*3772 1. Petitioner sold building lots under contracts by which he agreed to grade the street and lay a sidewalk in front of each lot. Held, on the particular facts disclosed, that the expense actually incurred in the grading of streets and laying of sidewalks should be included in the basis for determining gain resulting from sale of such lots.
2. Penalty for negligence allowed.
3. Penalty for fraud disallowed.
*569 This appeal is from the determination of deficiencies in income and profits taxes for the years 1919 and 1920, and the proposed assertion of 5 per cent penalty for negligence, provided by section 250(b) of the Revenue Act of 1918. The deficiencies in tax found by the respondent in his deficiency notice, and appealed from by the petitioner, were as follows:
| Year | Tax | Penalty | Total |
| 1919 | $3,082.78 | $297.18 | $3,379.96 |
| 1920 | 29,268.22 | 1,924.49 | 31,192.71 |
| Aggregates | 32,351.00 | 2,221.67 | 34,572.67 |
*570 At the close of the trial the respondent moved for the imposition of*3773 the fraud penalty as provided in section 250(b) of the Revenue Act of 1918. Three issues are, therefore, involved, viz: (1) Whether under the facts hereinafter found, the estimated and unincurred expense of grading streets and laying sidewalks should be included in the cost of building lots for the purpose of determining gain from the sale thereof; (2) whether a 5 per cent penalty for negligence shall be imposed on the petitioner for each of the taxable years involved, and; (3) whether the fraud penalty should be imposed on the petitioner for each of the taxable years involved. The petitioner waived an allegation of error respecting the disallowance by the respondent of claimed business expenses for 1919 in the amount of $10,308.70.
FINDINGS OF FACT.
The petitioner's business during 1919 and 1920 was buying acreage tracts of land at Newton Falls, Ohio, subdividing them into home sites and lots, and selling such lots. These sales were made through employed salesmen to whom petitioner paid a commission of 40 per cent. The terms of sales were, usually, an initial payment of about one-half of the purchase price, and the remainder on monthly installments which would be paid out*3774 in a few years. The petitioner's business was transacted under the trade name of "United States Realty and Security."
At the time of sale a contract was drawn and signed only by the grantor, the grantor's signature being as follows: "United States Realty and Security, by Milton A. Mackay, General Manager." Milton A. Mackay's signature was under seal. Each contract contained, among others, the following provisions in heavy leaded type:
Party of the first part agrees to pay all city, county and state taxes legally assessed against said premises which are due and payable during the first year from this date, and second party to pay all taxes thereafter. And said company agrees to grade the street in front of said lot, and lay sidewalk in front thereof at its expense. (Italics ours.)
The petitioner sold 392 lots in 1919, and 1,380 lots in 1920, or a total of 1,772 lots for both years.
During 1919 and 1920, the petitioner laid sidewalks on a total of 305 lots. He does not know how many such sidewalks were laid in each particular year. Those sidewalks which were actually laid during 1919 and 1920 were done by the petitioner's own engineering department at an average cost*3775 of $38.34 per lot. Had such sidewalks been laid during 1919 and 1920 by an independent contractor, they would have cost substantially in excess of $38.34 per lot.
In 1923 the petitioner tamped the footways adjacent to lots sold by him, ready for sidewalks, and laid cinders in front of 92 such *571 lots, but no concrete has yet been laid. (The hearing in this proceeding was held December 9, 1926.) Further construction of sidewalks was stopped on account of grading streets and the fact that the subdivisions were not built up, and because if sidewalks were laid before the building and street grading were completed, they would be destroyed. The petitioner had some requests from purchasers to build sidewalks, and, in some of these cases, he did not build the sidewalks.
The method employed by the petitioner in handling certain traveling expenses of salesmen and prospective purchasers was as follows: The agent would bring a prospective purchaser, and the petitioner would assume all costs of travel to the subdivision, from Pittsburgh and return, and charge the same to expense. On each Monday morning the agent would be required, whether he sold any lots or not, to sign a check*3776 equivalent to the number of customers he handled during the preceding week, at the rate of $7.50 per person. This check would be deposited in the petitioner's bank. These amounts were not credited to expense or included in income in any other way.
Petitioner did not keep his own books during 1919 and 1920; he had no experience in bookkeeping or the principles underlying bookkeeping; he was not familiar with his own books or the method employed in keeping them, except the customers' ledger in which payments were recorded. He did not attempt to supervise the work of bookkeeping. He did not personally prepare his income-tax returns for the years 1919 and 1920, but the same were prepared by his bookkeeper and checked by a certified public accountant who spent about five days in checking the same and advised the petitioner that they were correct. The petitioner knew, however, that these amounts involving traveling expenses of purchasers and prospective purchasers were coming out of the agent's checks for commissions. He also knew that said items were charged to the agent and going into expenses. He knew that he was getting back $7.50 for every man handled on the above-mentioned*3777 trips, but testified that he did not realize that it represented a recovery or reduction of expenses or should be added back to income. The petitioner made no recheck of any amount shown in the returns prepared as above stated. He paid no attention whatsoever to what was in it, but just signed what was put before him. In 1921, but after the filing of the 1919 and 1920 returns, the petitioner changed his method of handling these traveling expenses upon advise of a new bookkeeper employed by him.
OPINION.
