*128 Decision will be entered for the respondent.
Petitioner acquired real estate and other assets in 1930 as collateral for a loan. In 1936, pursuant to the instructions of the National Bank Examiner, petitioner's board of directors passed a resolution directing the transfer of the "loan" from the loans and discounts account to the other real estate account. In 1946 petitioner sold part of the real estate pledged as collateral. Held, the real estate was held as collateral and petitioner did not realize a capital gain or loss on its sale. Held, further, in computing the proper additions to petitioner's reserve for bad debts for the years 1947 and 1948, respondent did not err by including the above loan in the amount of petitioner's outstanding loans in the years 1930 to 1935, inclusive, or by failing to make any adjustment for partial worthlessness of the above loan.
*787 Respondent determined deficiencies in the income tax of petitioner for the years 1946, 1947, and 1948 in the amounts of $ 1,864.41, $ 1,895.63, *129 and $ 232.30, respectively. The issues for decision are:
1. Whether petitioner realized a capital gain or loss on the sale of certain real estate which it had received as collateral for a loan.
2. Whether the Commissioner properly disallowed an increase in petitioner's reserve for bad debts in the amounts of $ 1,763.26 and $ 488.91 in the years 1947 and 1948, respectively.
FINDINGS OF FACT.
The stipulated facts are so found.
The Hatboro National Bank, the petitioner, is a corporation organized under the National Banking Laws of the United States, with its principal office or place of business in Hatboro, Pennsylvania. The petitioner filed timely Federal income tax returns for the calendar years 1946, 1947, and 1948 with the collector of internal revenue for the first district of Pennsylvania. It keeps its books of account on the cash receipts and disbursements basis of accounting.
On January 9, 1930, petitioner increased its loan to Warren M. Cornell (hereinafter referred to as Cornell) from $ 23,730 to $ 32,500, accepting his demand note in that amount together with collateral security as follows:
(a) Life insurance policy for $ 10,000 on the life of Cornell, written by Penn Mutual*130 Life Insurance Co.
(b) Life insurance policy for $ 5,000 on the life of Cornell, written by New York Life Insurance Co.
(c) Twenty-five shares of the corporate stock of Hatboro Trust Co., Hatboro, Pennsylvania.
(d) By deed dated January 3, 1930, from Cornell and wife to petitioner, certain parcels of real estate briefly described as follows:
(1) Certain lot or piece of land with dwelling house and office building thereon in the Borough of Hatboro, Pennsylvania.
(2) Certain premises, farm buildings, plantation or tract of land situate in the Township of Horsham, Montgomery County, Pennsylvania, containing 76 acres and 46/100 of an acre, more or less.
(3) An undivided one-half interest in land, known as "Hatboro Farms", containing about 146 lots.
The note provided that the undersigned, Cornell, has delivered the above assets
as collateral security for the prompt payment, at maturity, of this and of any other liability or liabilities of the undersigned, due or not become due, or of *788 any that may be hereafter contracted with the holder of this Promissory Note; which collaterals, either the whole or any part thereof, hereby authorize and empower the holder of this Promissory*131 Note (provided the same or any other liability of the undersigned, as before described, be not paid at maturity) to sell at public or private sale at any time or times thereafter, without further reference or notice to , and with the right on the part of the holder of this obligation to become the purchaser, at such sale or sales, of the whole or any part of said collaterals (freed and discharged of any equity of redemption) and to transfer, assign and deliver up the same; and, after deducting all legal and other costs, attorney fees and expenses for collection, sale and delivery, to apply the residue of the proceeds of such sale or sales so made, to pay any, either or all of said liabilities, as said holder shall deem proper, returning the overplus, if any, to and should any deficiency occur, further promise and agree to pay the same to the holder hereof on demand.
On March 12, 1930, petitioner entered into an agreement with Cornell and Sarah E. Yerkes whereby the latter agreed to become primarily liable on certain additional notes of Cornell held by petitioner. The agreement also recites that petitioner holds the above-described real estate as collateral security for*132 the payment of Cornell's $ 32,500 note. Petitioner promised in the agreement to hold and apply any surplus from the proceeds derived from the collateral securing Cornell's $ 32,500 indebtedness to the payment of the indebtedness assumed by Sarah E. Yerkes. Petitioner also agreed not to convert and make sale of any of the parcels of real estate deeded to the petitioner as collateral security until the prices offered be first submitted to Sarah E. Yerkes and she be given 30 days thereafter in which to purchase the parcel or secure a purchaser therefor at a higher price.
