*641 1. Over a period of years decedent, who had been in the milk and dairy business for 36 years, invested a large sum of money in improved and unimproved real estate. During the taxable year he paid $400 to an auditor for a report on the receipts and disbursements of an apartment house that he contemplated buying. Held, the $400 is not an ordinary and necessary expense, because the particular transaction is held to have been an investment and not a trade or business carried on during the taxable year; held further, the decedent is entitled to a deduction of $4,257.85 for attorney fees, since the fees were paid in connection with and as a result of his milk and dairy business.
2. The amount of depreciation to which decedent is entitled upon a building owned and operated by him determined.
3. Prior to the taxable year decedent loaned money on second trust notes. The debtors having defaulted on both first and second trust obligations, decedent bid in the property at the foreclosure sale. Held, the balance of capital account against the debtors is a bad debt properly charged off.
*885 This proceeding involves a deficiency of $11,509.52 in income taxes for 1932. Each issue involves the right of the original petitioner herein, Henry N. Brawner, Jr., to a deduction for: (a) $400 paid to Joseph Zucker for auditing services; (b) $4,257.85 paid to counsel for legal services and expenses; (c) $1,108.21 additional depreciation; and (d) $21,558.12 representing a loss on investment. As an alternative to (d), the petition alleges that the $21,558.12 is deductible as a bad debt. A suggestion of the death of the original petitioner herein, and motion for substitution of parties having been filed October 20, 1937, an order was entered substituting his executors, Roger J. Whiteford and Edgar N. Brawner, as petitioners herein.
FINDINGS OF FACT.
HenryN. Brawner, Jr., deceased, was a resident of Washington, D.C., and was engaged in the milk and dairy business for 36 years. During all of this period he was associated with the Chestnut Farms Dairy. From March 1921 until January 1924 he was the sole owner of the business. He incorporated the business in 1924, and thereafter owned all of the 10,000 shares of capital stock*643 except four shares. In 1928 he exchanged all of his stock in the Chestnut Farms Dairy for stock and securities in the National Dairy Products Corporation. Brawner continued as president of the Chestnut Farms Dairy after its acquisition by the National Dairy Products Corporation and became a director of the latter corporation.
Prior to the taxable year decedent had become an extensive property holder in the District of Columbia, having acquired about 200 separate and distinct parcels of real estate. His holdings included improved and unimproved property, the improvements consisting of apartment *886 houses, stores, and store buildings, and an apartment house in Alexandria, Virginia. In addition to purchasing real property, decedent loaned money on first, second, and sometimes third trusts.
During 1921, 1922, and 1923 decedent's dealings in real estate were confined to three or four transactions a year, but later, when he had more money, his real estate transactions were more numerous. The funds used in acquiring real property or lending money thereon came from decedent's milk and dairy business and from his investments. After the transfer of the Chestnut Farms Dairy*644 to the National Dairy Products Corporation in 1928, he had approximately $1,000,000 at his disposal. A resume of his real estate transactions from 1928 to 1932, inclusive, reveals the following purchases and loans and the amounts thereof:
| Year | Number of real-estate transactions | Cost of properties purchased | Loans on real property |
| 1928 | 165 | $275,000 | $184,000 |
| 1829 | 5 | 164,000 | 69,000 |
| 1930 | 60,000 | ||
| 1931 | 4 | 502,000 | 32,000 |
| 1932 | 45,000 |
During these years decedent sold only one piece of real property, in 1928, and exchanged one piece without gain or loss in 1932. Petitioner received gross rentals in 1931 and 1932 of $15,642 and $21,786.46, respectively, on real properties that he owned and operated.
The purchasing, or selling, of property, the lending of money on real estate, the renting, leasing, repairing, and upkeep of improved properties, and the collection of rents and interest were all handled directly under decedent's supervision. He devoted two or three hours each day to his real estate interests and was assisted therein by the secretary of the Chestnut Farms Dairy. No outside agents were employed to assist him in carrying on his real*645 estate transactions. He handled no real estate transactions for others, nor did he hold himself out as a real estate broker. His real estate activities were confined solely to managing his own properties and to the acquisition of additional properties as an investment.
In his income tax returns for 1925, 1926, and 1928 decedent listed his "Occupation, Profession or Kind of Business" as "Dairy Products." In his tax returns for 1929, 1930, and 1931 he listed himself as "President, Dairy Products Business." On his return for the taxable year he reported that his business was "Capitalist: President Dairy Business"; and the income reported therein was from the sources and in the amounts following:
| Item | Amount |
| 1. Salaries, wages, commissions, etc., Chestnut Farms Dairy | $28,500.00 |
| Directors' fees | 905.00 |
| 2. Income from business or profession | |
| 3. Interest on bank deposits, notes, corporation bonds | 15,697.12 |
| 4. Interest on tax-free covenant bonds, etc | 4,287.50 |
| 7. Rents and royalties | 7,447.16 |
| 10. Dividends on (a) stocks of domestic corporations | 27,815.45 |
*887 Issue (a).
