*313 Decision will be entered for the respondent.
1. Petitioner Ruth V. Bair, one of the shareholders and bondholders of the F. & H. G. Corporation, was in 1938 indebted to F. & H. G. by reason of her previous borrowings from it. Interest at 6 per cent based on the average borrowings of all stockholders was adjusted among the accounts of the stockholders. In 1938, the corporation was dissolved. Petitioner Ruth V. Bair and the remaining stockholders conveyed all of the assets, including the claim against the former stockholders, to a revocable trust of which petitioner Ruth V. Bair is a grantor beneficiary. Under the terms of the trust instrument interest was to be adjusted among the accounts of the former bondholders in a manner similar to the adjustment made by the corporation. In 1945, petitioner Ruth V. Bair was credited with interest of $ 1,109.14, two other former bondholders were credited with $ 1,109.14 and $ 1,109.13, respectively, and the remaining former bondholder involved in the interest adjustment was debited with interest of $ 3,327.41. See Gertrude Rosenblatt, 16 T. C. 100. Petitioner Ruth V. Bair was credited with $ 7,848.39 on the*314 books of the trustee as her distributive share of the trust income, and, in addition to her monthly drawings specifically stated under the trust instrument, she withdrew $ 9,000 which was debited to the same account the interest was credited. Held, as the grantor beneficiary of a revocable trust petitioner received interest of $ 1,109.14 and an actual payment of that amount was made to her.
2. Petitioner Hilbert L. Bair and the other sole and equal stockholders of the Hildegarde Realty Co., Inc., a corporation with a nominal capitalization, advanced money to the corporation in equal proportions for the purpose of permitting the corporation to purchase real estate and maintain it. These advances were designated as loans. Held, the loss on liquidation of the Hildegarde Realty Co., Inc., represents a capital loss as the funds advanced under the guise of loans were capital contributions. Isidor Dobkin, 15 T. C. 31, followed.
*90 Respondent has determined a deficiency of $ 4,623.15 in petitioners' income tax for the calendar year 1945. In his amended answer respondent has affirmatively pleaded that petitioners' income should be increased in certain amounts enumerated in his amended answer and has asked that the deficiency be increased to $ 6,044.30. The deficiency results from several adjustments to petitioners' net income. All of the adjustments asked for by respondent in his amended answer, except for the actual amount of deficiency, and some of the adjustments in the deficiency notice are not contested by petitioners. *91 The adjustments which are contested were explained by respondent in the deficiency notice, as follows:
2. Interest Income increase -- $ 1,109.14.
Mrs. Ruth V. Bair is a grantor-beneficiary of the Goldsmith Trust. Aside from being credited for her share in the distributable income*316 of the trust, she was also credited for $ 1,109.14 representing an interest adjustment among the four grantor beneficiaries for the variation between their accounts. Contructive [sic] receipt appears to exist and the amount credited is herewith included in income. It is noted that the grantor-beneficiary who was charged for the interest, Mrs. Gertrude Rosenblatt, deducted the amount for which she was charged.
* * * *
6b) * * *
Loss resulting from liquidation of the Hildegard Realty Corp. is deemed to be a long-term capital loss allowable to the extent of 50% of taxpayer's share of the loss as computed in Exhibit A. * * *
By appropriate assignments of error petitioners contest these adjustments.
FINDINGS OF FACT.
The facts which have been stipulated are so found and are incorporated herein by reference.
Petitioners, husband and wife, living in Scarsdale, New York, reported their income for Federal income taxes for the year 1945 on a cash basis and filed their return with the collector of internal revenue for the third district of New York.