The petitioner placed the Cornell loan of $ 32,500 in its loans and discounts account in its general ledger. The National Bank Examiner's report of his examination of the books and accounts of the petitioner that ended at 1 p. m., January 4, 1936, in connection with the aforesaid $ 32,500 loan, contains the following:
| Overdue | |||
| Maker, indorser, and security | |||
| Amount | Due date | Class "A" | Slow |
| $ 32,500. Warren M. Cornell. Real estate | 8-23-31 | $ 32,500 | $ 32,500 |
| operator. Bank has deed to office building | |||
| now housing Post Office, also 1/2 interest | |||
| in 140 [sic] lots. R/E claimed to be worth | |||
| $ 50M, subject to prior liens of $ 10,500; | |||
| $ 15,000 insurance with CVS $ 3,200. This | |||
| should be transferred to other real estate | |||
| account. Previously instructed. |
*133 The minutes of the meeting of the board of directors of the petitioner dated March 12, 1936, read in part as follows:
It was regularly moved, seconded and carried that we transfer to other real estate Warren M. Cornell's loan of $ 32,500.00.
*789 Through the medium of a book entry the said Cornell loan of $ 32,500 was transferred on March 18, 1936, from the loans and discounts account to the other real estate account on the books of the petitioner. There were two mortgages on this real estate that were paid by the petitioner. Petitioner paid $ 1,714 to the Hatboro Building and Loan Association on July 7, 1938, and paid $ 7,500 to the Montgomery Trust Co. on August 23, 1939. Both payments were charged to other real estate, making a total of $ 41,714 charged to other real estate on the books of the petitioner.
Those certain premises, farm buildings, plantation or tract of land in the Township of Horsham, being a part of the collateral security given by Cornell, were abandoned by the petitioner when the mortgagee foreclosed.
On or before January 30, 1933, Cornell paid a total of $ 3,181.57 in interest on the $ 32,500 note, all of which was credited to interest income on the books*134 of petitioner. A further interest endorsement of $ 78 was made on the note on July 15, 1938.
Petitioner caused the unimproved lots, known as Hatboro Farms, to be appraised as of June 1, 1938. At that time the lots had an aggregate fair market value of $ 70,154.30, and the one-half interest in the 122 1/2 lots which petitioner sold on July 12, 1946, had an aggregate fair market value of $ 27,745.65 on June 1, 1938. The value of the lots was lower in 1936 than it was in 1938.
On February 1, 1944, petitioner transferred on its books the cash surrender value of the life insurance policies in the amount of $ 6,000 from other real estate to other assets.
In liquidating the collateral security given for the Cornell loan the following was realized:
| (a) Liquidating dividends received from Trustee of Hatboro Trust Co. in | ||
| liquidation. The dates of receipts and amounts are as follows: | ||
| Date | Amount | |
| January 23, 1939 | $ 177.26 | |
| February 20, 1940 | 62.50 | |
| October 29, 1942 | 62.50 | |
| Total | $ 302.26 | |
| (b) Net proceeds from sale of one-half interest in 23 1/2 lots in | ||
| "Hatboro Farms" sold at various times between April 28, 1939 and | ||
| October 30, 1943 | 5,818.89 | |
| (c) Net proceeds of sale of dwelling house and office building | ||
| November 25, 1941 | 11,584.61 | |
| (d) Net proceeds of sale of remaining 122 1/2 lots in Hatboro | ||
| Farms July 12, 1946 | 11,142.85 | |
| (e) March 9, 1950 received from Mutual Life Insurance Co | 9,776.56 | |
| (f) June 1, 1950 received from New York Life Insurance Co | 5,163.42 | |
| Total received in liquidation of loan to Cornell | $ 43,788.59 |
*135 *790 On its 1946 income tax return petitioner claimed a long-term capital loss of $ 7,736 on the sale of the unimproved lots. The Commissioner disallowed $ 7,246.83 of the claimed loss, holding that the one-half interest in the lots sold in 1946 had a cost basis of $ 11,632.02 with a resulting loss of $ 489.17.
By letter dated January 6, 1948, the Commissioner granted petitioner's request to employ the reserve method of accounting for bad debts, for Federal income tax purposes, beginning with the taxable year ending December 31, 1947. On its 1947 and 1948 income tax returns petitioner deducted $ 9,915.40 and $ 8,137.61, respectively, as additions to its reserve for bad debts. Of the amounts deducted the Commissioner disallowed $ 1,763.26 in 1947 and $ 488.91 in 1948. In computing the allowable deductions for additions to the reserve for bad debts in those years, using a 20-year moving average, the Commissioner did not include an amount representing any loss in connection with the Cornell loan, but did include the loan of $ 32,500 in the aggregate of loans outstanding in the years 1930 to 1935.
OPINION.
The principal issue presented is to determine the tax consequences of *136 petitioner's sale of a one-half interest in certain unimproved lots in 1946.
In view of the shifting positions (including its lack of clarity as to any of them) taken by petitioner -- in its returns for the taxable years involved, in its petition, in its opening statement at the hearing, and on brief -- it is somewhat difficult to apprehend precisely upon what theory petitioner is relying. In its return for the year 1946 petitioner claimed a long-term capital loss of $ 7,736 on the sale of lots. Respondent allowed a long-term capital loss of $ 489.17. In its petition the petitioner claims that the sale "constituted a liquidation of a debt." However, petitioner now contends in its brief that when it took the lots together with other assets received as collateral security for the $ 32,500 loan to Cornell in 1930, it was really purchasing the lots and other assets for $ 32,500.