During the taxable year decedent was contemplating the purchase*646 of an apartment house known as the Woodley Park Towers. In order to verify certain statements and to determine whether the property would be a good investment, he had an audit made of the receipts and expenditures of the apartment house. The audit cost decedent $400, but it convinced him that he did not want the property, and negotiations for its acquisition were discontinued.
Issue (b).
During 1932 decedent paid $4,257.85 to attorneys who represented him before the Bureau of Internal Revenue, the Board of Tax Appeals, and the Circuit Court in connection with his tax liabilities for the years 1921, 1922, and 1923, during which years decedent individually owned and operated the Chestnut Farms Dairy. Some of the items claimed by him as to these taxable years were allowed by the Bureau, while other items were litigated before the Board and the Circuit Court. The largest item involved a deduction claimed in 1921, 1922, and 1923 by decedent of approximately $114,000 paid to the widow of decedent's former partner in the dairy business.
Issues (c) and (d).
On or about May 2, 1928, decedent loaned $46,000 to McKeever & Goss. His loan was evidenced by five notes of $10,000*647 each, due on or before three years from May 2, 1928, bearing 6 percent interest and secured by a second trust on lot 8, square 217, known as 1414 K Street, N.W. As additional security Robert L. McKeever personally endorsed the notes. In 1928 a first trust had been placed on the property in the amount of $125,000, this trust being held by the Prudential Life Insurance Co. In 1930 interest payments on both trusts were suspended, and in 1931 decedent advanced an additional $4,103.33 to pay interest on and curtail the first trust. In July 1931 decedent bid in the property at a foreclosure sale for $32,500, the balance due on the first trust at that time being $115,625. Thereafter, he sued McKeever & Goss upon their notes and Robert L. *888 McKeever, individually, upon his endorsement thereof. The amount involved in the suit was $21,603.33, representing $50,000 in notes plus $4,103.33 advanced, less $32,500 paid to acquire the property.
During the taxable year decedent obtained a deficiency judgment against the said parties in the sum of $26,780, which included interest. He was unable to satisfy his judgment, however, as McKeever & Goss went out of business in July 1932, *648 leaving no assets, and Robert L. McKeever was adjudged a bankrupt in the fall of 1932. Decedent filed a claim in the bankruptcy proceedings but was unable to collect anything thereon. Later, in November 1932, he attached and collected $1,250, representing a fee of Robert L. McKeever that was pending and paid after the bankruptcy proceedings. In 1934 decedent's counsel collected $1,500 as a result of a suit by McKeever & Goss for commissions, but counsel retained this collection to cover his fee and expenses in connection with the litigation.
Decedent's books reflected his $46,000 loan by a debit entry, dated May 2, 1928, in an account entitled "McKeever & Goss" in the notes and accounts receivable part of his ledger. The entries on the debit and credit side of this ledger account through the taxable year were as follows:
| Debits | Credits | ||||
| 1928 | 1931 | ||||
| May 2 | Five notes, $10,000 each, etc | $46,000.00 | Nov.30 | Charged interest pd | $3,228.33 |
| 1931 | 1932 | ||||
| May 2 | Protest fees | 11.15 | Nov. 7 | Attachment | 1,250.00 |
| July 6 | H. L. Rust on 1st Trust | 4,103.33 | |||
| Oct. 30 | Curtail 1st Trust | 1,875.00 | |||
| 1932 | |||||
| Apr. 4 | Thos. J. Owen Fees Sale | 92.65 | |||
| Apr. 30 | Curtail 1st Trust | 1,875.00 | |||
| Oct. 29 | Curtail 1st Trust | 1,875.00 |
*649 In the latter part of 1932, after determining that McKeever & Goss had gone out of business without leaving assets and after Robert L. McKeever had been adjudged a bankrupt, decedent transferred the foregoing account from the notes and accounts receivable portion of his ledger to the real estate section thereof. At or about the time he transferred the account from notes and accounts receivable to real estate, he crossed out the title "McKeever & Goss" and entered in pencil the title "Real Estate 1415 K St., N.W."; and, at the same time, on the credit side of the account, in pencil, were written the separate notations "Building bought in for $32,500 July 1931" and "Judgment for difference against R. L. McKeever worthless bankrupt no assets 1932."
