*94 Decision will be entered under Rule 50.
1. Capital Gain -- Option -- Not Exercised -- Section 117 (g) (2). -- Petitioner sold stock in a corporation in 1940 and received from the corporation an option, then without value, to buy when he chose securities of the corporation at their 1940 values. He agreed with the corporation in 1942 for a cash consideration not to exercise the option. Held, the 1940 sale was closed for tax purposes in that year and section 117 (g) (2) applies to the 1942 transaction.
2. Capital Loss -- Transferee Paying Tax of Transferor -- Ordinary Loss. -- Payment of transferor's tax by a transferee is deductible as an ordinary loss and not as a capital loss. Stanley Switlik, 13 T. C. 121, followed.
3. Capital Gain -- Sale or Exchange -- Debt Retirement -- Section 117 (f). -- Commissioner, with burden of proof, failed to show debt was not retired within section 117 (f).
*244 The Commissioner determined a deficiency of $ 24,435.23 in income tax for 1943. The petitioner alleges that the Commissioner erroneously included in income for 1942 the entire $ 27,848.24 received from Cotwool Manufacturing Corporation which the petitioner reported as a long term capital gain and failed to allow as an ordinary loss deduction, $ 33,411.29 paid by the petitioner as a transferee during 1942, representing his share of Federal income tax deficiencies determined against Ellingwood Co. The Commissioner, by amended answer, alleges that he treated the gain from the payment of a Whitney Manufacturing Co. note as a short term capital gain when he should have treated it as ordinary income. One other issue raised in the petition has been settled by agreement.
FINDINGS OF FACT.
The petitioner filed his individual return with the collector of internal revenue for the third district of New York.
The petitioner, *96 and others, entered into an agreement with his brother, Gerrish H. Milliken, dated February 7, 1922, under which Gerrish agreed that he would purchase at current book value, any shares of Cotwool Securities Corporation (name changed later to Cotwool Manufacturing Corporation) at any time the petitioner might request.
The petitioner, in accordance with that agreement, called upon Gerrish on March 29, 1940, to buy 4,443 shares of Cotwool Manufacturing Corporation stock then owned by the petitioner. The book value of the stock, at that time, was over three times the fair market value of the underlying assets of the corporation. Gerrish explained to the petitioner the difficulty of purchasing at book value and offered to buy the stock at its fair market value.
The petitioner entered into an agreement with Cotwool and Gerrish dated June 28, 1940, under which he sold the 4,443 shares at their fair market value and, as further consideration, received the option to buy, at their fair market value on June 28, 1940, a proportionate part of the underlying assets of the corporation, at any time up to and including December 31, 1942. The option which the petitioner obtained in that contract *97 had no fair market value at that time and was not recognized as having any value by the petitioner in computing his gain on the sale of his stock.
*245 The option gave the petitioner the right to buy a $ 30,527.25 participation in demand notes of Whitney Manufacturing Co. for $ 3.05. He exercised that option on November 13, 1941, and he received $ 30,527.25 for his part of the notes on March 5, 1942. The record does not show that the $ 30,527.25 was not received by the petitioner upon the retirement of notes or certificates or other evidences of indebtedness issued by the debtor corporation with interest coupons or in registered form.
The petitioner reported his gain on the indebtedness of the Whitney corporation as a short term capital gain. The Commissioner, in determining the deficiency, made no change in this item.
The petitioner indicated in the early part of 1942 that he intended to exercise his option under the agreement of June 28, 1940, to buy certain specified securities owned by the corporation. He was advised that the corporation could not deduct a loss on a sale to the petitioner and would prefer to retain the securities but would pay him the difference between*98 the option prices and the current fair market values of the securities if he would not exercise the option. The petitioner agreed to that change. The corporation paid the petitioner $ 25,458.13 on February 19, 1942, and $ 2,390.11 on July 20, 1942, representing the difference between the option prices and the then fair market values of 12 securities which the petitioner had the right to buy under the agreement of June 28, 1940.
The petitioner reported the $ 27,848.24 on his return for 1942 as a long term capital gain. The Commissioner, in determining the deficiency, held that the entire amount was ordinary income.
The petitioner, as a transferee of Ellingwood Co., paid $ 33,411.29 in 1942 representing his pro rata share of deficiencies in taxes determined against the transferor corporation. He did not claim a deduction for that amount in his return for 1942 and the Commissioner did not allow a deduction in determining the deficiency.
