*2049 1. DEDUCTION - LOSS. - Petitioner's uncle's will created a trust and named petitioner and others as the beneficiaries thereof. Over a period of years while the trust was an active trust the property was completely absorbed by the payment of encumbrances thereon. The trust was terminated in 1924. Held, that petitioner did not sustain a deductible loss in 1924.
2. INCOME - JUDGMENT FOR DAMAGES. - On the basis of the rentals and income from a building which was the only asset of the corporation whose stock he purchased, the petitioner determined the amount he was willing to invest. The vendor breached its agreement by renewing certain leases without petitioner's knowledge and consent pending negotiations for the purchase and sale. Petitioner sued, and recovered in 1925 damages for such breach of contract. Held, that such amount did not constitute taxable income, but was a return of capital invested.
3. Id. - In 1925 petitioner received interest on said judgment from the date judgment was rendered to date of payment thereof. Held, that the interest constituted taxable income in that year.
*850 The respondent has determined deficiencies in the amounts of $5,714.24 and $3,173.09 in this petitioner's income taxes for the years 1924 and 1925, respectively.
The petitioner contends that the respondent erred (1) in disallowing the amount of $34,770 as a loss deductible from income for the year 1924 and (2) in including in income for the year 1925 the amount of $1,635 as taxable income, the said amount having been received by petitioner in 1925 as a penalty or interest on a judgment (also paid in 1925) in the amount of $9,889.03 obtained by petitioner by suit on account of a breach of an agreement pertaining to the purchase by petitioner of the stock of a corporation owning an office building. The respondent, by his answer, has denied error as alleged by petitioner and further he contends that the said amount of $9,889.03 was income to petitioner in 1925; that he erred in not including said amount in his computation of the deficiency for that year and that such amount should now be included and the deficiency increased accordingly. The petitioner's reply denies that such amount representing damages constitutes*2051 income, and, further, he pleads the statute of limitations in bar of an increase in the deficiency as asserted in the deficiency notice.
*851 FINDINGS OF FACT.
The petitioner is a resident of Missouri and his office is located in the International Life Building, St. Louis.
J. Gilman Chouteau, an uncle of the petitioner, died in the city of St. Louis, leaving a last will and testament which was duly admitted to probate on January 15, 1908, in the probate court of that city which court ordered and adjudged that the cash value of the property or interest of said decedent, subject to the State inheritance or transfer tax, was $139,480. The decedent's will provided for certain specific bequests and further provided in part as follows:
3rd. All the rest of my estate, real personal and mixed, and wherever situate, I give, devise and bequeath to H. Chouteau Dyer in trust, for the persons and purposes subject to the conditions and limitations and with powers and duties hereinafter set out, that is to say; the trust estate shall be held, controlled, managed and disposed of by my trustee, or his successor in trust, as follows: My trustee shall collect rents, make repairs, *2052 pay taxes, insurance and other expenses incidental to the care, management and protection of the trust property, with power also to sell, convey, lease, release, mortgage, divide, build upon, and otherwise improve the property and in any other additional manner not above specified to care for, manage and develop the said estate and every part thereof in such manner as seems wise to my trustee for the benefit of the estate. It is the wish that my trustee shall sell such piece or pieces of property, real, or personal, as from time to time in his judgment shall be advantageous to the estate, and apply the proceeds thereof in so far as possible, to the payment and liquidation of existing indebtednesses.
4th. It is my desire that the net annual income derived from the estate to the extent of five thousand dollars, or such sum as may remain up to that sum, shall be divided into the equal parts and paid by the trustee to the following persons and in the following shares, viz: - One share to my sister Corinne Dyer; One share to my sister Beatrice Clark; One share to my sister Lillia Winthrop; One share to my niece Bertha Turner; One share to my nephew Azby Chouteau; two and one-half shares*2053 to my great nephew Azby Chouteau, and two and one-half shares to my great nephew Henry Chouteau.
I further desire that the share in the income to be paid to my great nephew Henry Chouteau, or so much thereof as in my trustee's judgment shall be necessary, shall be paid during the minority of my said nephew for his maintenance and the furtherance of his education, and in the event said nephew's share in the income shall not during any year be sufficient for his proper maintenance and education in the judgment of my said Trustee, than I direct my trustee to advance to said nephew out of said nephew's share in my estate sufficient therefrom, charging any such advance without interest to said nephew's share. In the event the net annual income derived from the estate exceeds the sum of Five Thousand Dollars, it is my will that my trustee shall apply such excess to the payment and liquidation of existing incumbrances, until such incumbrances shall be paid, and in such case, that is when no debts remain, the whole net annual income shall be divided in the proportions set out.
