*89 Decisions will be entered under Rule 50.
1. In 1927 petitioners purchased land on which they erected an apartment building. To finance the project they executed their coupon bonds, secured by a first mortgage of $ 350,000 on the property. In 1928 they executed a second mortgage to secure the payment of second mortgage notes aggregating $ 125,000. In 1939 and in years prior thereto petitioners acquired their own bonds at large discounts. They expended approximately $ 148,000 therefor and in 1939 sold such bonds to Harry & Max Dunitz, Inc., a corporation controlled by them and owned by themselves and relatives. The purchase and sale of such bonds was established by them as an activity inherently necessary to their business of managing buildings. During the taxable years they purchased and sold such bonds in the aggregate amount of many hundreds of thousands of dollars. Held, that gain on disposition of the bonds came within the exceptions of section 117, Internal Revenue Code, and was taxable to petitioners as ordinary income and not as capital gain.
2. Amounts paid to attorneys for legal services rendered in connection with proposed assessments and an indictment involving*90 bond purchases and alleged fraudulent claims based thereon, held properly deductible under section 23 (a) (2), Internal Revenue Code.
*673 The respondent determined deficiencies of $ 17,270.64 and $ 1,291.28 in the income tax liability of petitioner Harry Dunitz for the years *91 1939 and 1940, respectively. He also determined deficiencies of $ 16,212.16 and $ 1,255.44 in the income tax liability of petitioner Max Dunitz for the same respective years.
The issues are:
1. Whether the transactions in 1939 relating to the disposition of mortgage bonds and notes by the partnership firm of Dunitz Bros., composed of the two petitioners, to Harry & Max Dunitz, Inc., resulted in ordinary net income or in capital gain.
2. Whether or not deductions of legal fees of $ 8,175 paid in 1940 by the partnership firm of Dunitz Bros. are properly allowable.
Certain other issues were conceded or abandoned.
FINDINGS OF FACT.
Certain facts were stipulated. In so far as they are pertinent to the issues, they are as follows:
The petitioners, Harry Dunitz and Max Dunitz, are individuals residing in the city of Detroit, Wayne County, Michigan. Individual income tax returns for the calendar years 1939 and 1940 were filed with the collector of internal revenue for the collection district of Michigan.
In 1927 Harry Dunitz and Max Dunitz, individually, purchased certain property on Webb Avenue in the city of Detroit and proceeded to erect an apartment building. To finance this project, *92 Dunitz Bros. borrowed from the Guaranty Trust Co. of Detroit approximately $ 350,000. On June 1, 1927, Harry Dunitz and Max Dunitz executed and delivered to the Guaranty Trust Co. of Detroit, as trustee, their *674 first mortgage coupon bonds in the aggregate principal amount of $ 350,000, bearing numbers 1 to 422, inclusive. At the same time Harry and Max Dunitz, together with their wives, who joined therein for the purpose of subordinating their dower interest, executed and delivered to the Guaranty Trust Co. of Detroit, trustee, a first mortgage dated June 1, 1927, for the purpose of securing the repayment of their bonds and the interest coupons attached thereto. The mortgage bonds had serial maturities; approximately $ 123,000 (sic) face value of such bonds had maturities ranging from June 1, 1929, up to and including June 1, 1937, while the maturity of the balance of $ 225,000 was fixed on June 1, 1937.
The property, located at 3711 Webb Avenue, was described variously as "Dexter Square Apartment" and sometimes as "Dexter Square Building." The 3711 Webb Avenue bonds were carried on the books of a partnership wholly owned by the petitioners and doing business under*93 the assumed name of "Pingree Investment Company" in an account captioned "Bonds in vault 1065," which caption refers to the description of this loan on the books of the Guaranty Trust Co., namely, loan account number 1065.
On June 1, 1927, the 3711 Webb Avenue property was subjected to a second mortgage lien securing a loan of $ 75,000. This lien was released by an instrument recorded on February 17, 1928. However, another second mortgage dated February 11, 1928, and recorded February 15, 1928, was executed and delivered by Harry and Max Dunitz and their respective wives to the Guaranty Trust Co. to secure the payment of the second mortgage notes aggregating $ 125,000.
The 3711 Webb Avenue property was sold by the petitioners to Michael E. O'Brien by warranty deed dated February 15, 1928. The petitioners acquired the property known as 3711 Webb Avenue from Michael E. O'Brien and Lydia C., his wife, by warranty deed dated September 9, 1929.
