*263 Decision will be entered for the respondent.
In 1927, decedent borrowed $ 125,000 from a bank on his promissory note and pledged mortgages aggregating $ 180,000 as security therefor. When the mortgages were not paid when due, decedent refrained from foreclosing; and the parties liable on the mortgages indorsed decedent's note to the bank, decedent signing as maker. Petitioners claim decedent became the accommodation maker of the note and that the mortgagors became the accommodated indorsers, that they were therefore primarily liable on the note, and that the amounts decedent paid to the bank on the note from 1933 through 1945 constituted a loss or a bad debt. Respondent contends decedent was not an accommodation maker, that he was primarily liable on the note, that the note evidenced his own personal indebtedness to the bank, and that a taxpayer can not deduct as a loss or a bad debt amounts he repays on his own indebtedness. Held, under all the facts, petitioners have failed to prove that decedent was, in fact, an accommodation maker; and, therefore, no amount paid by decedent to the bank on such indebtedness is deductible either as a loss or as a bad debt.
*1435 Respondent determined a deficiency in income tax for the year 1945 in the amount of $ 13,403.21. The sole *265 issue is whether petitioners are entitled to a deduction of $ 31,839.43 or any part of such amount as a loss under section 23 (e) (1) or ( 2) of the Internal Revenue Code or as a bad debt under section 23 (k) (1) of the Code for payments made on a promissory note to a bank dated May 5, 1932, in the amount of $ 62,500 on which note Ernest Schwehm (hereinafter referred to as decedent) appears as maker and two other individuals as indorsers.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein.
Decedent died on August 9, 1951, after the hearing in this case; and petitioners, the duly qualified executors of his estate, have been substituted for decedent after his death.
*1436 Decedent's income tax return was filed for the year in question, 1945, with the collector of internal revenue for the first district of Pennsylvania at Philadelphia, Pennsylvania.
In 1917, decedent purchased certain commercial real estate in Atlantic City, New Jersey, consisting of four contiguous parcels (hereinafter referred to as parcels A, B, C, and D) part of which fronted on the Boardwalk in Atlantic City. This property was purchased by decedent*266 as a unit for a consideration of $ 286,632.65, consisting of cash in the amount of $ 166,632.65 and subject to a first mortgage of $ 120,000 against parcels B, C, and D. Decedent assumed no personal liability for such mortgage. Parcel A was purchased by decedent free and clear of any encumbrances.
On January 15, 1923, decedent sold this property as a unit to one Max Kornfeld (hereinafter referred to as Kornfeld) for a consideration of $ 369,948.86. Decedent reported the difference between the purchase and selling price on his income tax return for 1923 and paid the tax attributable to the capital gain resulting therefrom. The consideration paid by Kornfeld consisted of cash in the amount of $ 69,948.86, the taking of title to parcels B, C, and D subject to the $ 120,000 mortgage on such parcels, and bonds by Kornfeld to decedent secured by purchase money mortgages by Kornfeld to decedent as follows:
| Parcel A, Bond and First Mortgage | $ 35,000 |
| Parcel B, Bond and Second Mortgage | 55,000 |
| Parcel C, Bond and Second Mortgage | 20,000 |
| Parcel D, Bond and Second Mortgage | 70,000 |
| Total | $ 180,000 |
The bonds and mortgages by Kornfeld to decedent were dated January 15, 1923, *267 with a maturity date of January 15, 1930. By deed dated March 15, 1923, Kornfeld conveyed his legal title to parcels A, B, C, and D to the Bankers Trust Company, Trustee, a New Jersey corporation doing business in Atlantic City, which held the title in trust for Louis Needles (a 35 per cent interest), Kornfeld (a 30 per cent interest), and Harry G. Sundheim, Stanley Folz, and Herbert P. Sundheim (a 35 per cent interest). The conveyance for their benefit was made subject to the payment of the bonds and mortgages aggregating $ 180,000 from Kornfeld to decedent and subject to the first mortgage on parcels B, C, and D.
On October 10, 1927, decedent obtained a loan of $ 125,000 from the Broad Street Trust Company of Philadelphia, Pennsylvania (hereinafter referred to as the Bank) evidenced by a personal demand note executed by decedent as maker. As security for the payment of the note, decedent pledged to the Bank the mortgages aggregating $ 180,000 running from Kornfeld to decedent. The demand note *1437 contained a recital of these pledged mortgages. The Kornfeld mortgages were not paid when they fell due on January 15, 1930.