In the event of any one or more of the persons named in the foregoing property shall die before the expiration*2054 of the trust as hereinafter provided, then the share in the income payable to such person or persons, shall be paid by my trustee to the living child or children in equal parts of such *852 person or persons, and in the event such person or persons have no living issue at his or their demise, then such share in the income shall be paid to his or their heirs.
5th. It is my will, desire and direction that the trust hereinbefore created shall continue for the period of ten years and the end of that period my trustee shall pay off all remaining indebtednesses of the estate, if any, by selling as much of the property remaining in his hands as may be necessary therefor and shall divide the balance of the estate then remaining on his hands into ten equal parts, and convey it as follows: - One part to my sister Corrine Dyer; One part to my sister Beatrice Clark; One part to my sister Lillia Winthrop; One part to my niece Bertha Turner; One part to my nephew Azby Chouteau; Two and one-half parts to my great nephew Azby Chouteau; and Two and one-half parts to my great nephew Henry Chouteau.
If before distribution any of the persons named in the foregoing paragraph to whom I have*2055 devised and bequeathed the body of my estate, shall die, then the share of such person shall be conveyed by my trustee to the child or children in equal parts of such persons living at the time of the distribution, and in the event any such person shall die before distribution without issue at the time of distribution, then the share of such person shall be conveyed to the heir or heirs in equal parts of such person.
The decedent's estate consisted of personal property including stock in a mining company, but principally of real estate situated in a manufacturing district in St. Louis. From 1890 up to the time of decedent's death that property increased in value due to the development of the district for commercial purposes, but subsequent to his death the values steadily declined. At the time of decedent's death he had four parcels of realty unencumbered and 10 parcels encumbered with mortgages totaling $165,000. The executor of his estate paid off those mortgages to the extent of $49,000 and at commencement of the trust there were eight parcels encumbered to the extent of $116,000. The trustee placed additional mortgages on four parcels in the amount of $49,500 and during*2056 the first 10 years of the life of the trust there were foreclosures on three parcels and the trustee sold the rest of the property, except for four lots, for a total of $2,642.40 in excess of the mortgages thereon. The rents from the property and the proceeds from the sales were not sufficient to pay all of the obligations of the trust and at the end of the 10-year period in 1918 the trustee held $36.83 in cash, some worthless mining stock, four lots encumbered by a mortgage in the amount of $3,000, and the unpaid sundry debts amounted to 993.54. The trustee was unable to sell those four lots and the trust was continued until 1924, in which year it was terminated when no property remained in the trust estate. For 1924 the petitioner claimed a deduction as a loss in the amount of $34,770 as representing an undivided one-fourth vested interest in the value of the trust estate in 1908, which interest became worthless in 1924, due to the fact that the real estate declined in value to such an extent that the *853 entire trust estate was absorbed in the payment of mortgages on the property and other obligations of the trust estate. The respondent disallowed the deduction which*2057 resulted in a portion of the deficiency asserted for the taxable year 1924.
In 1920 the Missouri-Lincoln Trust Company owned 5,575 shares of the 6,000 shares of the outstanding stock of the International Building Company, whose sole asset was a 17-story office building, known as the International Life Building, and the leasehold upon which the building stood. Frank Carter was president of both corporations and the board of directors of the latter was selected from the directorate of the former. Carter's agent approached petitioner as to the purchase of the building and leasehold or the stock and furnished him with a written statement as to the names of the tenants, the rentals paid by each, the dates of the expiration of the leases, the gross income, and the cost of maintenance and operation of the building. The petitioner relied upon that statement in determining the amount he was willing to invest and in March, 1920, he submitted to Carter an offer to purchase for $92,000 the entire stock issue of the International Building Company or the building and leasehold free of all indebtedness except a mortgage securing a bond issue of $268,000, and he gave Carter his check for $2,000*2058 as earnest money. At the same time Carter, at the petitioner's request, agreed that no new leases for space in the building would be made without the knowledge and consent of petitioner and during the negotiations Carter reiterated that agreement and petitioner relied upon it. The parties finally agreed that petitioner would pay $92,000 for the 6,000 shares of stock of the International Building Company at a price of $15.33 per share; that the Missouri-Lincoln Trust Company owned 5,575 shares and would endeavor to purchase from the owners the 425 remaining shares; and that in the event the said Trust Company could not purchase all of the 425 shares it would return to petitioner $15.33 for each share outstanding and unpurchased on June 1, 1920. The deal was consummated and petitioner acquired the said stock on April 2, 1920.