Interest issue. -- On December 14, 1938, petitioner Ruth V. Bair joined with Walter M. Goldsmith, Rosetta C. Goldsmith, Kate A. Goldsmith, *317 Gertrude Rosenblatt, and Lillian Goodman in the creation of a trust hereinafter sometimes called the Goldsmith Trust. The trust as modified and amended by agreements dated July 31, 1939, and February 23, 1940, is conceded to be a revocable trust. These six settlors transferred to the trustee all their right, title, and interest in and to all of the cash, securities, property, and assets of every kind and nature which they were entitled to own, possess, or receive as stockholders, creditors, and bondholders of F. & H. G. Corporation. One of the duties of the trustee is set out in paragraph I of the indenture which is as follows:
I. To pay all the debts, liabilities and obligations of the said F. & H. G. Corp'n, except the indebtedness of said corporation to bondholders, which shall be paid by the Trustee in the manner hereinafter provided.Under paragraph II (a) and (b) certain specified monthly payments were directed to be made to the settlors and other persons. Paragraph II (c) of the trust agreement is, as follows:
(c) To apply any income remaining after the aforementioned payments shall have been made, toward the payment of the indebtedness, with interest, as hereinafter *92 *318 provided of the F. & H. G. Corp'n to its bondholders, until such indebtedness shall have been paid in full. The parties do hereby agree that the indebtedness of F. & H. G. Corp'n to its bondholders as of the 31st day of December, 1938 was as follows:
| Rosetta C. Goldsmith and/or Walter M. Goldsmith | $ 149,936.25 |
| Kate A. Goldsmith | 10,000.00 |
| Lillian H. Goodman | 124,719.95 |
| Ruth V. Bair | 60,793.33 |
| Gertrude Rosenblatt | 34,202.06 |
After such indebtedness shall have been paid in full, to pay over any such surplus income equally to and among Walter M. Goldsmith, Gertrude Rosenblatt, Lillian H. Goodman and Ruth V. Bair.
Paragraph III and the pertinent provisions of paragraph IV of the trust agreement are, as follows:
III. In computing the interest on the indebtedness of F. & H. G. Corp'n to its bondholders, such indebtedness is to be determined as of the 1st day of December, 1938 and thereafter each bondholder shall be credited semi-annually with interest at the rate of 6% per annum upon the excess of the amount still due him over the average amount due each bondholder and shall be charged semi-annually with interest at the same rate upon the sum by which the amount still due him is*319 exceeded by the average amount due each bondholder. For the purposes of this paragraph "Bondholders" shall be deemed to be
Rosetta C. Goldsmith
Lillian H. Goodman
Ruth V. Bair
Gertrude Rosenblatt
and the amount of the indebtedness of F. & H. G. Corp'n to the bondholder, Kate A. Goldsmith, shall be added to the amount of the indebtedness of F. & H. G. Corp'n to Rosetta C. Goldsmith and both accounts shall be treated as a single account.IV. This trust shall continue during the life of Walter M. Goldsmith, unless terminated prior thereto under the provisions hereof, and shall terminate upon his death unless Gertrude Rosenblatt, Lillian H. Goodman, Ruth V. Bair, or in the event of the death of any one of them, the legal representatives or assigns of the one who shall have died and the legal representatives or assigns of said Walter M. Goldsmith shall all agree upon the nomination of a new trustee or trustees and consent to the creation of a new trust. During the lifetime of said Walter M. Goldsmith, no alteration, amendment or change of the terms of this Indenture which shall provide for the continuance of said trust after the death of said Walter M. Goldsmith, shall be valid*320 or enforceable unless agreed to by said Gertrude Rosenblatt, Lillian H. Goodman, Ruth V. Bair and Walter M. Goldsmith if they shall then be living, or if any of them shall have died, by the survivors and the personal representatives, executors, administrators or assigns of such of them as shall have died. Upon the termination of the trust the corpus thereof shall be disposed of by making the following payments in the order hereinafter stated:
(a) There shall be paid to the bondholders of F. & H. G. Corp'n such amount or amounts as may still be necessary to pay the indebtedness of said corporation to said bondholders in full with interest calculated as hereinbefore provided.
* * * *
*93 Petitioner Ruth V. Bair's account with the Goldsmith Trust was credited during the taxable year 1945, with interest in the amount of $ 1,109.14 pursuant to the provisions of paragraph III of the trust indenture. The account of Walter and Rosetta C. Goldsmith was credited with $ 1,109.13, the account of Lillian Goodman was credited with $ 1,109.14, and the account of Gertrude Rosenblatt was debited with $ 3,327.41.
Petitioner Ruth V. Bair's distributive share of the trust income as reported by*321 her in her joint return for the year involved did not include the amount of $ 1,109.14. Her distributive share of the capital gains of the trust referred to in respondent's amended answer was not included in her original joint return and does not include this amount of $ 1,109.14. No payment of the specific amount of $ 1,109.14 was made in cash to the petitioner Ruth V. Bair during the taxable year 1945.