During February or March, 1930, decedent received*268 an offer of about $ 400,000 for the purchase of the four parcels from H. G. Myers, a real estate broker in Atlantic City. Myers urged decedent to retake title to the property and accept the offer. Decedent considered foreclosing the mortgages and accepting the offer, but decided not to do so.
In the minutes of a meeting held by the board of directors of the Bank on January 15, 1930, the following appears:
The application of Ernest Schwehm for an extension of a demand loan of $ 125,000 secured by mortgages aggregating $ 180,000 and collateral security for a period of six months was, upon motion, approved.
The following motion appears in the minutes of a meeting of the board of directors of the Bank held on June 18, 1930:
Upon motion, resolved that we grant an extension of six months on loan of Ernest Schwehm for $ 125,000, providing $ 40,000 reduction be made and renewal note bear the endorsements of Max Kornfeld, Harry Sundheim and Needles, and also that receipted, the tax bill for the first half for 1930 be produced.
On July 16, 1930, Kornfeld, Harry G. Sundheim (hereinafter referred to as Sundheim), and Needles paid the Bank $ 40,000, which payment was applied on the $ 180,000*269 due under the Kornfeld mortgages reducing the principal due thereon to $ 140,000. At the same time, the Bank credited the said $ 40,000 to decedent's demand note of $ 125,000 to the Bank reducing the principal due thereon to $ 85,000. A new demand note dated July 16, 1930, was taken by the Bank in the amount of $ 85,000. It was signed by decedent on its face and on the back by Kornfeld, Sundheim, and Needles. The face of the note showed that the Kornfeld mortgages were repledged as security for this new note. Decedent's $ 125,000 note was canceled.
Kornfeld, Sundheim, and Needles made various payments to the Bank which the Bank applied to the principal due under the Kornfeld mortgages and also credited to the notes, as follows:
| Date | Amount |
| March 3, 1931 | $ 10,000 |
| April 1, 1931 | 10,000 |
| October 5, 1931 | 2,500 |
Between July 16, 1930, and May 5, 1932, various notes were executed representing this indebtness to the Bank. Each new note resulted in the cancelation of the prior note. On each note decedent signed as maker; and on all notes up to and including the one dated August 3, 1931, in the amount of $ 65,000 maturing 1 month thereafter, Kornfeld, Sundheim, and Needles*270 signed on the back as indorsers. The note dated September 3, 1931, in the amount of $ 65,000 maturing 1 *1438 month thereafter, was indorsed by Sundheim and Needles; and a note dated October 5, 1931, in the amount of $ 62,500 maturing 2 months thereafter, was signed on the back by decedent, Kornfeld, Sundheim, and Needles.
Kornfeld died on October 25, 1931, without leaving an estate from which his indebtedness to decedent on the mortgages or his liability, if any, to the Bank under the note of October 5, 1931, could be paid.
The other notes from December 7, 1931, up to and including the one of May 5, 1932, were signed on the back by Sundheim and Needles. Each of the notes on its face showed that the mortgages on parcels A, B, C, and D were held as collateral. The Bank's records also listed the indorsements of Kornfeld, Needles, and Sundheim, and subsequently of Needles and Sundheim, as collateral. The note of May 5, 1932, was a demand note in the amount of $ 62,500, and it is upon this note that decedent based his claim for a deduction in the taxable year 1945.
The holders of the first mortgage on parcels B, C, and D instituted foreclosure proceedings on October 11, 1932, *271 and on April 21, 1933, a sheriff's deed was issued to them. The second mortgages on parcels B, C, and D were wiped out by this proceeding as were all the rights, titles, and interests of the mortgagors and the mortgagee of the second mortgages.
On November 27, 1933, the Bank, as pledgee of the first mortgage on parcel A in the amount of $ 35,000, brought foreclosure proceedings in Atlantic City on said parcel A, and a sheriff's deed was issued to the Bank on said parcel on April 2, 1934. On May 16, 1934, the Bank conveyed parcel A to decedent by deed; and on that same date, decedent executed and delivered a mortgage on said parcel to the Bank in the amount of $ 35,000 with a maturity date of one year. This mortgage was given to the Bank as security for payment on the outstanding balance then due on the note of May 5, 1932.
Decedent made the following payments to the Bank in reduction of the face amount of $ 62,500 note to the Bank dated May 5, 1932:
| Date of payment | Amount |
| 1/13/33 | $ 15,000.00 |
| 2/14/33 | 828.18 |
| 9/29/33 | 2,000.00 |
| 6/19/34 | 510.00 |
| 10/3/40 | 30.00 |
| 11/22/40 | 25.00 |
| 11/16/41 | 204.00 |
| 2/27/41 | 1,346.17 |
| 2/27/41 | 300.00 |
| 10/1/42 | 196.08 |
From November 1942 through October*272 1945 decedent made monthly payments in the amount of $ 300 per month to the Bank.