However, pending the negotiations and while Carter was out of the city of St. Louis the vice president of the International Building Company, without the knowledge or consent of either petitioner or Carter, made two new leases for a large amount of space in the said building, one lease to commence on June 1, 1920, for a term of two years and the other to commence*2059 on May 1, 1920, for a term of four years and nine months. The petitioner did not learn of the new leases until after he had purchased the stock and he believed that the new leases provided for rents at less than the reasonable rental *854 value of the space, and he would not have consummated the deal had he known that the new leases had been made.
The petitioner instituted suit against the Missouri-Lincoln Trust Company for the recovery of damages alleged to have resulted from the breach of the said agreement. The court instructed the jury that if it found the facts to be substantially as set out above and that thereby this petitioner sustained loss and damage, the verdict should be for this petitioner; that the damage assessed should be, as found from the evidence, the sum which he, as a stockholder of the International Building Company, sustained by reason of the making of the new leases; that in determining the loss the total amount of rental required to be paid by the leases be deducted from the total amount which the jury found to be the reasonable rental value of the space and that there be allowed the plaintiff (this petitioner) such portion of said sum as the amount*2060 of stock delivered to him by the Missouri-Lincoln Trust Company under the agreement bears to the total amount of the outstanding stock of the International Building Company. A verdict was returned for the plaintiff (this petitioner) in which his damages were assessed in the total sum of $9,889.03 and judgment was rendered in that amount on or about January 10, 1923. The defendant, the Missouri-Lincoln Trust Company, took an appeal from that judgment, which was affirmed by the Supreme Court of the State on or about July 30, 1925.
On October 12, 1925, the Missouri-Lincoln Trust Company issued its check to petitioner in the amount of $11,524.03, which was paid on October 14, 1925, and the petitioner gave to that company his receipt certifying full payment and satisfaction of the judgment rendered on January 10, 1923, in the amount of $9,889.03 and also $1,635 interest thereon from January 10, 1923, to October 12, 1925.
In his return for the year 1925 the petitioner did not include in gross income either of the said amounts of $9,889.03 and $1,635.03. In computing the deficiency asserted the respondent included in gross income the amount of $1,635 as interest, but he did not include*2061 in gross income the $9,889.03 received as damages.
For the years 1924 and 1925 the petitioner kept his books and made his income tax returns on the cash receipts and disbursements basis. The petitioner's return for 1925 was filed on March 12, 1926. The deficiency notice was mailed on March 14, 1928, and the petition initiating this proceeding was filed with the Board on May 7, 1928.
OPINION.
TRUSSELL: The first issue relates to the petitioner's contention that in 1924 he sustained a deductible loss in the amount of $34,770. *855 He alleges that that amount represents the value in 1908 of a legacy devised to him by his uncle and that the loss was sustained through the decrease in the value of the property which by 1924 was finally and totally absorbed by the payment of various mortgages on the various parcels of property in which he had an undivided vested interest.
The Revenue Act of 1924 provides:
SEC. 214(a) In computing net income there shall be allowed as deductions:
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business;
(5) Losses sustained during the taxable year and not compensated*2062 for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *
(6) Losses sustained during the taxable year of property not connected with the trade or business * * * if arising from fires, storms, shipwreck, or other casualty, or from theft, and not compensated for by insurance or otherwise. The basis for determining the amount of the deduction under this paragraph or paragraph (4) or (5) shall be the same as is provided in section 204 for determining the gain or loss from the sale or other disposition of property;
The trust created in 1908 under the will of J. Gilman Chouteau for a period of 10 years until 1918 and then continued until 1924, because all of the encumbrances on the properties constituting the trust could not be liquidated as directed by the will, was an active trust. The trustee was directed to manage, control and dispose of the trust property and apply the proceeds of sales in so far as possible, to the payment and liquidation of encumbrances thereon and he was also directed to collect rents, make repairs, pay insurance, taxes, expenses, etc., and to divide and distribute the net*2063 annual income to the extent of $5,000 to certain specified persons, including petitioner, and further to apply any net income in excess of $5,000 to the liquidation of encumbrances until such encumbrances be paid. The real property constituting the trust estate was disposed of at a loss by sale by the trustee and by foreclosure proceedings at various times over a period of years and it is clear that the losses were sustained by the trust, a taxable entity separate and distinct from the taxpayer who is the petitioner in this proceeding. The effect of the losses sustained by the trust was to reduce the income, if any, or the corpus of the trust distributable to petitioner, but it can not be said that in 1924 this petitioner sustained the loss in question in his trade or business; or in any transaction entered into by him for profit, or arising from fires, storms, etc. Cf. ; ; and . The respondent has properly disallowed as a loss the claimed deduction of $34,770 from petitioner's gross income for the taxable year 1924.
