*1096 In 1925 petitioner established an account with his broker by depositing various stocks which he had held for more than ten years theretofore. In order to protect that account against decline in the market, in 1929, he opened a short account in the same stock with the same broker. In October 1934 both accounts became restricted under rule of the Federal Securities and Exchange Commission. Petitioner was required to report as taxable income all dividends credited to him in the long account but could not offset or deduct dividends charged to him in the short account. Therefore, he decided to liquidate both accounts. He accomplished this purpose by purchasing covering stock on the open market through another broker and selling through a third broker his long stock which his original broker turned over to the selling broker. Held, that the purchase of covering short stock and the sale of long stock were independent transactions and petitioner is entitled to compute gain or loss on them separately. duPont v. Commissioner, 98 Fed.(2d) 459; certiorari denied, 305 U.S. 631">305 U.S. 631.
*588 The respondent determined a deficiency of $305,636.09 in the petitioner's income tax for the year 1935. By his amended answer the respondent reduced the deficiency to not less than $93,962.85.
Various issues were raised by the petitioner. They have been so modified and settled that the controversy is now reduced to the simple issue of whether or not a series of transactions consisting of sales from the petitioner's long account and purchases for his short account resulted in taxable gain.
FINDINGS OF FACT.
The petitioner is an individual, with an office in New York, New York. He filed his income tax return for the year 1935 with the collector of internal revenue for the second district of New York. During 1935 and for many years prior he was president and a director of the Brady Security & Realty Corporation, a company owning and operating a large office building in New York City and large real estate developments in New Jersey. It also owned a portfolio of investment securities.
The petitioner was an executor and trustee of the estate*1098 of James C. Brady, deceased. That estate and the said corporation held securities and real estate valued at about $13,000,000. The petitioner was also an officer and director of numerous corporations. He devoted *589 practically all of his time to such activities. At no time after August 31, 1929, was he engaged in the business of buying and selling stocks.
In 1925 the petitioner deposited with Dominick & Dominick, brokers, hereinafter referred to as Dominick, certain shares of Chrysler Motors, Consolidated Gas, and Reynolds Tobacco stock, which shares had previously been purchased and owned by him for more than ten years. Subsequent to the opening of that account (known as the long account) with Dominick, the petitioner conducted various market operations from time to time through the medium of the account, resulting in increases and decreases in the number of shares therein, until on December 1, 1935, the shares of these three stocks which the petitioner owned, as reflected in this account, were as follows:
18,300 shares of Chrysler Motors
1,140 shares of Consolidated Gas
7,250 shares of Reynolds Tobacco
In order to protect his investment in the long account*1099 on February 7, 1929, the petitioner opened a short account with Dominick and executed short sales through this account. On December 1, 1935, the number of shares which, by virture of his short contracts, he was obligated to deliver to cover his short sales, was as follows:
18,300 shares of Chrysler Motors
1,140 shares of Consolidated Gas
1,400 shares of Reynolds Tobacco
Under rules of the Federal Reserve Board adopted pursuant to the provisions of the Securities Exchange Act of 1934, the petitioner's accounts became restricted. By reason of such regulations the petitioner's debit balance with Dominick could not be increased to an amount greater than it was on October 14, 1934, the date on which Regulation T became operative.
In 1934 the graduated capital gain and loss provisions of the internal revenue acts were adopted, and Regulations 86 were promulgated by the Secretary of the Treasury.
The petitioner was required to report as taxable income dividends credited to his long account but could not deduct or offset dividends charged to him in his short account. Hence, in November 1935, he decided to liquidate both his long and short positions. Under the restrictions*1100 of Regulation T he was compelled to close his two accounts simultaneously. He was advised that the proper and legal way to accomplish this end was to buy stock on the stock exchange in the open market to cover his short position and to sell his long stock in the open market and thus to liquidate the two accounts separately.
