*3071 Losses sustained by reason of investments becoming definitely valueless in the taxable year are allowable as deductions from income.
*1284 This proceeding results from the determination of deficiencies in income taxes amounting as follows: for 1919, $3,689.75; for 1921, $10,377.16.
The petitioner alleges error with reference to the following issues; there has been a failure to allow deductions from income of losses as follow: (1) An amount of $9,386.25 lost in a joint venture operated *1285 under the name of the Pulaski Tupelo Lumber Co. and claimed as a deduction in 1919; (2) an amount of $37,500 invested in the capital stock of the Metropolis Towing Co. and claimed as a deduction in 1921; (3) an amount of $2,500 invested in the capital stock of the H. Rampendahl Jr. Co. previously claimed as a deduction from income in 1922 and now claimed to be properly deductible in 1921.
FINDINGS OF FACT.
The petitioner is a resident of Quincy, Ill.
In 1917 the petitioner and W. B. Morgan engaged in the cutting into*3072 lumber and marketing of a portion of a certain stand of Tupelo timber located about 70 miles from Pine Bluff, Ark., under an oral understanding that the petitioner would furnish or procure the necessary cash capital and Morgan, who was without capital, would give his personal services; any resulting profits, after paying the petitioner interest at the rate of 6 per cent upon the capital advanced, to be shared equally. Only this single venture was agreed upon. The timber rights were owned by a corporation in which Morgan was interested. The petitioner and Morgan arranged to pay for the timber at an agreed price per thousand feet payable when the timber was cut. A small sawmill was purchased and installed on the timber site. Operations were conducted under the name of "Pulaski Tupelo Lumber Company." Cutting of the timber began in the latter part of 1917, and continued into 1918, when it was discontinued leaving uncut a portion of the available stand. After cutting the higher sticks the timber developed defects known as "shakes," so that the output was of less value than expected. Some sales of the product were made in 1918, but most of it was sold in 1919. At first the petitioner*3073 advanced cash out of his own resources, but later cash was borrowed from a bank.
The total borrowings approximated $18,000, of which all but $9,000 was repaid out of receipts from operations. Five promissory notes, signed "Pulaski Tupelo Lumber Company by W. B. Morgan," were given to the Quincy National Bank as follows:
| Date | Payable | Amount |
| Feb. 12, 1919 | 6 months after date | $1,000 |
| Feb. 22, 1919 | 6 months after date | 1,500 |
| Mar. 2, 1919 | 6 months after date | 2,500 |
| Mar. 9, 1919 | 6 months after date | 1,500 |
| July 23, 1919 | 6 months after date | 2,500 |
| Total | 9,000 |
By the middle of the year 1919, it became probable that the venture would result in a loss.
*1286 In December, 1919, the Quincy National Bank wrote to Morgan demanding immediate payment of the notes. Later in the same month the bank made demand upon the petitioner for payment of the notes. The petitioner gave the bank his personal note dated December 31, 1919, for the amount of $9,336.25, being the aggregate of the notes plus accrued interest due thereon. At the close of 1919, after disposing of all of the lumber and materials he could find sale for, Morgan reported to the petitioner*3074 that the loss resulting from the venture would amount approximately to $9,000. Morgan had secured employment in New Orleans; he was without means. In 1920, a buyer was found by Morgan for the secondhand equipment which had remained unsold and the proceeds of the sale, amounting to $1,000, were turned over to the petitioner. The note for $9,336.25 signed by the petitioner was renewed a number of times and was paid by the petitioner in 1923. In the return filed by the petitioner for 1919 a loss was claimed of the $9,336.25. This deduction has been disallowed by the respondent. In the return for 1920 filed by the petitioner income was reported of the $1,000 proceeds from the sale of equipment, received in 1920.
In 1918 the petitioner and Frank Dillman were interested in a corporation known as the Dillman Egg Case Co., owning between them all of the outstanding capital stock save a few qualifying shares. The corporation was located at Carruthersville, Mo., and required marine equipment for the care and movement of its logs on the river. To secure such equipment petitioner and Dillman entered into an agreement with one Rampendahl and the Metropolis Towing Co. for the reorganization*3075 and refinancing of that company.
On May 10, 1918, certificate No. 2, for 125 shares, $12,500 par value, of the capital stock of the Metropolis Towing Co. was issued to A. W. D. Weis. The cash and assets paid in for said stock were furnished by the Dillman Egg Case Co. and the account of the petitioner on the books of the Dillman Egg Case Co. was charged with $12,500. The authorized capital stock of the Metropolis Towing Co. was increased in 1920 to $100,000. In that year certificate No. 16, for 250 shares, par value $25,000, of the capital stock of the Metropolis Towing Co. was issued to the petitioner and the par value thereof was credited on the books of the Dillman Egg Case Co. as a reduction of the indebtedness of the towing company to the egg case company for cash advanced to pay operating expenses, repairs, and miscellaneous items. At the same time the account of the petitioner on the books of the egg case company was charged with the amount of the par value of the stock. The petitioner gave his personal note to the egg case company, dated September 30, 1920, payable on demand, for $37,500, bearing interest at 5 per cent per annum. The Metropolis Towing Co. went into*3076 bankruptcy in 1921. The creditors *1287 were not paid in full and nothing was recovered on the capital stock of the stockholders. The note for $37,500 was paid by the petitioner in 1925. In the return for 1921 filed by the petitioner a loss amounting to $37,500 was claimed as a deduction, and the deduction has been disallowed by the respondent.
