*727 A partnership in which petitioners are members received bonds in payment for services in lieu of cash, with the intent of converting them into cash. It was customary for the partnership to be paid in bonds, and it always sold bonds to a dealer. A loss was sustained on the bonds. Held, that the bonds were not capital assets, but were property held primarily for sale to customers in the ordinary course of the partnership's business.
*159 Respondent determined deficiencies in income tax for the year 1936 as follows:
| Docket No. 104269 | $640.77 |
| Docket No. 104270 | 640.77 |
| Docket No. 104271 | 626.03 |
| Docket No. 104272 | 626.03 |
Petitioners contest the deficiencies in part, and allege that respondent effed in determining that certain bonds were a capital asset of a partnership; that loss sustained on the bonds in 1936 was a capital loss; and that allowance for the loss is limited to $2,000 within section 117 of the Revenue Act of 1936. Each petitioner was a member of the partnership and deducted one-quarter of the entire amount of the*728 loss. Respondent disallowed the loss deductions claimed, allowing each petitioner only one-quarter of $2,000 for loss deduction.
FINDINGS OF FACT.
The separate return of each petitioner was filed with the collector for the second district of Texas. The decedent, John T. Fortson, and Viola Fortson were husband and wife in 1936. Joe B. and Lyda Fortson were husband and wife in 1936. All petitioners were domiciled in Texas and all income for the year 1936 constituted community income.
During 1936 and for many years prior Joe and John Fortson were partners in the partnership of Fortson Brothers Construction Co. The partnership was owned 50 percent by Joe and Lyda Fortson and 50 percent by John and Viola Fortson. The Fortson Brothers Construction Co., hereinafter called the Construction Co., carried on a business of contracting for, constructing, and repairing levees.
In 1925 the Construction Co. and Trinity Farm Construction Co. were contractors under a contract awarded by the supervisors of Dallas County Bois d'Arc Island Levee District No. 4, under the terms of which they were to construct certain levees for that district. The district was to issue to the contractors*729 its bonds, hereinafter referred to as the Levee District No. 4 bonds, in payment for the work done. During 1926 and 1927 the Construction Co. received in payment for its services 112 bearer bonds, $1,000 par value each. It took the bonds at 94 cents on the dollar, or at $940 for each $1,000. In the income tax returns for 1926 and 1927 each partner reported in his separate return his portion of the bonds at the above value as income.
In December of 1935 the Levee District No. 4 filed a petition in the United States District Court at Dallas applying for authorization to readjust and settle its debts. The petition set forth a plan for readjusting its indebtedness on the bonds in question under section *160 80, subsection B, of the Bankruptcy Act. The plan provided for reduction of the bonded indebtedness to 35.014 cents on each dollar of the unpaid principal of the outstanding bonds. No interest was to be paid except interest at 4 percent on the reduced value of such bonds from the date the bonds should be made available for refinancing. The R.F.C. was to provide the funds for the purchase of the bonds. The Construction Co. made objection to the plan, but the court overruled*730 its objections. The plan was approved by holders of bonds in the amount of $473,700, representing more than two-thirds of the district's indebtedness.
The court approved the plan on or about January 20, 1936. The order of the court provided that the holders of the bonds were required to deposit their bonds with the disbursing agent of the court (par. 5 of the order). The court directed the clerk to publish notice to the holders of the outstanding bonds directing all holders to deposit their bonds with the disbursing agent of the court within 30 days, or with the clerk of the court thereafter, within one year from the date of deposit of the redemption money in the registry of the court, or be forever barred from asserting any claim against the district. The district was ordered to deposit funds with the disbursing agent of the court before May 1, 1936, to pay the holders of outstanding bonds. All bonds surrendered to the disbursing agent and paid were to be marked "canceled" and returned to the district.
In 1936 the Construction Co. surrendered its 112 bonds and received $350.14 for each thousand dollar bond. Prior to the surrender of all of the bonds petitioner, under a*731 repurchase obligation, had to repurchase from a buyer 35 bonds which it had sold for 50 cents on the dollar, or $17,500. These bonds were included in the above 112 bonds. The construction Co. sustained a loss of $39,096.44 in 1936 on the 112 bonds, and the loss was charged off on its books.
The Construction Co. often received from municipal entities similar to levee districts, such as improvement districts, the bonds thereof in compensation for services. The payment to it by Levee District No. 4 of its bonds as compensation for services was not an isolated nor unusual instance. In all of the districts the procedure for getting construction contracts is to file bids setting forth bid price per yard of earth to be moved and bid price for bonds, that is, the price at which the contractor is willing to take district bonds in payment for services. The contractor is required to take bonds for the construction work. The low bidder receives the contract. The Construction Co. and Trinity Farm Construction Co. were the low bidders for the Levee District No. 4 job. They received the bonds as the construction work was completed.