The bondholders and stockholders of the F. & H. G. Corporation were the petitioners herein, Gertrude Rosenblatt, Lillian Goodman, each of whom owned in equal amounts one-quarter of the outstanding bonds and stock of the corporation, and Rosetta C. Goldsmith, Walter M. Goldsmith, and Kate A. Goldsmith, who together owned an aggregate of one-quarter of the outstanding bonds and stocks of the said corporation.
Some of the above bondholders and stockholders borrowed from the corporation during its existence various amounts from time to time. On July 25, 1935, all of the stockholders of F. & H. G. entered into an agreement relating to interest on the individual indebtedness of each stockholder of F. & H. G. Part of this agreement is, as follows:
As to the individual indebtedness, and*322 in view of our joint ownership of the corporation and in view of the fact that, upon liquidation of this corporation all of these indebtednesses will eventually be taken into account, that they really represent only adjustments of equities among ourselves, and that the amount of these accounts are increasing from year to year by reason of interest which has been charged on the same, we request that no interest be charged on them as a matter of corporate income. In other words, we request that an average of these accounts be taken each year and that interest shall be charged at the rate of 6% per annum to each account that is in excess of this average amount, the interest to be figured only upon such excess and that interest at the rate of 6% per annum be credited to each account which is less than this average amount, such interest to be based only upon the difference between the average amount of each of said accounts and the actual amount of each of said accounts. As we understand it, this will, in no way, affect the equities between us and the interest to be charged should exactly equal the interest to be credited on the individual accounts taking them as a whole.
Upon dissolution*323 of F. & H. G. in 1938, the bonds of the corporation were cancelled and a net credit balance remained for each former *94 bondholder, which balance is set out above in paragraph II (c) of the trust agreement. These balances are the amounts owed to the bondholders by the corporation, minus the bondholders' "drawing accounts."
During the taxable year 1945, petitioner Ruth V. Bair received a payment in the amount of $ 9,000 in excess of the monthly payments of $ 706.25 specified in paragraph II (b) of the trust agreement, which amount was charged to her capital account on the books of the trust. The payment of $ 9,000 was not reported as income by petitioner Ruth V. Bair. No part of the $ 9,000 payment made to petitioner Ruth V. Bair during the year 1945 was specifically allocated on the books of the Goldsmith Trust to the payment of the $ 1,109.14 in question, but both the $ 1,109.14 and the $ 9,000 were entered in the same account.
Petitioner Ruth V. Bair's distributive share of the trust income as shown on her return for 1945, was $ 7,776.81. It is conceded by petitioners that during the calendar year 1945, the Goldsmith Trust (a) received long term capital gains in the amount*324 of $ 21,577.77, of which petitioner's distributable share was $ 5,394.29, taxable to the extent of $ 2,697.15; (b) received short term capital gains in the amount of $ 494.55, of which petitioner's distributable share was $ 123.64, taxable in full, and (c) reported ordinary net income of $ 33,207.26 which should have been $ 33,343.14, or an increase of $ 135.89, of which petitioner's distributable share was $ 33.97.
Loss issue. -- In July 1926, petitioner Hilbert L. Bair made a contract with Shayfor Corporation for the purchase of premises known as 3 and 5 West 36th Street, Borough of Manhattan, City of New York, for the sum of $ 387,000. The purchase contract provided for the payment of $ 87,000 in cash, and the property was to be conveyed subject to a first mortgage of $ 200,000 held by the Mutual Life Insurance Company, and a second mortgage of $ 100,000 held by Marion K. Proctor and William I. Law, as trustees under the will of John Proctor, deceased.
On September 28, 1926, the Hildegarde Realty Co., Inc. (hereinafter sometimes referred to as the corporation) was organized under the laws of the State of New York with an authorized capital of 20 shares without par value. *325 The corporation was formed for the purpose of engaging in the real estate business. At its organization meeting on September 28, 1926, the corporation accepted an assignment of the contract between petitioner Hilbert Bair (hereinafter called Bair) and Shayfor Corporation. The assignment was accepted at a value of $ 100 over and above the amount agreed to be paid by Bair, and in return, on September 28, 1926, issued to Bair its capital stock certificate for 20 shares valued at $ 100. On the same day, Bair transferred 10 shares of the stock to another individual and Bair thus remained the *95 owner of one-half of the capital stock of the corporation until its dissolution on August 14, 1945.
