*2435 DEDUCTION - BAD DEBT. - In its 1922 return petitioner took deductions for specific bad debts and also for a reserve for partial loss on notes secured by contracts for deeds for real estate. None of the collateral security was sold during 1922, but petitioner claims right to a bad debt deduction in place of the reserve, because of an estimated shrinkage of the value of the collateral to $14,993.08 less than the amount of the notes. Held that partial worthlessness of the debts in 1922 has not been established.
*280 This proceeding involves the correctness of respondent's redetermination of a deficiency in the amount of $1,873.05 in petitioner's income tax for the calendar year 1922.
Petitioner assigns as error the respondent's disallowance as a bad debt deduction the amount of $14,993.08 set up as a reserve for bad debts, it being alleged that certain notes were ascertained to be partially worthless and charged off in that amount at the close of the year 1922.
FINDINGS OF FACT.
Petitioner is a Minnesota corporation which for several years*2436 has been engaged in the business of selling lumber and other building materials at Minneapolis.
For some time prior to 1922 petitioner had been selling building materials to the American Building Co. and at the close of the year 1922 petitioner held that company's notes totaling $149,930.82, given for materials purchased and used in houses which had been constructed and also houses which were under construction at that time.
The American Building Co. sold the houses to purchasers on contracts for deeds on the basis of a small cash payment and small monthly payments spread over a number of years. The contracts for deeds were assigned to the petitioner by the American Building Co. as collateral security for the latter's notes. The total face amount of the contracts for deeds assigned to petitioner was in excess of the amount of the notes to allow for the proper discount in the event such contracts for deeds were sold by petitioner for cash upon default of the purchasers. At the time the various contracts for deeds were assigned to petitioner it did not ascertain their market value nor did it ascertain the value of the property.
*281 In the latter part of 1922 petitioner*2437 ascertained that the American Building Co. was in a poor financial condition and that it would have to look to the collateral security for recovery on the American Building Co.'s notes. At that time petitioner's secretary and manager inspected the numerous houses and estimated their value to be about 30 per cent less than the face amount of the contracts for deeds held as collateral and about 10 per cent less than the total amount of the notes. He also ascertained at that time that some of the houses were encumbered with prior liens. Petitioner did not sell any of the contracts for deeds during 1922, and the parties have stipulated that, so far as sales are concerned, no specific loss was realized in 1922 on any of the collateral or the debt of the American Building Co.
In subsequent years, particularly 1924, 1925, and 1926, petitioner sold some of the contracts for deeds and realized $25,000 less than the face amount of such contracts. Petitioner still holds a number of the contracts for deeds and also it has possession of several houses taken over upon default by the purchasers.
At the close of the year 1922, the petitioner set up on its books a reserve in the amount of*2438 $14,993.08 for a loss on the American Building Co.'s notes, that amount representing petitioner's estimate that the value of the collateral was that much less than the total amount of the said notes. The said amount was not written off as a bad debt nor was it deducted on petitioner's 1922 tax return as a bad debt ascertained to be worthless and charged off. In its returns for 1921 and 1923 petitioner deducted only bad debts actually ascertained to be worthless and charged off, but in its 1922 return petitioner deducted specific bad debts totaling $1,245.48, and it also deducted the amount of $14,993.08 as "Anticipated Loss vs Bills Receivable," under the heading, "Other Deductions."
In determining the deficiency in controversy, the respondent disallowed the deduction of the reserve set up for the anticipated loss on the American Building Co.'s notes.
OPINION.
TRUSSELL: The petitioner admits that it made a mistake in deducting $14,993.08 as bad debt by the reserve method for only the one year 1922, but its contention now is that it should not be penalized by a technicality and that it is entitled to an additional bad debt deduction in the amount of $14,993.08 instead of the*2439 deduction for a reserve.
In the case of , the facts briefly were that the taxpayer had maintained a reserve for bad debts for the years 1919, 1920, and 1921; and that for the year 1921 the taxpayer took a deduction for specific bad debts and also for an addition to the reserve. The Board approved the Commissioner's *282 disallowance of the addition to the reserve and held that the taxpayer was not entitled to a deduction for specific bad debts, and in addition thereto, a deduction for a reserve for bad debts. Upon appeal the Circuit Court, , held that while the taxpayer was entitled to but one of the said deductions, its error in originally claiming both deductions did not destroy its real rights, which should not be determined upon merely technical grounds, and that an addition to the reserve should be allowed including the specific bad debt item. The converse of that rule applies to the case at bar and we are of the opinion that if petitioner is entitled to the claimed deduction of $14,993.08 it should be allowed as a specific bad debt deduction in place of the so-called reserve, *2440 which has not been maintained since 1922 and which was in effect a write-down of the account of the American Building Co.
The testimony of the single witness, petitioner's secretary and manager, is directed solely to the estimated shrinkage in the value of the collateral security for the notes. The petitioner has failed to show the financial condition of the American Building Co. in 1922, other than the witness' statement that it was very poor, and petitioner has failed to fully establish the worthlessness of the notes in 1922. The evidence indicates that all of the contracts for deeds assigned to petitioner were taken as blanket collateral for all of the notes, but the record does not disclose the total amount of such collateral.
No part of the collateral was sold or disposed of in 1922, and no specific loss or bad debt was realized or ascertained in that year. Aside from the fact that it has not been definitely established, as a matter of record, that the notes were worthless in 1922, the petitioner had not in that year exhausted its collateral security and we are of the opinion that petitioner is not entitled to a specific bad debt deduction in the amount of $14,993.08*2441 for the year 1922. Cf. ; ; .
Judgment will be entered for the respondent.