In January 1931 a corporation, known as Harry & Max Dunitz, Inc., was organized under the laws of Michigan. The stock of the corporation was owned as follows:
| Shares | |
| Harry Dunitz | 333 |
| Minnie Dunitz (wife of Harry) | 167 |
| Max Dunitz | 167 |
| Ethel Dunitz (wife of Max) | 167 |
| Albert Nelson (brother of Ethel) | 166 |
| Total | 1,000 |
*94 During the month of January 1931 the petitioners and their wives acquired additional shares of stock in the corporation in exchange *675 for a number of equity interests in property, which thereupon were transferred to the corporation. The stock was then held as follows:
| Shares | |
| Harry Dunitz | 2,000 |
| Minnie Dunitz (wife of Harry) | 1,000 |
| Max Dunitz | 1,834 |
| Albert Nelson (brother of Ethel) | 166 |
| Ethel Dunitz (wife of Max) | 1,000 |
| Total | 6,000 |
The equities and property so transferred included the 3711 Webb Avenue building.
The opening entry upon the books of Harry & Max Dunitz, Inc., showing the acquisition of the 3711 Webb Avenue property, was as follows:
| Improved property -- Dexter Square Apartment | |||
| Mortgage 1st | $ 330,000.00 | ||
| Mortgage 2nd | 40,000.00 | ||
| Equity | 40,000.00 | ||
| To Mortgages payable Dexter Square | $ 370,000.00 | ||
| Capital Stock | 40,000.00 |
The Commissioner contends and the petitioners deny that at no time prior or subsequent to the transfer of the equity of the 3711 Webb Avenue property were Harry and Max Dunitz, or either of them, released in writing by the trustee under the first and second mortgages, or the holders of the bonds and *95 notes issued thereunder, from the personal individual liability originally incurred by them for the payment of the mortgage bonds and notes.
Between 1927 and 1931 first mortgage coupon bonds numbered 1 to 24, inclusive, in the aggregate principal amount of $ 20,000, were paid and canceled, leaving $ 330,000 in bonds outstanding. Bonds maturing June 1, 1931, were defaulted. Subsequently, the Union Guardian Trust Co., as trustee, filed a bill of complaint for the foreclosure of the first mortgage and, pursuant to the terms of the mortgage, the successor trustee declared the entire unpaid principal of $ 330,000 due and payable. In 1932 the successor trustee was appointed and duly qualified as receiver in the foreclosure suit.
On January 1, 1934, Harry & Max Dunitz, Inc., acting as mortgagor or owner, and the Union Guardian Trust Co., as trustee, entered into a "Memorandum of Agreement" for the amendment of certain of the terms of the original mortgage executed by Harry and Max Dunitz, individually. The agreement contained no specific release of the personal liability of the petitioners on the mortgage bonds and *676 notes issued under the terms of the mortgages above described, *96 but there appeared therein the following recital:
Whereas, said owner is now vested with the fee title absolute in and to all of said premises subject only to said mortgage encumbrance and unpaid taxes and assessments, if any;
Whereas, said owners, Harry and Max Dunitz, Inc., first party herein has assumed and agreed to pay all of said mortgage indebtedness, and represents that it is now the sole owner of the legal title to all of said mortgaged property, subject to no encumbrance prior to said mortgage.
The Guaranty Trust Co. of Detroit, trustee under the second mortgage on the 3711 Webb Avenue property, was succeeded as trustee by the Detroit Trust Co., pursuant to an order of the Circuit Court of Wayne County, Michigan, entered on July 30, 1931, in cause No. 196,272. On October 6, 1934, the Circuit Court of Wayne County appointed Pearl I. Kelley as successor trustee under the aforesaid second mortgage. Pearl I. Kelley was then employed by the petitioners herein as a bookkeeper. At the time Pearl I. Kelley was appointed successor trustee under the second mortgage on October 6, 1934, the total unpaid notes then secured by the second mortgage amounted to $ 40,000. The $ 40,000*97 of unpaid second mortgage notes was purchased for $ 4,100 in October 1934 by the petitioners, doing business under the assumed name of Pingree Investment Co. (Saul G. Dunitz, son of Max Dunitz, nominee). On January 9, 1936, Pearl I. Kelley executed a "Certificate of Subordination" which, in effect, subordinated the second mortgage to the lien and terms of the first mortgage.
