*709 INVOLUNTARY CONVERSION. - Petitioner realized a profit from the insurance on its building which was destroyed by fire in 1932. The building was not replaced until 1936. On receipt of the insurance part of the money was invested in bonds and kept so invested until replacement of the building; a reserve was set up on the books in the amount of the profit realized. Held, that there was no replacement "forthwith" within the meaning of section 112(f), Revenue Act of 1932; held, further, that the investment in bonds and setting up of a reserve did not constitute the establishment of a replacement fund, and that the gain realized is subject to tax.
*452 In this proceeding the respondent determined a deficiency in income tax for the year 1932 in the amount of $3,707.44. The major part of the deficiency arises from respondent's trestment of profit from fire insurance as taxable income. The petitioner assigns such treatment as error and contends that the profit comes within the nonrecognition provisions of the taxing act. Other alleged errors*710 have been conceded by the petitioner.
FINDINGS OF FACT.
Petitioner, a Vermont corporation, is a close corporation, its outstanding stock of the par value of $78,000 being held by four or five members of one family.
In May 1932 a building owned by petitioner in St. Johnsbury, vermont, part of the deficiency arises from respondent's treatment of profit frontage, was originally constructed as an opera house. In 1914 or 1915 it was remodeled and thereafter had two stores on the ground floor and a motion picture theater above them. The stores were rented to merchants. In 1927 two modern motion picture theaters were opened nearby. Thereafter petitioner's theater lost money and operation of it was discontinued in 1929 or early 1930.
The petitioner in 1932 received insurance on account of the destruction of the building in the amount of $43,483.01. Of the amount so received $21,409.54 represented a gain or profit. The profit of $21,409.54 was entered on petitioner's books in an account entitled "Reserve for Reconstruction of Opera House Block." That account was carried on the books through 1935. Upon receipt of the insurance the petitioner expended $30,065.64 for Federal*711 Government bonds. In 1933 those bonds were sold or redeemed to the extent of $10,000 *453 and that amount was invested in municipal bonds. Those investments were held through 1934. In 1935 the investment in Federal Government bonds was reduced by $10,000 and investment in municipals was increased in the amount of $5,000.
In 1932, following the destruction of the old building, the president of the petitioner thought it advisable to proceed with the construction of a new building on the site. At that time supplies were cheap and the cost of labor was low. Other members of the corporation thought differently and overruled the president's proposal. Business conditions in St. Johnsbury at that time were bad. The tenants of the old building were in arrears with their rent and there was no prospect of renting a new building. The majority of petitioner's stockholders thought it advisable to delay construction and thus avoid the expense of taxes and insurance on a building until business conditions improved.
In the early part of 1935 petitioner had plans drawn for a new building, but the contractors' estimates of costs were considered to be higher than expected rentals*712 would warrant, and the plans were discarded. Another set of plans was drawn in the fall of 1935 or spring of 1936 and with these in hand the petitioner sought prospective tenants. None could be found and the plans to build were again dropped. About May or June of 1936 a representative of Sears, Roebuck & Co. proposed renting a building if constructed by petitioner on the old opera house site. New plans were immediately prepared, and, after some negotiation and changes in the plans, about September 1936 construction was actually started on a new building to be occupied by Sears, Roebuck & Co. as a department store. The new building has a 60-foot frontage, and a depth of 100 feet. It is one story in height, with a basement. The total cost of the new building was $42,175.88.
OPINION.
ARUNDELL: The petitioner in this case realized an admitted gain of $21,409.54 from the proceeds of the insurance carried on its building that was destroyed by fire. This gain it says is a nonrecognized gain under the provisions of section 112(f) of the Revenue Act of 1932. That section, 1 set out in full in the margin, provides that, *454 where property is involuntarily converted into*713 money which is forthwith in good faith, under the Commissioner's regulations, expended in the acquisition of other property similar or related in service or use, or in the establishment of a replacement fund, no gain or loss shall be recognized.
We think it beyond serious question*714 that the old and the new buildings were "similar or related in service or use" within the meaning of the statute. Both were business properties; in the old, part of the income was from rents from stores on the ground floor and part from the operation of a motion picture theater; in the new, the income was from rents from ground floor stores. There were differences in the type of construction and the height and depth of the buildings, but the statute does not require exact physical duplication. .
