*2856 1. Accounts or commissions receivable acquired by petitioner at its incorporation in January, 1917, in exchange for capital stock are capital assets.
2. The cost of surveying and staking land held capital expenditure
3. Traveling and entertaining expenses authorized by a corporation but not shown actually to have been expended and to be ordinary and necessary business expenses, disallowed.
*463 This proceeding is brought to redetermine the income and profits taxes of the petitioner for the years 1920 and 1921. The respondent has asserted deficiencies in the amounts of $25,237.42 and $30,737.55, respectively. The case was submitted on depositions.
The petitioner alleges the following errors:
(1) The inclusion in the net income of 1920 of the sum of $9,440.41, representing commissions receivable acquired by the petitioner as capital assets in January, 1917.
(2) The disallowance as a deduction from gross income of the sum of $900 expended for surveying and staking a parcel of land during 1920.
(3) The reduction of the Improvement Reserve from $75,000 to $15,000 for the years*2857 1920 and 1921.
(4) The disallowance of certain expenditures made in the current maintenance of the petitioner's properties during 1921.
(5) The reduction of the alleged net operating loss for 1919 from $30,000 to $6,221.06 through the disallowance of expenses for traveling and entertaining and the rejection of losses claimed to have been sustained by reason of the concellation of land contracts.
(6) The treatment of the sale of a certain tract of land as a transaction fully completed within the year 1921 rather than a sale on the installment basis.
(7) The disallowance as deductions of commissions credited during the year 1921 to the accounts of individuals indebted to the petitioner.
(8) The inclusion of the sum of $2,251.54 in income for the year 1921, representing a brokerage commission on transactions not consummated during that year.
FINDINGS OF FACT.
The petitioner is a corporation organized in January, 1917, under the laws of the State of Michigan, with principal offices at Detroit. *464 It is engaged in the real estate business, both as a principal and as a broker.
At the time of its organization in January, 1917, the petitioner acquired certain*2858 assets in exchange for its capital stock. Among them were accounts receivable representing commissions due in the sum of $78,829.17. During the years 1917, 1918, and 1919 the sum of $69,388.76 was collected on such accounts, leaving a remainder un-collected of $9,440.41. On December 31, 1921, there remained un-collected $202.53. The amount of such collections for 1920 was $9,237.88.
In 1920 the petitioner expended the sum of $900 for surveying a certain subdivision, known as Frishkorn Highlands Subdivision, and placing wooden lot boundary stakes thereon. The petitioner charged this amount to expense. The respondent disallowed the item as an expense but did not increase the cost of the property by including it as a capital item.
Prior to 1920 the petitioner acquired certain acreage, subdivided and promoted it as "Frishkorn Highlands Subdivision." It platted the land, graded and cindered streets, installed sidewalks, planted shade trees and otherwise rendered the subdivision attractive to prospective purchasers of lots. The petitioner set up on its books an account entitled "Reserve for Improvements" and credited thereto the sum of $75,000. No date is given for such action. *2859 The respondent reduced this reserve to $15,000. During the period from 1920 to 1923, inclusive, the petitioner expended the sum of $21,658.64 in such anticipated improvements, while on October 3, 1927, it paid to the City of Detroit $47.15 to cover a charge for the installation of water service. On January 1, 1928, the balance to the credit of that reserve was $53,294.21, and only three lots remained unsold at that time.
On January 25, 1918, and January 25, 1919, the board of directors of the petitioner entered orders fixing certain salaries for its officers and adopting allowances to them for traveling expenses and entertaining, aggregating $10,000 per year. The respondent allowed as expense deductions $5,000 per year. No evidence was introduced to prove the amount actually expended.
At the time of its incorporation the petitioner received certain land contracts, totaling $43,878.93, in exchange for its capital stock. Land contracts of the value of $794.13 and $3,847.55 at date of cancellation were canceled during 1918 and 1919, respectively. The lots represented by these contracts were again sold, either in the same or subsequent years.
During the summer of 1921 the*2860 petitioner sold, under contract, 71 lots in a certain subdivision known as "Park View, St. Clair" for $48,255, of which the purchasers paid initial installments of $8,210.94. *465 During November, 1921, the petitioner sold to R. H. Dunning the remaining 210 unsold lots in that subdivision, together with its land contracts for the 71 lots previously sold, for a total consideration of $40,000. Dunning paid $4,789.06 in cash, making a total of $13,000 cash received by the petitioner in 1921.
