*592 1. The taxpayer selling lots on the deferred payment plan has the right to have included in the cost of such lots the estimated future expenditures for contractual improvements such as streets and water mains.
2. The written promises covering the deferred payments, held without fair market value, upon evidence that with diligent effort no buyer could be found willing to purchase at any price, in view of the circumstances.
*1155 Respondent determined a deficiency of $10,543.82 in petitioner's income tax for 1931. Petitioner assails his computation of profit on sales of lots in a real estate development because of (1) the exclusion from cost of an unexpended reserve for improvement of the tract *1156 developed, and (2) the use of the face value of contractual promises for deferred payments as part of the selling price.
FINDINGS OF FACT.
The petitioner, a corporation with principal office at Los Angeles, California, was engaged in 1931 and prior years in developing, improving, and selling in lots*593 a tract of land near Cambria, California. In 1931 it entered into about 300 contracts for sale, whereby the vendee paid a part of the purchase price immediately and agreed to pay the remainder in monthly installments over a period of three years. Petitioner agreed to give immediate possession of the lot and to furnish the vendee with a clear title thereto after all payments had been made; it agreed further to grade streets and install water mains. In case of default in an installment payment, at petitioner's option, all the remainder became due or the contract was canceled and the vendee forfeited all payments made.
An estimate of the cost of the street improvements and water mains, made by a certified civil engineer, was included in the cost of the property appearing on petitioner's books, and a reserve account was set up to reflect the unexpended portion of this estimate. On May 31, 1933, the unexpended reserve amounted to $46,614.62. At the close of 1931, 45.26 percent of the lots had been sold and 51.23 percent of the improvement reserve had been spent. Between December 31, 1931, and May 31, 1933, the expenditures for improvements amounted to $7,845.91.
The aggregate*594 selling price of the lots covered by the contracts for sale executed in 1931 was $131,948.68, of which the amount of unpaid balances at the end of that year was $66,471.77. Collections of these balances amounted to $24,364.31 in 1932, $11,754.27 in 1933, $5,575.75 in 1934, and $2,633.52 in 1935, a total of $44,327.85. In 1929, 1930, and 1931, the aggregate selling price of lots covered by petitioner's contracts for sale was $1,010,543.17. During that period, contracts involving $225,447.50 of that amount were canceled, those involving $159,682.50 being canceled in 1931. Not all of the contracts, however, were of the same type, and there were fewer cancellations of those requiring payment of over 50 percent of the purchase price in the year of execution, such as the 300 here involved, than of those requiring lesser payments.
Several parcels of petitioner's subdivided tract were subject to mortgages for loans which aggregated $126,458.73 at the beginning of 1931 and $57,117.40 at the close. By arrangement with the mortgagees, a title to lots sold, clear of all encumbrance, was given to the vendee after full payment had been made.
At the close of 1931 the obligations of the*595 vendees were without fair market value.
*1157 OPINION.
STERNHAGEN: 1. The respondent, in determining the deficiency, has computed the cost to be used as the basis for determining petitioner's gain upon the sale of its lots as including only the amount actually spent, and excluding the estimated amount of future expenditures for improvements such as the laying out of streets and the installing of water mains. There is no substantial dispute as to the amount of such unexpended reserve, although there are minor discrepancies in the figures. As shown by the findings of fact, the correct figure derived from the evidence is $46,614.62. The respondent's disallowance is predicated upon the view that no estimate of future expenditures whatever may be included in the petitioner's cost, and in defending this view he urges that at most such inclusion is a gracious privilege which the Commissioner by his regulations has heretofore granted, but that the grant is upon the express condition stated in Mim. 4027, XII-1 C.B. 60, that petitioner must file a waiver of the statute of limitations, which it has not done. It is well established that as a matter of law the petitioner has the*596 right to include in its cost such estimated future expenditures for the development of the property as required by its contracts of sale. Kentucky Land, Gas & Oil Co.,2 B.T.A. 838">2 B.T.A. 838; Milton A. Mackay,11 B.T.A. 569">11 B.T.A. 569; Osgood Land & Livestock Co.,22 B.T.A. 387">22 B.T.A. 387; Birdneck Realty Corporation,25 B.T.A. 1084">25 B.T.A. 1084. The Commissioner has, since 1919, recognized this right, O.D. 226, 1 C.B. 76; O.D. 567, 3 C.B. 108. In the Revenue Act of 1926, section 214(a)(11), 1 such expenses in case of casual sales of real property, were included among deductions, and this was carried through the Revenue Acts of 1928 and 1932. In omitting it from the Revenue Act of 1934, the Senate Finance Committee made it clear that it was because the Treasury had not theretofore limited such inclusion in cost or deductions to casual sales and therefore it was unnecessary to continue such provision in the statute. 2
*597 The argument that the cost may not include future expenditures because the condition of Mim. 4027 has not been complied with, must be rejected. That ruling was not published until 1933, long *1158 after the return for 1931 was due, and was not by its terms made retroactive, and therefore has no application in this proceeding. It may, however, be seriously doubted also whether, since the inclusion of future expenditures in cost has been held to be a matter of right, the Commissioner may refuse it because the taxpayer has omitted to file the waiver required by the mimeograph regulation. This needs not to be decided in this proceeding, since in no event is the mimeograph regulation applicable.
The respondent is reversed in his determination that the estimated future expenditure should be excluded from cost.
2. The petitioner sold 300 of its lots under contracts upon which 40 percent or more of the contract price was paid down. The deficiency is based upon the determination that the contracts were, at the end of 1931, of a fair market value equal to their face, and that in consequence the entire amount of both the down payments and the unpaid obligations should be included*598 in petitioner's gross income. The petitioner contends that the fair market value of the unpaid balance of the contracts was nil. This is supported by the testimony introduced in petitioner's behalf and which was neither broken down by cross-examination nor overcome by countervailing evidence. The Commissioner introduced no evidence. From the petitioner's evidence, it appears that in 1931 the obligations of the vendees of lots sold in that year were without a market at any price; that a dealer in such paper familiar with the market, whose customers might normally be expected to purchase such paper, was unable to find a buyer at any price, and that this was, in his opinion, because of the location of the development in question, the extent and nature of its encumbrances, and the continuous fall in value of such real estate at that time. While there is evidence, as shown by the findings, that in subsequent years substantial collections were made by the petitioner upon these outstanding obligations, this is not enough to support an inference of fair market value in 1931 contrary to the direct statements of the unimpeached witnesses.
Upon the two contested points, the Commissioner's*599 determination was in error.
Judgment will be entered under Rule 50.
Footnotes
1. SEC. 214. (a) In computing net income there shall be allowed as deductions:
* * *
(11) In the case of a casual sale or other casual disposition of real property, a reasonable allowance for future expense liabilities, incurred under the provisions of the contract under which such sale or other disposition was made, under such regulations as the Commissioner, with the approval of the Secretary, may prescribe, * * *. ↩
2. The present law permits an individual who makes a causal sale of real property to reduce his gain from such sale by expenditures which he has contracted to make but which cannot be determined until a later year. The Treasury interprets section 22 as authorizing the application of this principle to any sale of real estate regardless of whether it is a casual sale. Under such an interpretation, a special rule is unnecessary and this subsection is, therefore, omitted as surplusage. * * * [Senate Finance Committee Report No. 558, p. 25 (73d Cong., 2d sess.).] ↩