On September 25, 1934, the petitioners, acting under the assumed name of "Pingree Investment Company," began to purchase the unpaid first mortgage bonds and continued to make such purchases on the open market over a period extending through January 19, 1939. Pertinent data relative to the par value of such bonds, the dates of acquisition, the dates of disposition, cost, price received, and profit are set forth below, as follows:
| Par | Dates acquired | Date sold or | Cost | Sale price | Profit |
| transferred | |||||
| $ 224,900 | 9/25/34-12/18/36 | 1/4/39 | $ 68,851.00 | $ 179,920 | $ 111,069.00 |
| 47,500 | 1/6/37-7/3/37 | 1/4/39 | 21,206.00 | 38,000 | 16,794.00 |
| 97,600 | 7/23/37-1/4/39 | 1/4/39 | 58,549.38 | 78,080 | 19,530.62 |
| 370,000 | 148,606.38 | 296,000 | 147,393.62 |
As of January 1, 1939, the petitioners herein directly or indirectly*98 had legal or equitable ownership of first mortgage bonds outstanding against the 3711 Webb Avenue property in the total amount of $ 322,100, and bonds having a total face value of $ 7,900 were held by outsiders, making a total of $ 330,000 in first mortgage bonds outstanding *677 on that date. The names in which the first mortgage bonds outstanding on January 1, 1939, were registered were as follows:
| Saul Dunitz | $ 116,800 |
| Sydney J. Dunitz | 9,000 |
| Mrs. Pearl I. Kelley | 15,000 |
| Pearl I. Kelley | 23,500 |
| Pingree Investment Co | 66,400 |
| Louis Roach | $ 41,700 |
| Pollie Milzer | 8,500 |
| Sundry names | 49,100 |
| Total | 330,000 |
On or about January 4, 1939, Harry & Max Dunitz, Inc., acquired from the petitioners, doing business under the assumed name of Pingree Investment Co., $ 330,000 face value outstanding first mortgage bonds of 3711 Webb Avenue for 80 per cent of par or face value. There was no written contract between Harry & Max Dunitz, Inc., and the Pingree Investment Co., or with the petitioners individually, relative to the foregoing transaction, nor was there any formal action taken by the board of directors of Harry & Max Dunitz, Inc. On or about January 4, 1939, the $ 40,000*99 face value of second mortgage notes purchased on October 1, 1934, for $ 4,100 by the so-called Pingree Investment Co., Saul G. Dunitz, nominee, were acquired by Harry & Max Dunitz, Inc., for 80 per cent of par or face value. The transactions herein set forth may be summarized as follows:
| Description | Par value | Cost | Price | Profit |
| First mortgage bonds | $ 330,000 | $ 144,506.38 | $ 264,000 | $ 119,493.62 |
| Second mortgage bonds | 40,000 | 4,100.00 | 32,000 | 27,900.00 |
| Total | 370,000 | 148,606.38 | 296,000 | 147,393.62 |
The foregoing transaction was recorded on the books of Harry & Max Dunitz, Inc., by the following entries:
| (1) | |||
| Mortgage Payable -- Dexter Square | $ 296,000 | ||
| To | |||
| Pingree Investment Co | $ 296,000 | ||
| To record purchase of bonds covering mortgage of Dexter Square | |||
| Apts. 1-4-39. | |||
| (2) | |||
| Mortgage Payable -- Dexter Square | $ 74,000 | ||
| To | |||
| Cost of Building -- Dexter Square | 74,000 | ||
| To reduce cost of building, bonds purchased at less than par | |||
| value 1-4-39. |
On January 4, 1939, first mortgage trust bonds on the 3711 Webb Avenue property having a face value of $ 311,600 were on deposit with the Detroit Bank as collateral security for a loan*100 of $ 40,000. The records of the Detroit Bank show Saul G. Dunitz as the borrower, with Harry Dunitz and I. Jacobson as endorsers. The foregoing bonds were delivered by the Detroit Bank to the Union Guardian *678 Trust Co. on January 17, 1939; on the same date, the so-called Pingree Investment Co. delivered additional first mortgage bonds in the face amount of $ 11,500 and at the same time posted a surety bond to protect the Union Guardian Trust Co. against liability for a $ 1,000 bond which was deemed to have been lost. The total face amount of bonds actually or constructively delivered to the Union Guardian Trust Co. was $ 324,100. The balance required to make up the $ 330,000 face value of bonds outstanding was delivered in the form of a check dated January 19, 1939, by Harry & Max Dunitz, Inc., on behalf of the so-called Pingree Investment Co., in the face amount of $ 6,444.01. The check was delivered to the Union Guardian Trust Co. as payment for principal and accrued interest on bonds outstanding in the face amount of $ 5,900. After delivery of the first mortgage bonds and second mortgage notes by Harry & Max Dunitz, Inc., to the Union Guardian Trust Co., as trustee, *101 the bonds and notes were canceled by the trustee and then returned to Harry & Max Dunitz, Inc.