During the year 1921 the brokerage department of the petitioner accrued on its books brokerage fees aggregating $2,251.54, representing commissions expected from the sales of real estate during that year, but which sales were never consummated. On January 31, 1922, the petitioner made a reverse entry by debiting the "Surplus Adjustments Account, Prior Years" with the amount of $2,251.54 termed "adjusting previous year's commission."
Assignments of error numbers 4 and 7 were abandoned by the petitioner.
OPINION.
VAN FOSSAN: At the time of its organization the petitioner received in exchange for its capital stock certain assets, including commissions receivable amounting to $78,829.17. *2861 During the years 1917, 1918, and 1919 the petitioner collected a considerable portion of the commissions so acquired. During 1920 petitioner collected, and the respondent included in the petitioner's income, the sum of $9,237.88, representing all but $202.53 of the entire remaining balance of commissions receivable acquired by the petitioner on organization, January 1, 1917. It is clear that the commissions receivable turned in to petitioner for stock constituted capital assets. The subsequent collection of the same, if not in excess of the value at the date of acquisition, was merely a conversion of capital assets to a different form and did not give rise to income.
The item of $900 covering the cost of surveying and "staking" Frishkorn Highlands Subdivision is a capital expenditure. ; . The petitioner's custom of treating such a charge as an expense does not establish its character as such. The cost of the properties should be increased by the amount of this item.
The petitioner arbitrarily set up an account of $75,000 as a "reserve for improvements" applicable*2862 to the Frishkorn Highlands Subdivision. This amount was presumed to cover the cost of platting the land, grading and cindering streets, installing sidewalks and making other desirable and necessary improvements preparatory to and coincident with the sale of lots to the general public. On January 1, 1928, the total amount expended for such purpose was approximately $21,600 and at this time only three lots were left unsold. The respondent reduced the amount from $75,000 to $15,000 as of the years 1920 and 1921, which action gave rise to the sole question *466 raised as to this item. While it appears that petitioner's estimate of $75,000 was entirely too liberal, it further appears that during the period involved petitioner actually spent the sum of $21,658.56 in such anticipated improvements. This sum should be allowed.
The petitioner seeks to have its 1919 net operating loss increased by $12,441.68 by the addition of an allowance for traveling and entertaining expenses of its officers, amounting to $5,000 in each of the years 1918 and 1919 and by the amounts of $354.13 and $2,087.55, representing losses sustained during 1918 and 1919, respectively, by reason of the cancellation*2863 of certain land contracts acquired by the petitioner at its organization. The petitioner authorized its officers to expend an aggregate of $10,000 during each of the years 1918 and 1919 as traveling expenses and cost of entertaining prospective purchasers. The petitioner has presented no evidence that its officers expended more than the $5,000 per year allowed by the respondent; neither has it shown that such expenses were ordinary or necessary in its business. Therefore, we find no error in the determination of the respondent. ; . The land contracts were acquired by the petitioner at their face value in exchange for stock and constituted capital assets on January 1, 1917. Upon the subsequent cancellation of the contracts presumably the lots were repossessed. If equal in value to the unpaid balance of the contracts no loss was suffered. We do not know their value. We do know they were resold in many cases at a profit. The evidence is insufficient to enable us to determine that there was a loss.
During the summer of 1921 petitioner promoted the Park View, St. Clair Subdivision and*2864 sold 71 lots therein to various purchasers for $48,255, of which $8,210.94 was paid in cash. In November, 1921, the petitioner sold to R. H. Dunning for $40,000, with $4,789.06 in cash, its entire holdings in the subdivision, including the contracts of purchase relating to the 71 lots. So far as petitioner was concerned the $40,000 represents the total sale price of its interest in the entire property. The rights arising from the prior contracts were supplanted by the Dunning contract. When December 31 arrived petitioner had in its hands $13,000. It was no longer interested in either the property or the contracts. The entire transaction was closed. The respondent correctly refused to allow petitioner to report this income on the installment basis.
As to the last item, the commissions accrued in the brokerage department, the evidence is so inadequate and confused as to make it impossible to determine the precise situation obtaining. In this event, we have no alternative but to hold that petitioner has not demonstrated that respondent erred.
Judgment will be entered under Rule 50.