It was the intent of the Construction Co. to sell the*732 bonds received *161 for construction work and that was the intent with respect to the bonds of Levee District No. 4.
The Construction Co. diligently attempted to sell the bonds in question by contacting dealers in Dallas, St. Louis, and Cincinnati. The Trinity Farm Construction Co. likewise attempted to sell the bonds which it had received in payment for the work. Trinity was unable to sell its bonds. The Construction Co. was unable to sell any bonds until 1933. The only way to sell the bonds, a block of $112.000, was to dealers. From the time the bonds were received until 1933 no offer for the bonds was received. The Construction Co. held the bonds in question only because it could not sell them.
At the time the bonds were received the market for levee district bonds was very poor. Levee District No. 4 defaulted in the payment of taxes and interest. From 1926 to 1933 there were no known sales of the Levee District No. 4 bonds by dealers. The bonds had no fair market value from 1926 until the latter part of 1933. This was due largely to the fact that the outstanding obligations of at least 80 levee districts in north Texas were in default and the defaults were*733 long standing. From 1933 until 1936 the average market price for the bonds was from 12 to 30 cents on the dollar. Prospects of refinancing of levee district bonds by the R.F.C. contributed to giving such bonds some fair market value at the end of 1933.
All, or practically all, of the work of the Construction co. was for levee districts. All of the compensation which it received for that work was in the form of bonds of the levee districts. The Construction Co., up to the time of the depression, regularly disposed of these bonds by sales. The sales were principally to one particular dealer, J. B. Oldham. The Levee District No. 4 bonds were held only because Oldham could not buy them, because he could not sell them, and no other dealers would buy them, due to the lack of market for them in the depression period. The Construction Co. tried to sell the bonds throughout and over the period, and contacted Oldham continuously.
The Construction co. was not financially able to hold the bonds, and because of its inability to sell them, it had to borrow money during the period the bonds were held. In 1933 the Construction Co. sold 35 out of the 112 bonds for 50 cents on the dollar, *734 but the sale was made under a repurchase agreement whereby it would repurchase the bonds at the same price at the option of the purchaser. The Construction Co. repurchased the bonds in 1936.
From 1929 up until the date of the hearing the Construction co. did not do any construction work for levee districts, because there was no market for levee district bonds. It was not profitable to undertake such work where payment was made only in bonds and *162 the bonds were not salable. However, the Construction Co. retained its equipment.
The bonds of Levee District No. 4 were received by the Construction Co. in lieu of cash as a means of securing the contract, with the intention of converting them into cash as soon as possible. The bonds were not capital assets. They were held primarily for sale to customers in the ordinary course of the company's business.
OPINION.
HARRON: The definition of capital assets set forth in section 117(b) of the Revenue Act of 1936 excludes "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." Respondent contends that the bonds in question do not come within the above exclusion, *735 so that they properly were determined to be capital assets, and that, consequently, the allowance for the loss was limited, properly, to $2,000. Petitioner contends that the bonds were property which fell within the above exclusion.
Petitioner relies upon , and . In our opinion those cases are controlling. See also .
The facts show clearly that it was the custom in the business of doing construction work for levee districts for the districts to make payment for the work in its bonds. In fact that was the only way the contractor could be paid. The Construction Co., the partnership in which the four petitioners were members, did construction work for many levee and improvement districts in Texas from 1920 to 1929 and, in each instance, received bonds in payment for services. Excepting in one instance, not material, the Construction Co. sold the bonds as soon as possible. The intent always was to sell such bonds. That was the only way the Construction Co. could keep itself with funds on hand to carry on business. *736 The company's receipt of the bonds in question in payment for work done, therefore, was not an isolated instance of receiving bonds. The adversity experienced in disposing of the bonds was unusual in the company's experience. The situation is amply explained by the facts, all of which show that the company was caught in the nation-wide depression in 1929, and following, which was visited upon the levee districts of northern Texas. The general depression made it impossible for the company to sell the bonds, but the original intent to sell them remained. The business adversity did not convert the original purpose to sell the bonds into a purpose of investment.
The facts leave no doubt on the point that the bonds came into the company's possession as a necessary incident to the conduct of its business - to the sale of its services - and they were not received or *163 intended to be held as a capital asset. Disposition of the bonds through sale was likewise essential to the carrying on of its business.
Under all of the facts it is held that the loss sustained was a loss upon property held primarily for sale to customers in the ordinary course of business. The loss is*737 deductible as an ordinary loss. Respondent is reversed on authority of the cases above cited.
Decision will be entered under Rule 50.