Therefore, from time to time during the month of December 1935, the petitioner instructed E. W. Clucas & Co., brokers, hereinafter called Clucas, to sell for him certain shares of stock and instructed Dominick *590 to deliver to Clucas for sale shares of stock held in his long account. Pursuant to such instructions, Clucas sold on the floor of the New York Stock Exchange such shares as it was instructed by the petitioner to sell. Clucas received from Dominick certificates of stock for delivery pursuant to such sales, and delivered to Dominick checks representing their selling prices. All stock delivered to Clucas was charged to the petitioner's long account. The checks were credited to his long account. These transactions were carried out by Clucas in the ordinary course of business.
In this manner, the petitioner sold from his long account in*1101 December 1935, 10,600 shares of Chrysler common for $898,549.89, 5,900 shares of Reynolds Tobacco for $329,760.75, and 200 shares of Consolidated Gas for $6,294.86, all of which shares the petitioner had owned and held for more than ten years. Likewise the petitioner sold 500 shares of Consolidated Gas for $15,787, which shares he had owned and held for over five years. The costs of these several lots of stock had been as follows:
| 10,600 shares of Chrysler common | $253,107.15 |
| 5,900 shares of Reynolds Tobacco | 54,280.00 |
| 200 shares of Consolidated Gas | 6,256.60 |
| 500 shares of Consolidated Gas | 38,834.40 |
During December 1935, from time to time the petitioner instructed Robert Winthrop & Co., brokers, hereinafter called Winthrop, to purchase certain shares of stock. Winthrop, having no member on the floor of the New York Stock Exchange, purchased through Stokes Hoyt & Co. on the New York Stock Exchange shares of Chrysler, Consolidated Gas, and Reynolds Tobacco stock as instructed by the petitioner. Upon receipt of the stock purchased, Winthrop delivered the shares to Dominick, and Dominick credited the stock to the petitioner's short account. In this manner, in*1102 , december 1935, the petitioner bought 10,600 shares of Chrysler at a cost of $902,357.50, 1,400 shares of Reynolds Tobacco at a cost of $78,120, and 700 shares of Consolidated Gas at a cost of $22,280. The short sales, covered by the shares purchased in the foregoing purchases, had occurred prior to 1935 and were reflected in the petitioner's short account. They were 10,600 shares of Chrysler sold for $485,298.50, 1,400 shares of Reynolds Tobacco sold for $39,603.90, and 700 shares of Consolidated Gas sold for $91,959.50.
In some instances, due to variations in the market, the petitioner was required to pay additional sums to Dominick in order to maintain a proper margin.
In his income tax return for the year 1935 the petitioner reported a taxable gain of $276,288.73 as realized from the sale of Chrysler, Reynolds Tobacco, and Consolidated Gas stocks from his long account *591 and a capital loss of $395,521.57 as realized by covering his short commitments by his purchases made in the open market during December 1935. He returned a net capital loss of $2,000.
In his notice of deficiency the respondent proposed a deficiency of $305,636.09 on the ground that the petitioner*1103 was a stock trader and that as such he was not entitled to capital gain limitations on the profits from the above described sales from his long account. By his amended answer the respondent asserted a deficiency of not less than $93,962.85 on the ground that the liquidation of the petitioner's long and short positions was a single transaction and was "a mere form and without substance."
OPINION.
VAN FOSSAN: The respondent bases his contention that the petitioner is chargeable with taxable gain largely on the assumption and theory that the sale of the long stock, the purchase of the new stock, and the covering of the short sales constituted a single and indivisible transaction. He cites many cases to support the general principle that a single transaction may not be broken up into various elements in order to avoid a tax. He then argues that the steps taken by the petitioner were integral parts of a unified plan and affirms that the facts of record support his view.
It can not be gainsaid that the petitioner had the absolute right to establish and maintain both long and short accounts in the same stock. Article 117-6 of Regulations 86, 1 as well as the well known practices*1104 of the stock exchange recognize that right. The regulation deals with the results of its exercise. Article 117-6 provides in part:
* * * If, however, he covered the short sale by delivering shares which he held for more than one year but not for more than two years, only 80 per cent of the recognized gain or loss would be taken into account.
Thus the respondent's own regulation contemplates the taxpayer's right to maintain a long account as well as to purchase and own outright stock with which to cover his short sale commitments.