At the time of the formation of the Hildegarde Realty Co., Inc., it was intended that the corporation would purchase the property located at 3 and 5 West 36th Street, New York City. In order to complete the transaction it was necessary that the corporation pay $ 87,000 in cash to the seller. The $ 87,000 cash required for the acquisition of the property was advanced to the corporation by its two stockholders and the premises were acquired by it in accordance with the contract. On February*326 14, 1927, the directors of the corporation authorized the issuance of promissory notes in the sum of $ 87,000 to be executed by the corporation and payable to the parties who had advanced the $ 87,000.
The premises 3 and 5 West 36th Street, Borough of Manhattan, City of New York, were, on October 13, 1932, conveyed to the second mortgagees, Marion K. Proctor of Portland, Oregon, and William I. Law of Rutherford, New Jersey, for $ 400, subject to existing first and second mortgages and unpaid taxes, after an action to foreclose the second mortgage had been commenced on September 9, 1932, for defaults in the payment of interest and taxes.
On April 27, 1934, the corporation purchased premises 136 East 44th Street, Borough of Manhattan, City of New York, at a cost of $ 40,000, subject to mortgages aggregating $ 37,500. On June 24, 1935, the corporation acquired 245-7 East 55th Street, Borough of Manhattan, City of New York, at a cost of $ 14,000, free and clear of mortgages. In the year 1936, the corporation acquired 310 East 49th Street, Borough of Manhattan, City of New York, at a cost of $ 7,500, free and clear of mortgages. On December 6, 1937, the corporation acquired 37-41 West*327 98th Street, Borough of Manhattan, City of New York, at a cost of $ 56,500, subject to two mortgages aggregating $ 50,500. On February 1, 1939, the corporation acquired 106-110 Christopher Street, Borough of Manhattan, City of New York, at a cost of $ 95,138.92, subject to mortgages aggregating $ 75,138.92. In addition to the funds required for the acquisition of these premises, sums which were advanced by the two stockholders were expended from time to time in rehabilitating the 49th Street and 55th Street properties, and in improvements to the other properties. In addition, the stockholders advanced the funds necessary for the remodeling of the 36th Street property, and also to make up for the loss in operations of the premises during the time that it was owned by the corporation.
Since 1937 the moneys advanced by the stockholders were carried on the books of the corporation as "Loans payable to Stockholders." Prior to that time no formal books of the corporation were maintained; however, moneys advanced by the stockholders were reflected in the *96 minute books and the checkbooks of the corporation as loans made by the individual stockholders to the corporation. The funds*328 required by the corporation for the purchase of the above real estate and for its operations in excess of funds acquired through mortgage and through its income were advanced solely by the two stockholders in equal cash amounts, and the funds so advanced for purchasing and remodeling the real estate constituted the great proportion of the amounts carried on the books of the corporation as "Loans payable to Stockholders," and in the minute books and checkbooks of the corporation as loans made by the individual stockholders to the corporation.
The corporation was dissolved by a certificate of dissolution filed in the office of the Secretary of the State of New York on August 14, 1945, and the assets distributed in kind to the stockholders.
The books of the corporation reflected interest credits upon the amounts advanced by the two stockholders. As of the date of the dissolution of the corporation, the corporation showed on its books a credit to the two stockholders jointly the sum of $ 183,391.61, of which sum $ 58,279.33 represented interest credits, and the sum of $ 125,112.28 represented cash advanced by the two stockholders to the corporation. Pursuant to the liquidation of the*329 corporation, the two stockholders received from it assets valued at $ 98,454.80. Therefore, the total loss claimed by the two stockholders on the liquidation of the corporation was the sum of $ 26,757.48, one-half of which sum, $ 13,378.74, represented the loss of the petitioner, Hilbert L. Bair. 1
Since 1926, Bair devoted the greatest portion of his time to the real estate business. From 1931 to date, except for the period of service in the armed forces, he devoted all of his time to the real estate business. Bair devoted a substantial amount of his time to the business of Hildegarde Realty Co., Inc. Between 1926 and 1931, he devoted approximately 25 per cent of his time to Hildegarde business. From 1931 to the dissolution of the corporation, except for the period for which Hildegarde held no real property and except for the period he was in the armed forces, Bair devoted between 60 and 100 per cent of his time to*330 the business of Hildegarde Realty Co., Inc. He supervised construction, managed properties, collected rents, at times supervised agents collecting rents, and engaged in the usual duties involved in handling real property with respect to the Hildegarde holdings.