The stipulation of facts filed by the parties is incorporated herein by this reference.
OPINION.
The petitioner contends that the $ 27,848.24 which he received in 1942 from Cotwool Manufacturing Corporation was a long term capital gain. One of his*99 theories seems to be that the receipt of this money in 1942 was an additional "amount realized" on the sale of his Cotwool Manufacturing stock in 1940. That theory is untenable. The evidence shows that the option had no fair market value when received. The fact that it was received by the petitioner in connection with the sale of his Cotwool Manufacturing Corporation stock does not keep that sale open for income tax purposes so that the amount here in question would represent an additional "amount *246 realized" on that 1940 sale. The 1940 transaction was a closed one for tax purposes at the time it occurred. The option was property and it had a zero basis in the hands of the petitioner from that time forward.
The petitioner's other theory on this point is that the option was a capital asset having a zero basis and was sold in 1942, so that the gain was a long term capital gain. A long term capital gain is defined in section 117 (a) (4) as the gain "from the sale or exchange of a capital asset held for more than 6 months." The words "sale or exchange" as used in section 117 may not be expanded to cover transactions which are not sales or exchanges. Property passes from*100 one person to another in a sale or an exchange. The option was property in the hands of the petitioner but it was nothing in the hands of the optionor and could not be transferred to it. The optionor could not give itself the right to buy its own assets at a fixed price. Thus, if the petitioner surrendered the option to the optionor for cash, the option ceased to exist. Also, if he merely allowed it to expire, it ceased to exist. The situation is similar in principle to that in which a debt is paid off or an obligation is fulfilled by the obligator, in which cases it has been held that no "sale or exchange" within the meaning of section 117 takes place. ; , affd., ; ; ; ; , dismissed, ;*101 ; ; . Cf. .
Congress has inserted some special provisions into the Internal Revenue Code requiring that certain transactions, which are actually neither sales nor exchanges, be treated as sales or exchanges for the purpose of section 117. See section 115 (c) and section 117 (f). One of those special provisions is section 117 (g) (2) which provides that "gains or losses attributable to the failure to exercise privileges or options to buy or sell property shall be considered as short-term capital gains or losses." This provision came into the law as section 117 (e) (2) of the Revenue Act of 1934 at which time the following comment was made in the Conference Report (73d Cong., 2d Sess. H. Rept. 1385 p. 23):
Finally, under the amendment it is the gains or losses attributable to "the failure to exercise" privileges or options to buy or sell property and not all gains or losses attributable to such privileges*102 or options which are to be treated, as a matter of law and without regard to varying circumstances, as gains or losses from sales or exchanges of capital assets held for 1 year or less.
An option can be sold or exchanged, in which case the general provisions *247 of section 117 apply. But if gain results from a failure to exercise it, section 117 (g) (2) applies. Here the petitioner was paid for failing to exercise his option. A gain resulted. The transaction is thus literally within the words of section 117 (g) (2) and the gain must be treated as a short term capital gain. Cf. .
The next contention of the petitioner is that he is entitled to a deduction of $ 33,411.29 for 1942, representing the entire amount which he paid as his pro rata share of a tax deficiency determined against his transferor, Ellingwood Co. The Commissioner contends it was a long term capital loss. This issue is controlled by the decision of this Court in , in which it was held that a similar payment gave rise to an ordinary deduction for loss and did not constitute *103 a capital loss.
The next issue is one on which the Commissioner has the burden of proof. The petitioner reported his gain from the payment of an indebtedness due from Whitney Manufacturing Co. as a short term capital gain. The Commissioner made no change in determining the deficiency but, by an amended answer, now claims that the payment of the debt was ordinary income rather than a short term capital gain. Section 117 (f) provides that amounts received by the holder upon the retirement of bonds, debentures, notes or certificates or other evidences of indebtedness issued by any corporation, with interest coupons or in registered form shall be considered as amounts received in exchange therefor. Section 117 (a) defines short term capital gain as the gain from the sale or exchange of a capital asset held for not more than 6 months. The period during which the petitioner owned the indebtedness was less than 6 months. The respondent has failed to show that the $ 30,524.20 was not received by the petitioner upon the retirement of notes or certificates or other evidences of indebtedness issued by a corporation with interest coupons or in registered form and, hence, for that reason, *104 if for no other, has failed to show that the petitioner did not correctly report his gain from the payment of this debt.
Decision will be entered under Rule 50.