure undoubtedly resulted in a deduction, Commissioner v. Spreckels, 120 F. 2d 517; Regulations 111, section 23 (k)-3, the claim would be allowable only to the Trust Company if it was in fact a trustee and not to petitioner notwithstanding his beneficial interest. Under the special rule of the Pennsylvania cases we conclude that petitioner's interest at the time of foreclosure was purely that of the beneficiary of a special trust. Harton's Estate, 331 Pa. 507">331 Pa. 507, 1 A. 2d 292; Guthrie's Estate, 320 Pa. 530">320 Pa. 530, 182 A. 248">182 A. 248; Rambo's Estate, 327 Pa. 258">327 Pa. 258, 193 A. 1">193 A. 1. Under those circumstances the *254 loss on foreclosure would have to be taken by the trust and not by petitioner himself. T. Rosslyn Beatty, 28 B. T. A. 1286; George W. Vreeland, 16 T. C. 1041. That being so, the situation is comparable to one where a different taxable entity, such as a corporation, suffers a loss which cannot be deducted by another taxpayer, say, one of its stockholders. It follows that only when the transaction was finally completed and the proceeds were paid to petitioner was the loss deductible by him. We conclude that the basis adopted by petitioner which was the original amount of the investment ( Maguire v. Commissioner, 61 S. Ct. 789">61 S. Ct. 789; Helvering v. Reynolds, 61 S. Ct. 971">61 S. Ct. 971), was properly used by him in computing the loss. William George McKitterick, 46 B. T. A. 597.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(k) Bad Debts. --
(1) General rule. -- Debts which become worthless within the taxable year; * * *
* * * *
(4) Non-business debts. -- In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩
2. Rules of Practice before The Tax Court of the United States:
RULE 32. -- BURDEN OF PROOF
The burden of proof shall be upon the petitioner, * * * except that in respect of any new matter pleaded in his answer, it shall be upon the respondent.↩