On or about January 4, 1939, Harry & Max Dunitz, Inc., entered into an "Agency Contract" with another corporation, the Glendale Holding Co., hereinafter called Glendale, all of whose stock was owned by or on behalf of the petitioners. The contract contained the following provisions:
Whereas, The Harry and Max Dunitz, Incorporated, a Michigan corporation, is the present owner of property described as The Dexter Square Apartments, located on the West side of Dexter between Burlingame and Webb, Detroit, Wayne County, Michigan, sometimes described as 3711 Webb, which consists of eighty-nine (89) apartments and twelve (12) stores, and is desirous of securing a mortgage loan on said property without becoming liable in its corporate capacity for the repayment of said loan;
And Whereas, The Glendale Holding Company, a Michigan corporation, is desirous of securing a loan on said property for the use and benefit of The Harry and Max Dunitz, Incorporated, for and in consideration of the sums hereinafter set forth:
* * * *
I.The said Harry and Max Dunitz, Incorporated, will deed and convey the legal*102 title to the aforesaid property to the said Glendale Holding Company without consideration.
II.The said Glendale Holding Company will hold the legal title to said property, subject to the orders and directions of the said Harry and Max Dunitz, Incorporated, as to use, management and further conveyances of the said property.
III.The said Glendale Holding Company will, at the direction of the said Harry and Max Dunitz, Incorporated, make every effort to secure a mortgage loan on said property and upon securing said mortgage loan, will make itself corporately *679 liable for the repayment of said loan and will transfer and convey to the said Harry and Max Dunitz, Incorporated, the net proceeds from said loan.
IV.The said Glendale Holding Company will, at the direction of the said Harry and Max Dunitz, Incorporated, consummate any sale of said property on the terms and conditions as directed and will convey legal title of said property to the purchaser thereof, under the terms and conditions as directed by the said Harry and Max Dunitz, Incorporated. The Glendale Holding Company will, when, as, and if such sale is consummated, transfer to the said Harry and Max Dunitz, Incorporated, *103 the net proceeds from such sale.
V.The said Harry and Max Dunitz, Incorporated, agrees to save the said Glendale Holding Company harmless for all costs and expenses in connection with the aforesaid transaction and will, in case a mortgage in executed, as is contemplated at the present time, pay to the said Glendale Holding Company, or cause to be paid to the said Glendale Holding Company out of the proceeds of the mortgage, or permit the said Glendale Holding Company to retain out of the proceeds of the mortgage, as consideration for securing the mortgage and for the other responsibilities and agreements incorporated herein, the sum of Fifteen Hundred ($ 1,500.00) Dollars.
VI.It is contemplated that the Glendale Holding Company while taking legal title to said property and making itself corporately liable on said contemplated mortgage, will act pursuant to the direction of said Harry and Max Dunitz, Incorporated, will either employ the said Harry and Max Dunitz, Incorporated to manage the property at a regular fee, or will manage said property pursuant to the directions of the said Harry and Max Dunitz, Incorporated, and will in every other respect act as an agent or nominee of *104 the said Harry and Max Dunitz, Incorporated.
VII.In case no sale or mortgage is consummated, the Glendale Holding Company will, at the direction of Harry and Max Dunitz, Incorporated, reconvey said property to the said Harry and Max Dunitz, Incorporated, without consideration.
VIII.In Witness Whereof, the respective corporations have caused these presents to be signed by their officers and the corporate seals affixed on this 4th day of January, A. D. 1939.
Pursuant to the terms of the foregoing agreement, Harry & Max Dunitz, Inc., executed a warranty deed dated January 4, 1939, conveying the 3711 Webb Avenue property to Glendale. On or about January 12, 1939, Glendale entered into a contract for the sale of the 3711 Webb Avenue property to R. E. Olds of Lansing, Michigan.