At the bottom of the account on the credit side appears the following entry, headed "Memo":
*889 First Trust Note $125,000 dated April 30, 1928, 10 years, 5-1/2% semi annual curtails $1,875.00 balance due on note 7/1/31 $115,625.00. Curtails H. N. B. Jr.
| 7/6/31 | 1,875.00 |
| 10/30/31 | 1,875.00 |
| 4/30/32 | 1,875.00 |
| 10/30/32 | 1,875.00 |
| 4/30/33 | 1,875.00 |
| 10/30/33 | 1,875.00 |
Upon acquisition of the premises at 1415*650 K St., N.W., decedent valued the building at $125,000 and estimated its remaining life as 50 years. This valuation was fixed after an inspection of the building in August 1931. The building was a four-story reenforced concrete and brick structure with a limestone front, 32 rooms, an elevator, a slag roof with a very expensive skylight, a basement the full length of the building, and a good heating plant. The building was constructed in 1923 and was in good condition in August 1931. In valuing the building, decedent considered, in addition to its physical condition, its potential rental value and the $125,000 first trust on the premises.
In his return for the taxable year decedent claimed a deduction of $2,500 for depreciation of the building at 1415 K St., N.W., but the Commissioner reduced the amount of the deduction $1,108.21, his reasons therefor being stated in his deficiency letter as follows:
In the return a deduction of $2,500.00 (2 per cent of $125,000.00), representing depreciation on a building at 1415 K Street, N.W., was claimed. It appears the property was assessed as follows:
| Land | $81,000.00 |
| Improvements | 72,000.00 |
| Total | $153,000.00 |
The*651 cost of the property, $147,576.79, has been allocated to land and building on the basis of assessed values as follows:
| Land | $78,128.89 |
| Improvements | 69,447.90 |
| Total | $147,576.79 |
The depreciation allowable is, therefore, a remaining balance of $68,197.90 ($69,447.90 less $1,250.00) prorated over a remaining life of 49 years of $1,391.79 instead of $2,500.00 as claimed on your return, and depreciation was overstated $1,108.21. As a result of this adjustment rental income has been increased by $1,108.21.
Decedent made no claim on his 1932 return for a deduction representing a bad debt or a loss as a result of his loan on the property at 1415 K St., N.W., and the subsequent foreclosure and his acquisition of that property.
*890 OPINION.
KERN: Issue (a) involves the right of decedent to deduct $400 paid in connection with the proposed purchase of an apartment house. The right to the deduction is premised upon the contention that decedent was extensively engaged in buying and selling real estate and in making loans secured by real property. The petitioners rely upon section 23(a) of the Revenue Act of 1932, which provides for the deduction of all ordinary*652 and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.
As was said in the case of , "The decided cases touching upon what constitutes the carrying on of a business do not announce any comprehensive rule that can be readily applied to the varying facts that are presented in this class of cases." It is generally recognized that "those who take the position of passive investors, doing only what is necessary from an investment point of view" are not carrying on a trade or business within the meaning of this section of the revenue Act. However, those who are actively engaged in the enterprises in which they are financially interested may be considered as carrying on a business. It is also true that a person actively and regularly engaged in buying and selling for profit, substantial quantities of securities, or considerable numbers of real estate tracts, will be considered as carrying on a business with regard to such trading. *653 ; . In some cases the result of the taxpayer having made investments is that the taxpayer thereafter is engaged in one business, or many businesses, depending upon the character of the investments made, all within the meaning of said section of the act. .
In the instant case decedent had in the year 1928 the sum of $1,000,000 derived from the dairy and dairy products business available for investment, and from that date to and including the taxable year 1932 he invested approximately that amount in real estate and in real estate loans, having purchased during those years 174 pieces of real estate, but selling only one piece and exchanging one piece without gain or loss. In 1932 the gross rentals received by him amounted to $21,786.46. We must conclude from these facts that he was not engaged in the business of buying and selling real estate as a real estate broker, and, further, that he was engaged during these years in the business of managing rental property purchased by him as an investment.
The deduction claimed*654 by him, however, and involved in this issue of the instant case, is not an item propertly connected with his business of managing rental properties owned by him, but is, on the *891 other hand, an item of expense incurred by him incident to a proposed investment; that is, a contemplated purchase by him of additional rental property. Therefore, we must conclude that it was not an ordinary and necessary expense paid or incurred during the taxable year in carrying on a trade or business, and as to this issue, we approve respondent's determination.
Issue (b).