Respondent contends that the assets, including the lots, were received by petitioner as collateral security for the loan. Respondent further contends that when in 1936 petitioner transferred "Cornell's loans of $ 32,500" from its "loans and discounts" account to its "other real estate" account it acquired absolute*137 title to the collateral, and that petitioner's basis for determining gain or loss as to each of the properties formerly held as collateral was the value of such property when taken in satisfaction of the loan.
In our opinion, the correct theory is the one set forth in the petition which, paradoxically, is the theory least favorable to the petitioner. *791 There is absolutely no merit in petitioner's position that it was purchasing assets when it received the lots and other assets as collateral security for the Cornell loan. We also disagree with respondent's position that petitioner acquired absolute title to the collateral when it transferred the loan from one account to another in 1936 pursuant to the instructions of the National Bank Examiner. "Bank holding note as [sic] collateral does not, because of default in payment of debt due it, become owner of collateral, but must acquire title thereto in manner authorized by contract of pledge." 7 Zollmann, Banks and Banking, section 4886. The note given by Cornell authorized the petitioner, if the debt was not paid at maturity, to sell the collateral at public or private sale to anyone including itself, and to apply *138 the proceeds to the payment of the debt and costs, returning any surplus to Cornell. While this contract gave petitioner the right to purchase the assets pledged as collateral at private sale, this right was not exercised. As the Supreme Court of Pennsylvania pointed out in Thomas v. Waters, 38 A. 2d 237, 240, 241, 350 Pa. 214">350 Pa. 214, "* * * the power to sell and to buy was not one to be executed by a taking. * * * Until foreclosure the pledgee could not obtain an absolute title and the foreclosure could take place only pursuant to the agreement contained in the notes; * * *." Respondent does not contend that petitioner sold the assets to itself. The wording of the resolution of petitioner's board of directors passed on March 12, 1936, negates any possibility that a sale, rather than a mere book transfer, was intended. Also, the interest endorsement to the note made on July 15, 1938, is wholly incompatible with the position that in 1936 petitioner accepted the collateral in full discharge of the indebtedness.
Absolute title to the collateral did not pass and Cornell's equity of redemption was not foreclosed until petitioner sold to others*139 or otherwise liquidated the collateral in later years. Jones v. Costlow, 36 A. 2d 460, 349 Pa. 136">349 Pa. 136; Huntingdon Valley Trust Co. v. Norristown-Penn Trust Co., 196 Atl. 821, 329 Pa. 356">329 Pa. 356. See also Moss Industries v. Irving Metal Co., 61 A. 2d 159 (N. J.). The proceeds from the sale of the lots in 1946 should have been applied toward the discharge of the indebtedness, and petitioner did not realize any capital gain or loss on the sale. Old Colony Trust Associates v. Hassett, 150 F.2d 179">150 F.2d 179.
The facts in the instant case are unlike those in Elverson Corporation, 40 B. T. A. 615, affd. (C. A. 2) 122 F. 2d 295, and First National Bank, Philipsburg, Pa., 43 B. T. A. 456, cited by respondent. There the taxpayer acquired title to the collateral by or in accordance with the terms of an agreement with the debtor.
In passing we might point out that petitioner's right to a deduction for partial worthlessness of the Cornell loan in 1946 is*140 not before us as petitioner has not claimed a right to such a deduction in either its *792 1946 income tax return or in its petition. (Cf. Regs. 111, sec. 29.23 (k)-1(c).) Furthermore, in no event could the deduction exceed the difference between the cash surrender value of the policies of insurance, which was the only remaining collateral, and the remaining balance due on the loan. Dominion National Bank, 26 B. T. A. 421. Since there is no evidence with respect to the cash surrender value at the end of 1946 of the policies of insurance it is impossible to determine if and to what extent the Cornell loan had become worthless. Cf. Mayer Tank Mfg. Co. v. Commissioner, (C. A. 2) 126 F.2d 588">126 F. 2d 588.
Respondent granted petitioner's request to switch to the reserve method of accounting for bad debts beginning with the taxable year 1947. Petitioner complains that respondent, in computing (in the manner provided in Mim. 6209, 1947-2 C. B. 26) the proper deductions for additions to petitioner's bad debt reserve in 1947 and 1948, erroneously included the $ 32,500 Cornell loan in aggregate loans*141 outstanding in the years 1930 to 1935, inclusive. In the alternative petitioner contends that if there was debt it became partially worthless, and an appropriate adjustment should be made in the aggregate amount of bad debts used in the computation. There is no merit in either of petitioner's alternative contentions. The evidence shows that the Cornell loan was outstanding in the years 1930 to 1935, inclusive, and petitioner has not shown that the loan became partially worthless. Therefore, there is no basis for disturbing respondent's determination.
Decision will be entered for the respondent.