On January 18, 1939, the Travelers Insurance Co. loaned $ 150,000 to Glendale and the latter executed a first mortgage as security for the *680 loan. The proceeds of the foregoing $ 150,000 loan were distributed by the Travelers Insurance Co. as follows:
| Paid to or for: | ||
| Detroit Bank (loan of Saul G. Dunitz) | $ 40,000.00 | |
| Service charge | 1,500.00 | |
| Sundry charges | 1,042.65 | |
| Borrower | 107,457.35 | |
| Total loan | 150,000.00 |
*105 Contemporaneously with the execution and recording of the foregoing mortgage in favor of the Travelers Insurance Co., the trust mortgage dated June 1, 1927, securing the above mentioned first mortgage bonds and the trust mortgage dated February 11, 1928, securing the second mortgage bonds referred to above were released of record.
A total profit of $ 61,926.54 was realized for the calendar year 1939 on the sale of the Webb Avenue property to R. E. Olds of Lansing, Michigan, and such profit was reported on the 1939 corporation income tax return of Harry & Max Dunitz, Inc. No claim for refund is now pending. The corporation originally paid income tax of $ 12,110.40. As a result of a field examination, excess profits tax of $ 155.69 was assessed and income tax of $ 957.26 was refunded, resulting in a net overassessment of $ 801.57. The adjusted net income of the corporation was $ 67,594.79. An additional cost of the 3711 Webb Avenue property was allowed in the amount of $ 452.60. The profit consisted of the following items, namely:
| Profit on sale of Dexter Square (Webb Avenue property) | $ 26,466.06 |
| Profit on sale of Bellerive bonds (Part of sale consideration) | 35,460.48 |
| Total profit | 61,926.54 |
*106 It was agreed that the profit of $ 26,466.06 realized on the sale of Dexter Square property represents the difference between the net amount realized on the sale of such property, $ 296,709.94, and the adjusted basis of said property to Harry & Max Dunitz, Inc., $ 270,243.88, and that the profit of $ 35,460.48 on the sale of Bellerive Hotel Bonds represents the difference between the total selling price received for the bonds of $ 145,360.48, and their basis to Harry & Max Dunitz, Inc., of $ 109,900. This basis, in turn, represented the value of $ 107,475 assigned to the Bellerive Hotel bonds acquired on the sale of the Dexter Square property, plus other acquisitions in the amount of $ 2,425.
In the event that the Tax Court should decide that the bonds and notes on the property located at 3711 Webb Avenue were capital assets in the hands of the petitioners herein and that the disposition of the bonds and notes to Harry & Max Dunitz, Inc., in 1939 constituted a sale of capital assets, it was stipulated and agreed that the holding *681 periods and percentage of gain reported in the partnership return of Dunitz Bros. for the calendar year 1939 were correct.
The funds used by Harry*107 & Max Dunitz, Inc., to acquire the Webb mortgage bonds and notes from the petitioners herein were acquired from the proceeds of the mortgage given to the Travelers Insurance Co. and from the sale to R. E. Olds. The account on the books of Harry & Max Dunitz, Inc., recording this transaction was as follows:
| Account of Pingree Investment Company | |||
| 1939 | Dr. | Cr. | |
| Jan. 2 | Balance forwarded | $ 61,590.20 | |
| 4 | 1065 Bonds | $ 296,000.00 | |
| 19 | 140,000.00 | ||
| 20 | 1065-Lost Instrument & Coupon | 104.70 | |
| Mar. 3 | 815.00 | ||
| 10 | 35,000.00 | ||
| May 5 | 5,000.00 | ||
| June 8 | 25,000.00 | ||
| 21 | 6,000.00 | ||
| 23 | 1,000.00 | ||
| July 26 | 1,750.00 | ||
| 31 | 5,000.00 | ||
| 31 | 500.00 | ||
| Aug. 2 | 2,750.00 | ||
| 17 | 2,000.00 | ||
| Sept. 5 | 9,490.10 | ||
| $ 296,000.00 | $ 296,000.00 |
The trial balance book and general ledger of Pingree Investment Co. disclose that Pingree in its balance sheets as of December 31, 1937, 1938, and 1939, carried an account entitled "Bonds and Stock," and that it used its opening balance plus purchases, less a closing balance for the years 1937, 1938, and 1939, in arriving at its cost of bonds sold.