The attorney fees which are claimed as a deduction grew out of the litigation of decedent's tax liability in 1921, 1922, and 1923. During these years he was engaged in operating the milk and dairy business as a sole proprietorship. There can be no doubt that decedent was engaged in that business, and we are satisfied that the sum of $4,257.85 was paid out as attorney fees by decedent during the taxable year. In our opinion, this expenditure grew out of and proximately resulted from the milk and dairy business carried on by decedent and is deductible as an ordinary and necessary expense of that business. *655 ; . Cf. , and cases cited.
Issue (c).
The amount of the depreciation deduction to which decedent is entitled depends upon the value of the improvements at 1415 K Street, N.W., since the life of the building is not in dispute. Decedent valued the building at $125,000; the respondent valued it at $69,447.90, thereby reducing decedent's deduction for depreciation $1,108.21, and increasing his rental income by the same amount.
Respondent's determination being prima facie correct, decedent was under obligation to overcome this valuation by proving the value of the improvements in a different amount. His proof consisted of the testimony of his assistant, who described the building and the method used in valuing it. This witness testified that his allocation of cost to the improvements was based upon a personal inspection of the property in August 1931, upon consideration of the income-producing ability of the property, and upon the amount of the first trust. In order to support the opinion of*656 this witness counsel endeavored to qualify him as an expert in valuing properties. We are not persuaded that his experience would justify us in considering him to be an expert or in relying on his valuation. Upon this issue we, therefore, determine that decedent did not maintain the burden of proof, and respondent's valuation and computation of depreciation will be adopted.
*892 Issue (d).
Decedent has asserted his right to a further deduction as to 1932 income, either as a bad debt or as a loss. In the petition a slightly larger deduction is claimed as a loss, $21,558.12, or, in the alternative, that the amount is deductible as a bad debt. In his brief decedent reversed positions and contended that the deduction claimed, $21,530, is a bad debt, or, in the alternative, is a loss.
A brief summary of the pertinent facts will tend to clarify this issue. Decedent loaned $46,000 to McKeever & Goss on second trust notes and later advanced to them the sum of $4,103.33. Upon default, the makers of the notes and their endorser, R. L. McKeever, were sued and judgment was obtained for $27,680, including interest. The judgment could not be executed because of the bankruptcy*657 of the individual and the failure of the firm without assets. Being unable to collect the judgment, decedent claimed that the difference between the judgment obtained and credits against it, of $4,000, which was not loaned, and of $1,250, an amount collected after judgment, represent a bad debt, or the loss sustained.
With regard to decedent's contention that this proposed deduction should be allowed as representing a bad debt, respondent contends that there was no proper charge-off thereof made by decedent within the taxable year, as required by section 23(j) of the Revenue Act of 1932.
When decedent crossed out the title "McKeever & Gross" on the account involved herein, and entered in pencil the title "Real Estate 1415 K Street, N.W.", transferred the account from the notes and accounts receivable portion of his ledger to the real estate section thereof, and made the notation "Building bought in for $32,500, July 1931" and "Judgment for difference against R. L. McKeever worthless, bankrupt, no assets 1932", it is our opinion that a proper charge-off of the account against McKeever & Goss, carried on decedent's books was accomplished, conforming to the rules laid down in the*658 following cases: ; ; ; ; ; .
It would seem clear that decedent, by the actions and notations mentioned above, and more fully set out in the findings of fact herein, evidenced the ascertainment of worthlessness of this account substantially as of the date of such ascertainment and within the taxable year, and effectively eliminated his claim against McKeever & Goss as an asset. However, article 23(k)-3 of Regulations 94 provides as follows:
*893 If mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has*659 been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. * * *
In view of this provision, it is therefore apparent that decedent could deduct as a bad debt only that portion of the worthless judgment against McKeever & Goss which constituted capital. Since there is no evidence in the record that any portion of the judgment representing interest has been reflected in decedent's income tax returns, the amount of his capital represented in the account against McKeever & Goss is the sum of $46,000, plus $11.15 protest fees, plus the advancement of $4,103.33. To be credited on this is the sum of $1,250 received by him on this account by means of an attachment, November 7, 1932, and also the sum of $32,500 which is the amount for which the mortgaged property was sold.
It is, therefore, our conclusion on this issue that the claim of decedent for a deduction as a bad debt should be allowed in the sum of $16,364.48.
Reviewed by the Board.
Decision will be entered under Rule 50.
LEECH, dissenting: I dissent on the first point. It seems to me this record establishes the fact*660 that the petitioner, during the taxable year, was in the business of owning and operating real estate; that as an ordinary and necessary expense of that business, he paid, during that year, the disputed $400, and, accordingly, is entitled to its deduction under the Revenue Act of 1932, section 23(a).
STERNHAGEN and ARUNDELL agree with this dissent.