In 1926, Bair became a stockholder of Hildegarde Realty Co., Inc.; in 1930, he became a stockholder of the 120 East 86th Street Corporation, and in 1936, he became one of the two stockholders of Barel Realty Corp. The capitalization of 120 East 86th Street Corporation was $ 500 or $ 1,000. Between $ 125,000 and $ 150,000 was advanced to *97 this corporation which was carried as a loan on its books. Barel Realty Corp. was capitalized at $ 100 or $ 500. Each of the stockholders advanced in the neighborhood of $ 18,000 or $ 20,000. Such advances were, and still are, carried on the books of the corporation as a loan.
All of the advances by Bair to the Hildegrade Realty Co., Inc., constitute capital investments in the corporation and the loss sustained on the liquidation of that corporation is deductible only to the extent of 50 per cent of the actual loss.
OPINION.
Interest issue. -- Petitioner Ruth V. Bair is one*331 of the grantor beneficiaries of the Goldsmith Trust, conceded to be a revocable trust, and petitioners have conceded the correctness of respondent's allegations in his amended answer relating to the portion of the trust income taxable to petitioners. However, respondent in the deficiency notice increased petitioners' net income by the amount of $ 1,109.14 which represents interest credited to the account of petitioner Ruth V. Bair in accordance with paragraph III of the trust indenture, and petitioners contest this adjustment.
In accordance with paragraph III of the trust instrument an interest adjustment was made by the trustee between the accounts of four of the former bondholders of F. & H. G. Interest in the amount of $ 1,109.14 was credited to the account of Ruth V. Bair on the books of the trustee. Two other former bondholders' accounts were credited with interest of $ 1,109.14 and $ 1,109.13, respectively, and the remaining former bondholder's account, that of Gertude Rosenblatt, was debited with interest of $ 3,327.41. Petitioner Ruth V. Bair during the year 1945, withdrew $ 9,000 in cash from the trust and the $ 9,000 was debited to the same account as the interest was*332 credited. The two other former bondholders who were credited with interest during 1945, also withdrew $ 9,000 in cash; however, the remaining former bondholder whose account was debited with interest in the total amount of all the other bondholders' interest credits did not withdraw $ 9,000. The interest adjustment results from the indebtedness of the former bondholders to F. & H. G., and petitioner Ruth V. Bair received interest of $ 1,109.14 because she had borrowed less money from F. & H. G. than the average of all the former bondholders. As one of the former stockholders of F. & H. G., petitioner Ruth V. Bair had a net claim against the former bondholders and it was upon this net claim that the interest was actually computed and credited to her account.
Since the interest of $ 1,109.14 and the cash withdrawal of $ 9,000 were credited and debited to the same account, we hold that petitioner *98 Ruth V. Bair received an actual payment of interest because a payment not allocated by the parties is treated as a payment, first of interest and then of principal. Millar Brainard, 7. T. C. 1180, remanded pursuant to stipulation; Estate of Paul M. Bowen, 2 T. C. 1,*333 and Theodore R. Plunkett, 41 B. T. A. 700, affd., 118 Fed. (2d) 644.