The opening balances, plus purchases and the closing balances of bonds of Pingree for the years 1937, 1938, *108 and 1939 follow:
| 1937 | 1938 | 1939 | |
| Bonds on hand at beginning plus | |||
| purchase | $ 1,128,814.52 | $ 738,866.87 | $ 736,685.12 |
| Bonds on hand, end | 414,678.07 | 416,120.61 | 327,817.94 |
The bond sales and profits of Pingree per books for the years 1936 to 1939, inclusive, follow:
| 1936 | 1937 | 1938 | 1939 | |
| Bond sales | $ 552,848.95 | $ 777,052.53 | $ 343,656.33 | $ 584,477.45 |
| Profit | 136,886.87 | 51,162.28 | 20,926.19 | 177,762.48 |
The profit reported was based upon the cost of each bond sold. At no time have the petitioners valued the bonds at the beginning or end of the period at other than cost.
*682 The record discloses the following additional facts:
In their income tax returns for the taxable years the petitioners gave their principal occupation and profession as "real estate." Petitioner Harry Dunitz stated that petitioners were engaged in the building and real estate business.
The primary purposes of the petitioners in buying the bonds secured by mortgages on various buildings were to enable them to acquire the property, to control it in order to secure its management, to hold the bonds in anticipation of a rise in price, or to sell them for cash.
The petitioners*109 bought the bonds through brokers. They bought the bonds to trade. If trades were not effected, they would sell the bonds.
At times the petitioners purchased certain bonds which they did not want in order to obtain bonds which they did want. The former were then sold. The petitioners accumulated a large number of bonds on certain buildings which they planned to acquire, held the bonds for a considerable length of time, and sold them because their plans did not materialize.
In 1938 the petitioners individually engaged in transactions involving ten issues of mortgage bonds and notes, including those on the Dexter Square Building. In 1940 they carried out transactions involving eleven such issues, and Dunitz Bros. eventually owned all but four properties whose securities they had been acquiring. The bonds and notes secured by mortgages on the Dexter Square Building were held primarily for sale to customers in the ordinary course of the petitioners' business.
In 1940 the petitioners, as partners, paid the sum of $ 3,000 to Arthur R. Wood for legal services in successfully defeating a proposed assessment against them by reason of their having allegedly realized taxable income in 1937*110 and 1938 through the purchase of first mortgage bonds at a discount.
In 1940 the petitioners paid $ 5,000 to William Henry Gallagher for legal services rendered in representing and defending them against an indictment found against them individually in connection with a receivership proceeding. They were charged personally with listing, as payable and outstanding against the corporate property, bonds which they themselves had purchased and canceled. The charge was presenting false and fraudulent claims. The indictment was never prosecuted and was finally dismissed in 1945.
In his notice of deficiency the Commissioner held that the amount of $ 147,393.62 which was earned by the partnership firm of Dunitz Bros. during the year 1939 in transactions whereby certain mortgage bonds and notes on the 3711 Webb Avenue property were retired, was taxable to the petitioners as ordinary income. The sums paid to the two attorneys were disallowed as deductions.
*683 OPINION.
The principal issue is whether the amounts realized by the petitioners from the disposition of bonds originally executed by them and secured by mortgage on the Dexter Square Building constituted ordinary income or capital*111 gain.
The respondent justifies his action in taxing as ordinary income profits from the disposition of the Dexter Square Building bonds on the ground that at no time had the petitioners relieved themselves of their liability for the payment of the mortgages or of the bonds and notes issued by them pursuant to the mortgages. He contends that such liability was a valuable factor in the final settlement and disposition of the bonds and continued until the obligations were canceled by the trustee in January 1939, thus giving rise to income. As an alternative argument, the respondent insists that, even if this Court recognizes the transfer of bonds and notes from the petitioners to their corporation as a sale, the bonds come within any or all of the first three classes of property excluded in section 117 (a) (1). 1
*112 The petitioners argue that at the most they were only contingently liable on the bonds in question and hence they were relieved of no obligation as principal when the bonds were canceled. They also contend that the agreement of January 1, 1934, to which they were parties, served to release their liability by reason of its extension of the due date. They further assert that, if the respondent's theory is correct as to the absence of a sale in the taxable year if income was realized on the cancellation of the petitioners' indebtedness through acquisition of the bonds, such income was realized at the time of acquisition.