We do not understand the petitioner to seriously contend that there was an actual expenditure "forthwith" within the meaning of the statute. More than four years elapsed between the receipt of the insurance and the expenditure in the construction of a building to replace the one destroyed. We have heretofore construed the term "forthwith" to mean: "As soon as by reasonable exertion, confined to the object, it may be accomplished." ; *715 . In , we held a period of two years to be within the statutory term. However, in that case the taxpayer, during the two-year period, prosecuted diligently his search for property similar to the property condemned. The facts here are different. It was entirely within the petitioner's power to construct a new building immediately following the destruction of the old. The delay was occasioned by the apprehension that tenants could not be found. This, in our opinion is vastly different from a delay occasioned by inability to locate similar property as in the Buckhardt case. We are aware of the economic conditions existing in 1932 and realize that hesitancy to expend money in new construction was a natural consequence of those conditions. Giving full recognition to those conditions and also to the decisions holding the involuntary conversion section to be a relief provision, we can not persuade ourselves that money held for more than four years before being expended has been expended "forthwith."
There is left the question of whether the petitioner "forthwith" established "a replacement*716 fund" as permitted by the statute and regulations. The petitioner did two things which it points to as bringing it within the statute. First, it invested some $30,000 of the proceeds of the insurance in Federal and municipal bonds in 1932 and held those bonds, with slight changes to take care of redemptions, through 1934 and continued to hold $25,000 of bonds *455 through 1935. Second, it set up an account called "reserve for reconstruction" in the amount of the profit realized, $21,409.54, and carried that account, with slight changes of less than $200, through the year 1935.
Article 580 of Regulations 77 provides that where it is not practicable to replace or restore the converted property, the taxpayer may obtain permission from the Commissioner to establish a replacement fund in his accounts. In such case, the taxpayer is required to make application on form 1114 for permission to establish a replacement fund and to furnish a surety bond in an amount not in excess of double the amount of estimated tax that would be payable if no replacement fund were established. Section 112(f) of the statute makes nonrecognition of gain dependent on compliance with the Commissioner's*717 regulations.
In , we pointed out that it was not the intent of the statute to completely exonerate involuntary gains from tax, "but rather to condition the extent of the relief upon the taxpayer's own actions after realizing the gain." Continuing in that case we said:
* * * In other words, while recognizing the inequity of taxing involuntary gains in all cases to the same extent as voluntary gains, once the gain is realized the taxpayer has several avenues open to him, any one of which he may voluntarily take and thus by his own action place a limit on the amount of tax he will be required to pay. He may elect to pocket his gain and subject it to tax in its entirety. He may, under the respondent's regulations, replace the converted property at a cost at least equal to the proceeds of the conversion, or if this is not practicable, he may establish a replacement fund and thus escape any tax. Or he may replace in part and become subject to tax on a part of the gain realized.
In allowing a taxpayer these options to fix for himself the amount of his tax and the year of taxation it is not unreasonable that the*718 Government should safeguard its revenues by provisions to insure payment of whatever amount is ultimately due based on the taxpayer's election. This has become particularly important under the recent taxing acts, which have shortened the period in which the Government may assess and collect. The regulations promulgated by the Commissioner are designed to assure ultimate payment of whatever is due when the taxpayer eventually replaces. They ask nothing more than that and they ask for no advance deposit or payment. Nothing in the regulations is pointed out as being unreasonable or working a hardship on the taxpayer. We think it not unreasonable to require compliance with the simple rules laid down by the regulations as a condition to the postponement of tax on a realized profit.
It is plain that in this case there has been no compliance, nor any gesture towards compliance, with the regulations. The petitioner *456 neither sought nor obtained permission to establish a replacement fund nor did it file a bond covering the tax. In addition to the matter of failure to comply with the regulations, it is at least doubtful whether the investment of part of the insurance proceeds*719 in bonds can be regarded as the establishment of a replacement fund. That investment was not marked on the books as being held for any particular purpose, and for the entire period of four years that the investment was held it was available for any purpose. No resolution of the directors limited its use or required it to be held for any particular purpose. The account designated "Reserve for Reconstruction" can not be regarded as a replacement fund within the statute. It is to be noted that the amount so labeled was only the amount of the profit realized from the insurance proceeds. We do not believe the statute contemplates that profit shall escape taxation by labeling it a reserve. The statute does not speak of a reserve. It provides for a replacement fund. The reserve carried on the books in this case can not be treated as meeting the statutory requirement of a replacement fund.
Decision will be entered for the respondent.
Footnotes
1. SEC. 112. (f) INVOLUNTARY CONVERSIONS. - If property (as a result of its destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation, or the threat or imminence thereof) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, expended in the acquisition of other property similar or related in service or use to the property so converted, or in the acquisition of control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expended, the gain, if any, shall be recognized, but in an amount not in excess of the money which is not so expended. ↩