Petitioners contend that respondent is bound by his statement in the deficiency notice that the interest was constructively received and may not now argue that this interest was actually received. Respondent determined that petitioner Ruth V. Bair received interest of $ 1,109.14, and the parties have stipulated the facts necessary for our holding in this proceeding. Moreover, at the trial of this proceeding, petitioners were aware of respondent's argument of actual receipt of interest. Respondent determined in the deficiency notice that petitioner received interest of $ 1,109.14. As we said in Millar Brainard, supra:
* * * It is our function, however, to redetermine a deficiency and not respondent's reasons for it. Edgar M. Carnrick, 21 B. T. A. 12; Raoul H. Fleischmann, 40 B. T. A. 672. See Dorothy Whitney Elmhirst, 41 B. T. A. 348. * * *
Even though we find actual payment of interest here, there is an additional reason for including the interest in petitioner's*334 income. Since the Goldsmith Trust is a revocable trust, for the purposes of taxation the trust entity is ignored and the income of the trust is included in the income of the grantors, section 166, Internal Revenue Code. The interest adjustment between the former bondholders of F. & H. G., while not income of the trust, represents interest arising from the borrowings of the former bondholders of F. & H. G. Were it not for these borrowings there would have been no interest adjustment between the former bondholders. Petitioner Ruth V. Bair as a former stockholder of F. & H. G. had a net claim against the former bondholders of F. & H. G. in an amount larger than the claims against her. All of these former bondholders were grantor beneficiaries of the Goldsmith Trust and the interest adjustment under the trust instrument directly affected the share of the corpus to which petitioner Ruth V. Bair was entitled. Since petitioner Ruth V. Bair had such control over the corpus to make the income therefrom taxable to her, it is only consistent to hold that the right to receive the interest under paragraph III of the trust instrument constitutes such control as to include it in petitioner's*335 income, whether actually received or not. Corliss v. Bowers, 281 U.S. 376">281 U.S. 376; Helvering v. Clifford, 309 U.S. 331">309 U.S. 331. On this issue respondent is sustained. See Gertrude Rosenblatt, 16 T. C. 100, this day decided.
Loss issue. -- Petitioners contend that the sums advanced to the Hildegarde Realty Co., Inc., represent loans to the corporation and *99 the loss upon liquidation of the corporation is a bad debt loss incurred in the trade or business of petitioner Hilbert Bair. Respondent has determined that the loss sustained by petitioner Hilbert L. Bair is a capital loss allowable only to the extent of 50 per cent.
In order that the Hildegarde Realty Co., Inc., might purchase the property under the contract it held and for which contract the corporation had issued all of its capital stock valued at $ 100, cash in the amount of $ 87,000 was needed. This money was supplied equally by its two sole and equal stockholders, one of whom was petitioner Hilbert L. Bair. For the purpose of purchasing other property and maintaining it, these two stockholders later advanced additional funds*336 in equal proportions. The fact that the corporation was inadequately capitalized is obvious and the original $ 87,000, as well as the subsequent advances contributed by its stockholders, was immediately put at the risk of the business in the same manner as the capital of a normal corporation. While the funds advanced by petitioner Hilbert L. Bair were designated as loans to the corporation, we are not bound by the designation to the point where the true substance of the transaction may not be examined. Sam Schnitzer, 13 T. C. 43, affd., CA-9, January 9, 1951.
The Hildegarde Realty Co., Inc., was organized for the purpose of dealing in real estate. Its capital was nominal, $ 100, and as assignee of a contract to purchase property it immediately required $ 87,000 cash, and later additional funds, one-half of which was supplied by petitioner Hilbert L. Bair, the holder of one-half of the corporation's stock. In Isidor Dobkin, 15 T. C. 31, a case almost identical with the instant proceeding, we held on the authority of Edward G. Janeway, 2 T. C. 197, affd., 147 Fed. (2d) 602,*337 that the contributions to a New York realty corporation in equal proportion to the stockholdings were capital contributions when placed at the risk of the business, although designated as loans for which notes were issued and upon which interest was paid. In the instant proceeding all of the contributions to the Hildegarde Realty Co., Inc., although designated loans, were actually capital contributions and we have so found. From this finding and on the authority of Isidor Dobkin, supra, we hold that the respondent did not err in determining that the loss on the liquidation of the corporation was a capital loss.
Because the only issues in controversy have been decided in favor of the respondent, and petitioners have conceded the correctness of respondent's addition to net income set out in the amended answer, a deficiency of $ 6,044.30 as set out in the amended answer will be entered.
Decision will be entered for the respondent.
Footnotes
1. The figures in this paragraph are taken from the stipulation of facts and are not in dispute.↩