LANSDON: During the taxable years the petitioner sold 1,772 lots. Each lot was sold on representation to the purchasers that a cement sidewalk would be constructed in front thereof at the cost of the *572 vendor and the contract of sale in every instance included the provtsion as to such construction, which we have quoted above. Wtthin the years involved cement sidewalks were laid on 305 lots, at an average cost of $38.34, or a total of $11,693.70. At this rate it would have cost $67,938.48 to lay sidewalks on all the lots so sold in such years. At the date of hearing there had been no additional cement sidewalk construction.
The petitioner contends that under*3778 the provision of his sales contract he is obligated to build cement sidewalks on all the lots sold and that the cost of such construction is a capital outlay and should be included in the basis for determining gain or loss resulting from sales of lots. He, therefore, contends that the amount of $67,938.48 should be added to his other capital investments in the lots sold in the taxable years and included in the amounts that he is entitled to recover by sale before any gain is realized. The respondent concedes that the cost of constructing the sidewalks is a capital outlay, allows such cost in the amount of $11,694.19, which was actually expended in the taxable years, and disallows the remainder on the theory that the contract is not an enforceable obligation of the petitioner and that his conduct indicates that he did not accept the liability or intend to build any more sidewalks after the end of the taxable years.
There is no evidence that any of the sales contracts had been surrendered on or before December 31, 1920, or that any other action to render them void or unenforceable had been taken. We are of the opinion that the sidewalk clause was an enforceable provision of the*3779 contract. It was executed in Pennsylvania, but, as it related entirely to the sale of land located in Ohio, performance must necessarily be in the latter State. "A contract made in one State * * * to be performed in another, is governed by the laws of the latter State, which determines its validity, obligation and effect." Pittsburgh C.C. & St. L. Ry. Co. v. Sheppard,56 Oh.St. 68; 46 N.E. 61">46 N.E. 61. Montana Coal & Coke Co. v. Cincinnati C. & C. Co.,69 Oh.St. 351; 69 N.E. 613">69 N.E. 613. "A party to a contract actually entered into, can not by his own action, release himself of liability thereunder, where no right to do so is reserved in the contract itself." Cincinnati v. Edison Electric Co.,9 Ohio Dec. 438">9 Ohio Dec. 438. The claim advanced by the respondent that the contract was unenforceable and assumed to be sustained by the admission of evidence which tended to show that in October, 1921, the petitioner was attempting to avoid performance by subterfuge or evasion is without force either at law or in equity. The language is clear and neither requires nor admits of construction.
The contention of the petitioner that*3780 the cost of the land subdivided and sold as this was includes not only the original price, but the cost of building the sidewalks, is sustained by the authorities, *573 including the respondent. Improvements add pro tanto to the value of the thing purchased. Montgomery, in his work entitled Auditing, Theory and Practice, Vol. II, p. 278, says: "Only such part of expenses as really adds to the value of the property, such as the grading and paving of streets, the cost of water and sewer installation, etc., is a proper addition to the capital account." "In some cases land development companies incorporate in the agreements of sale to purchasers of lots, definite agreements to make improvements, such as street paving, gutters and sidewalks. * * * If such improvements have not been contracted for, an amount sufficient to cover the cost of these improvements should be charged to the cost of lots and credited to a reserve account. This is necessary in order to determine the profit earned on sales of this kind." Id., p. 282.
The only reference to this matter we find in rulings of the Bureau of Internal Revenue are in Cumulative Bulletin No. 1, p. 76, and Cumulative Bulletin*3781 No. 3, p. 108. The former is Office Decision 226:
Where building lots contained in a given tract of land are sold before the contemplated development work is completed, the profit realized should be determined on the basis of the cost of the land, or its fair market value on March 1, 1913, if acquired prior to that date, plus actual and estimated future expenditures for the development of the property in accordance with the contract of sale.
The latter is Office Decision 567:
Profit realized on the sale of lots, the selling price of which includes the cost of certain development work already made or to be made in accordance with the contract of sale, should be based on the cost of the land to the vendor, or its fair market value as of March 1, 1913, if acquired prior to that date, plus that actual and estimated future expenditures for development.
It may be observed that both of these rulings relate to section 213(a) of the Revenue Act of 1918, under which the taxes are defined. While these orders are stated by the Bureau of Internal Revenue to "have none of the force or effect of treasury decisions" they "constitute a service of information from which taxpayers and their*3782 counsel may obtain the best available indication of the trend and tendency of official opinion in the administration of the income and profits tax provisions of the Revenue Acts," and when repeated in substance, as here, are very persuasive as to the best thought of the respondent's office. The Board considers them to be a correct exposition of the law, and directly applicable to the instant case. We are of the opinion that the petitioner was liable to all purchasers of lots for the construction of cement sidewalks. The evidence is conclusive that the cost of the walks constructed in the taxable years was $38.34 per lot. The petitioner sold each lot subject to a burden of at least this amount, which we believe should be included in the basis for the determination of gain or loss from the sale thereof.
*574 The evidence adduced by the petitioner against the assessment of the 5 per cent penalty for negligence in the rendition of his tax returns is not convincing. On this issue the respondent is approved. We are convinced that the respondent has not sustained the burden of proof necessary to establish his affirmative allegation of fraud The penalty for fraud is disallowed. *3783 The petitioner abandoned his claim for a deduction from gross income of an amount of $10,308.70 alleged to represent ordinary and necessary expenses and on this issue the respondent is sustained.
Reviewed by the Board.
Judgment will be entered on 10 days' notice, under Rule 50.
STERNHAGEN and ARUNDELL dissent.