*1105 *592 The petitioner's object in establishing a short account in 1929 had no relation to tax avoidance. His purpose was to be able to offset possible losses due to a decline in the market with commensurable gains arising from his delivery of shares covering his short account at less than the contractual price. The consideration of tax-saving appeared in 1935 when he became acutely conscious that he was compelled to report as income dividends which were being credited to his long account but was unable to obtain any compensating offset or reduction of dividends which were being charged against him in his short account.
Under Regulation T of the Federal Reserve Board adopted pursuant to the provisions of the Securities Exchange Act of 1934, the petitioner's accounts became restricted and consequently he could not increase his debit balance with Dominick beyond its amount on October 14, 1934, the effective date of the regulation. Therefore, he was forced to close his long and short accounts simultaneously. He was advised that the proper method of accomplishing such liquidation was to buy stock on the open market to cover his short sales and to sell his long stock likewise*1106 on the open market. This he proceeded to do in December 1935.
While made concurrently, the petitioner's purchases and sales were wholly independent of each other. They follow the path outlined in the regulations and approved in principle in ; certiorari denied, , and . In those cases the respondent took a view opposite to that which he now proposes. There, the court and the Board held that the measure of gain or loss was confined to the value of the securities purchased in the open market and applied to the short sales account. This ruling is in harmony with Regulation 117-6, which requires inferentially that long and short accounts in the same stock be treated as separate accounts. Petitioner elected to close his short sales by making independent covering purchases on the market. This course he was justified in pursuing, whether he paid for them from the proceeds of sales from his long account or from any other source.
The petitioner's motive in protecting his long account with Dominick was wholly legitimate. The short sale device enabled*1107 him to do so. (See , for a comprehensive description of a short sale.) The respondent argues that the short sales were not transactions entered into for profit, as required by the statute. The obvious answer to this argument is that the petitioner relied on the anticipated gains from short sales to offset losses feared from the sale of stocks from his long account. The expectation of such gains was in fact the basic reason for his opening the short account. This was a profit motive.
*593 Respondent's third point is that the loss, if any, claimed by the petitioner was fully compensated for by insurance or otherwise and thus is not deductible. He bases this contention on his original theory that the petitioner's acts in selling stock from his long account and purchasing stock for his short account were interdependent and that thus the loss automatically was accompanied by a compensating gain. What we have said on this subject heretofore applies here. The petitioner chose to adopt the method which, under the principle approved in the duPont cases and in *1108 , affirming , enabled him to separate his covering purchases from his sales and to keep each type of transaction on an independent basis, from the viewpoint of taxation. The treatment of such purchases and sales was strictly in accord with his purpose and with his instructions to his brokers.
The stocks in both the long and short accounts were identified and traced as they progressed on their several ways. As we said in Henry F. duPont:
* * * We do not think that it can be doubted that, if the petitioner had in August 1932 instructed his brokers to close his short account by a covering purchase of 62,500 shares of duPont common stock and the purchase had been made, the gain or loss upon the transaction reflected in the short account would be the difference between the proceeds from the short sale and the cost of the covering purchase.
No sham or fictitious sales or purchases were made but every item clearly reflected the underlying legitimate purpose of the petitioner.
The petitioner is entitled to compute separately his gain and loss on the*1109 two types of transactions.
Decision will be entered under Rule 50.
Footnotes
1. ART. 117-6. Gains and losses from short sales.↩ - For income tax purposes, a short sale is not deemed to be consummated until delivery of property to cover the short sale, and the percentage of the recognized gain or loss to be taken into account under section 117(a) from a short sale shall be computed according to the perido for which the property so delivered was held. Thus, if a taxpayer made a short sale of shares of stock and covered the short sale by purchasing and delivering shares which he held for not more than one year, 100 per cent of the recognized gain or loss would be taken into account under section 117(a), even though he had on hand other shares of the same stock which he held for more than one year. If, however, he covered the short sale by delivering shares which he held for more than one year but not for more than two years, only 80 per cent of the recognized gain or loss would be taken into account. If the short sale is made through a broker and the broker borrows property to make delivery, the short sale is not deemed to be consummated until the obligation of the seller created by the short sale is finally discharged by delivery of property to the broker to replace the property borrowed by the broker.