In his brief the petitioners' counsel states that "under Michigan law the assumption of the mortgages by Harry and Max Dunitz, Incorporated, as agreed upon in the agreement * * * acted as a release from liability to petitioners." However, he quotes no Michigan law and cites no Michigan cases in support of his position. He cites only United States v. Hendler, 303 U.S. 564">303 U.S. 564, to show that an assumption of indebtedness constitutes "other property" under the Federal statute.
The respondent further states that the entire plan was conceived*113 and carried out in order to enable the petitioners to purchase their *684 own obligations at a huge discount, to effect an alleged sale of the bonds as capital assets to a corporation, owned and controlled by themselves, to which the real estate had been transferred and, thus, to avoid the higher taxes to which the transaction would be subject at ordinary income tax rates.
Both the petitioners and the respondent now agree that income of over $ 147,000 was realized by the petitioners in 1939, but they differ as to the basis of its taxation. In order to derive the income in that year the petitioners must have made a recognizable sale or exchange of the securities. Otherwise the income was realized in the years of acquisition, as the petitioners argue. United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1. The facts of record are persuasive that the petitioners are correct in their position that a sale was effected, and we so decide.
However, in order that the petitioners may take advantage of the capital asset basis of taxation established by section 117, the bonds must not come within the classes of property specifically excluded therefrom by the *114 statute. The respondent contends that the purchase and sale of bonds secured by mortgages on buildings which the petitioners managed or attempted to manage through such purchases, constitute an essential and integral part of their business. On the facts before us, the respondent's view is correct. The purchase of the bonds in question and other similar securities was inherent and necessary to the petitioners' business. The manifest purpose of acquiring them, their use to further that purpose, their retention, and sale or other disposition to assist in accomplishing that purpose, show clearly that the petitioners' single intent was to hold the bonds primarily for sale to customers in the ordinary course of their business.
It is obvious that the bonds were neither purchased nor held as an investment. As stated in Bouvier's Law Dictionary (3d Rev., vol. 2, p. 1681), the word "invest" means "To lay out capital in some permanent form so as to produce income," and Black's Law Dictionary (3d Ed., p. 1006) defines the word, "To loan money upon securities of a more or less permanent nature, or to place it in business ventures or real estate, or otherwise lay it out, so that it may produce*115 a revenue or income." Funk & Wagnalls New Standard Dictionary likewise contains this definition: "To use (money) for any purpose from which profit is expected." The record affords no suggestion that the receipt of income from the bonds was even a minor factor of their acquisition and the conduct of the petitioners in connection with such acquisition and the treatment of the bonds belies any idea of their retention as an investment. See Jack W. Schiffer, 39 B. T. A. 161; Kanawha Valley Bank, 4 T.C. 252">4 T. C. 252.
The petitioners' patent purpose in acquiring the bonds and their acts consequent thereto were not devoted to purchasing and holding *685 bonds as capital assets, but to buying, trading, and selling property to customers in a course of procedure established by them as a component part of their ordinary trade or business.
The bonds belong in the category of "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade and business." United States v. Chinook Investment Co., 136 Fed. (2d) 984, and the profit derived by the petitioners from their sale*116 is taxable as ordinary income.
An inspection of the books of Pingree Investment Co., an assumed name of the petitioners, shows that the petitioners bought and sold bonds aggregating several hundred thousand dollars in the three-year period prior to 1939. In that year it made sales totaling $ 584,477.45, on which it earned a profit of $ 177,762.48. The petitioners dealt in ten issues of bonds secured by mortgages on buildings, some of which they acquired and managed. In 1940 they carried out transactions involving eleven such issues, and eventually they owned all but four properties whose bonds they had so acquired. In view of this situation, the bonds may be well said to have constituted the petitioners' stock in trade or property of a kind which would properly be included in the petitioners' inventory and thus come within the scope of the first and second statutory exceptions.
The second issue requires little discussion. The amount paid by the petitioners to Wood was clearly and properly related to the management, conservation, and maintenance of property held for the production of income as provided in the statute. 2 Therefore, it is deductible in the stipulated sum of $ *117 3,000. See Bingham v. Commissioner, 325 U.S. 365">325 U.S. 365. The item of $ 5,000 paid to Gallagher for defense of petitioners against an indictment is deductible as an ordinary and necessary expense under section 23 (a) (1). Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467. On brief, the respondent, in effect, concedes the deductibility of these two items.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this chapter --
(1) Capital Assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l)↩.
2. Sec. 23 (a) (2), I. R. C.↩