Prior to 1921 the petitioner acquired capital stock, par value $2,500, of a corporation known as the H. Rampendahl Jr. Co., Inc., for cash at par, which cash was advanced by the Dillman Egg Case Co. and charged to the account of the petitioner on the books of the egg case company. In 1921 the Rampendahl Company went into bankruptcy; the creditors were not paid in full and the stockholders received nothing for their stock. In the return filed by the petitioner for 1922, a loss of $2,500 was claimed on the investment in this stock. The deduction was disallowed by the respondent for 1922 on the ground that it should have been deducted in 1921.
The books of account of the petitioner were kept on a basis of cash receipts and disbursements. The returns of the petitioner were filed upon the same basis.
OPINION.
LANSDON: The*3077 issues in this case all relate to the deduction of losses from income. It is not disputed that deductible losses were sustained by the petitioner in the amounts claimed. The questions to be decided are whether he is entitled to take such deductions in the taxable years. The petitioner filed his income-tax returns and kept his books of account on a basis of actual cash receipts and disbursements. In consequence, the respondent contends that the losses are only deductible within the years when paid in cash out of the capital of the petitioner. The petitioner contends that the losses, as distinguished from expenses, are deductible from income in the years in which they "occurred," that is, when the attendant facts and circumstances determined that there could be no recovery of the capital which had been invested. In this case the capital invested was in part borrowed, and was not repaid within the taxable years. The parties differ as to the significance to be attached to this fact.
The first issue is governed by the Revenue Act of 1918; the second and third issues by the Revenue Act of 1921. The provisions of the Acts pertinent to the issues are the same. Section 212(b) of*3078 both Acts provides as follows:
The net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income * * *.
Section *1288 214 of both Acts provides as follows:
(a) That 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 for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business * * *.
In other paragraphs of section 214 of the statutes provision is made for the deduction of expenses, interest, and taxes, and it is specified that they shall have been paid or incurred during the taxable year - this is*3079 to be construed, under section 200, according to the method of accounting of the taxpayer.
It will be noted that the statutes provide that the losses shall have been sustained during the taxable year. In the absence of statutory definition of the word "sustained" we are of the opinion that the time when a loss was sustained for income-tax purposes by a taxpayer on the cash basis is a question to be decided in every case from the facts. We are unable to agree with the respondent that no loss is ever sustained until paid in cash where the cash-basis taxpayer is the user of borrowed capital. So broad a rule is contrary to the liberal provisions of the statutes in the matter of the method of determining income and is impracticable of general administration. It is obviously impossible to earmark the capital employed in every transaction which results in loss.
Taxation of income by the Federal Government is based on an annual period. . If the principle for which the respondent herein contends is accepted, taxpayers may determine for themselves the years and the income to which deductions on account of losses are applicable. *3080 In each of the years here involved the record is clear that the petitioner had large resources, enjoyed ample credit, and was solvent. If his business situation at the end of 1919 had indicated a loss for that year the deduction here sought would have been worthless to him, since there would have been no income against which it could have been charged nor any tax liability to be reduced. If he had reason to anticipate large profits and substantial taxable income in the following year it would have been to his advantage to defer his claim for a deductible loss. To do so, if the theory of the respondent is sound, it was only necessary to borrow money and arrange for the payment of the notes in the next year. It is hardly reasonable to impute to Congress an intent to permit taxpayers to elect, for their own benefit, the years in which business losses should be deducted from income.
To support his contention as to the loss sustained in 1919 in the circumstances set forth in the findings of fact, supra, the respondent *1289 relies on our decision in *3081 . In that case it appears that when the petitioner gave the notes in controversy, he received in exchange the notes of the corporation due him on account of funds advanced. At that time the corporation was in the hands of trustees in bankruptcy and it was not known that its assets were insufficient to pay any part of the claims of its creditors. The transaction giving rise to the loss claimed and represented by the petitioner's notes had not been finally closed. In the instant case no such situation existed and therefore we are of the opinion that the Davis case establishes no rule upon which the issue here can be decided.
We are of the opinion that all the losses here in question were sustained in the years in which the several investments became worthless. In such respective years each of the deals became a closed transaction and the petitioner's net assets were reduced in the amount of the loss sustained. It is not material whether such losses were met by the payment of cash from funds in hand or with cash borrowed from the bank and evidenced by notes payable in a subsequent year. The loss had been sustained and the transaction*3082 had been closed by a cash payment. The use of the petitioner's credit to secure funds from the bank was a new and different deal and had no more to do with the petitioner's tax liability than any other borrowing that he did in the taxable year. Cf. .
If the deductions herein claimed are allowed for the respective taxable years in which the losses occurred, correct income and true tax liability for such years may be determined. If postponed, manifestly income of the years to which they are eventually applied and to which they have no proper application will be distorted.
Reviewed by the Board.
Decision will be entered for the petitioner, under Rule 50.