*2064 *856 The respondent has alleged that he erred in not including in petitioner's gross income for 1925 the amount of $9,889.03 received by petitioner in that year in satisfaction of a judgment in his favor for damages sustained through the breach of an agreement by the Missouri-Lincoln Trust Company from whom petitioner purchased the stock of the International Building Company, whose sole asset was an office building and leasehold. During the negotiations for the said purchase and contrary to the Missouri-Lincoln Trust Company's agreement, two new leases were made for space in the building without the knowledge and consent of the petitioner, who believed that such new leases provided for rentals at less than the reasonable rental value of the space. The respondent contends that petitioner contracted to pay and did pay a certain amount for the stock which he received; that the court decided that he was entitled to receive $9,889.03 in addition thereto as a result of the breach of the agreement; and that such amount constituted income derived from capital. We believe the respondent has become confused as to the reason petitioner was given judgment and the manner in which the*2065 jury was instructed to compute the damage. It would seem that because the damage or loss was measured upon the difference between the rentals under the leases and the reasonable rental value of the space, the respondent concludes that the judgment represents a return to petitioner of a loss in rents from the building. However, the petitioner was not entitled to receive rents from the building, which was owned by the International Building Company, a corporation of which petitioner was merely a stockholder. It can not be said that the judgment recovered represented additional rent due for space in the building. The court's instruction to the jury was that the damages assessed should be the sum which petitioner, "as a stockholder of the International Building Company," sustained by reason of the making of the new leases and the difference between the rentals required to be paid by the new leases, and the reasonable rental value of the space was merely the basis for determining the amount of the damage.
The petitioner was a capitalist investing in the stock of the International Building Company and prior to making his investment he made a study of the information furnished*2066 him as to the tenants of the building, the rental paid by each, the dates of the expiration of the leases, the gross income, and cost of maintenance and operation of the building. He relied upon that information and his belief that rentals could be increased upon the renewal of certain leases about to expire, in determining the amount of $15.33 per share he was willing to invest in the stock in 1920. The market value of the stock was dependent, in a measure, upon the rentals or *857 returns from the building, which would determine the return upon petitioner's investment, and when the new leases were executed without petitioner's knowledge and consent and in breach of the agreement the value of the stock was decreased, with a resulting loss in or damage to petitioner's capital investment. The judgment in the amount of $9,889.03 recovered in 1925 represented a return of capital and reduced the cost of the stock to petitioner. It did not constitute income within the meaning of the Revenue Act of 1926 and the respondent did not err in failing to include such amount in petitioner's gross income for the year 1925.
The judgment for petitioner in the amount of $9,889.03 was rendered*2067 on or about January 10, 1923, and on appeal by the Missouri-Lincoln Trust Company, the judgment was affirmed on or about July 30, 1925. At the same time that the said company paid to petitioner the amount of $9,889.03 in satisfaction of the judgment, it paid interest thereon in the amount of $1,635 from January 10, 1923, to date of payment. The respondent has included that amount in petitioner's gross income for 1925, and the petitioner contends that such amount did not constitute taxable income, but represented a penalty. When petitioner's cause of action was merged into a judgment he became entitled, by statutory law, to interest on the debt of record as compensation for any delay in the payment of the debt by the Missouri-Lincoln Trust Company. . Section 213 of the Revenue Act of 1924 provides that gross income includes all "interest" except that upon (1) the obligations of a State, Territory or any political subdivision thereof, or the District of Columbia; or (2) securities issued under the Federal Farm Loan Act; or (3) the obligations of the United States or its possessions. We are of the opinion that the*2068 amount of $1,635 received by petitioner in 1925 as interest constituted taxable income in that year.
The petitioner has pleaded the statute of limitations in bar of the assessment of any increase in the deficiency for 1925 as asserted by the deficiency notice, but our decision that the $9,889.03 damages recovered did not constitute income obviates the necessity of expressing any opinion on this issue.
Judgment will be entered for the respondent in the amounts as asserted in the deficiency notice.