*1439 On February 11, 1941, decedent, his wife, and the Bank entered into an agreement, pertinent provisions of which were as follows:
SCHWEHM is indebted to TRUST COMPANY [the Bank] in the sum of $ 49,828.24 with interest thereon from January 1, 1941, on (a) a certain collateral note dated May 5, 1932, originally in the sum of $ 62,500., now reduced to $ 43,902.82, said collateral note being endorsed by Louis Needles and Harry G. Sundheim, for which SCHWEHM originally deposited certain collateral security of which there remains only a bond and mortgage dated May 16, 1934, recorded at Atlantic County in Book No. 611 of Mortgages, page 437 &c., to secure payment of $ 35,000., * * *.
* * * *
The debt is overdue, and payment thereof has been demanded by TRUST COMPANY. SCHWEHM has requested a postponement of the time of payment on the terms hereinafter set forth, and TRUST COMPANY is willing to grant same, and further is willing not to contest the validity of certain transfers heretofore made by SCHWEHM to MRS. SCHWEHM.
In 1936, the Bank instituted proceedings against Sundheim and Needles on the promissory*273 note to the Bank dated May 5, 1932, for the purpose of collecting the balance remaining due on said note. Sundheim and Needles each denied in his affidavit of defense that he was the maker of the note, and affirmatively alleged that he had indorsed the note for the accommodation and benefit of decedent and impleaded decedent as a defendant. At the time of the institution of this suit, decedent was a director of the Bank, having been one from at least 1927 and continuing in such capacity to at least the date of the hearing of this case.
On October 27, 1945, the parties to this law suit (the Bank, decedent, Needles, and Sundheim) consummated a settlement under the terms of which Needles and Sundheim paid the net sum of $ 2,900 to the Bank. The remainder of the payment ($ 350) was kept by decedent's attorneys for the services they rendered. The suits instituted by the Bank against Needles and Sundheim were withdrawn; and releases dated September 27, 1945, were exchanged among the decedent, Sundheim, and Needles, and among the Bank, Sundheim, and Needles.
On October 13, 1945, as a part of the settlement arrangements, decedent executed a new note to the Bank in the amount of $ 31,260.57*274 which did not bear the signature of either Sundheim or Needles. This note was reduced to $ 28,360.57 by the $ 2,900 payment of October 27, 1945. Decedent made payments on this new note of $ 300 monthly for each month from November 19, 1945, through January 1950. In January 1950 decedent made an additional payment of $ 13,060.57 which satisfied in full the amount due the Bank.
Sundheim became financially worthless and judgment proof prior to 1940 and remained so up to and through the year 1945. Needles, although thought by the Bank and by decedent to be financially *1440 worthless, was always solvent up to and until consummation of the 1945 settlement.
In his individual tax return for 1945, decedent claimed a bad debt deduction of $ 114,600 based on the defaulted balance on the Kornfeld mortgages. In his petition, decedent pleaded alternatively that he was entitled to a deduction of $ 114,600, or of $ 31,839.43. The latter amount was claimed to be the loss decedent suffered on the note. At the hearing, the claim for the deduction of $ 114,600 as a loss resulting from the defaulted mortgages was abandoned, and the case has proceeded on the question of the loss, if any, incurred*275 on the note to the Bank which decedent signed as maker and which was indorsed by Sundheim and Needles.
Petitioners have failed to prove that the decedent, the maker of the note of May 5, 1932, was merely an accommodating party on said note, and that the accommodated parties were Sundheim and Needles, and, as a result, have failed to prove that decedent either suffered a loss or a bad debt in 1945 based on said note.
OPINION.
The issue to be decided is whether decedent, upon the releases given to Needles and Sundheim in 1945, incurred a deductible loss in that year for payments which he made to the Bank from January 13, 1933, through October 27, 1945, in the amount of $ 31,239.43 and for two payments to the Bank totaling $ 600 he made in November and December, 1945.
Petitioner's claim that they are entitled to the deduction is based on the theory that the series of notes executed from July 16, 1930, through May 5, 1932, were accommodation notes. They maintain that decedent became an accommodation maker and that Kornfeld, Sundheim, and Needles, and (after Kornfeld's death) Sundheim and Needles, became the accommodated parties; that they were therefore liable on the note; and that the*276 amounts decedent paid to the Bank on the note from 1933 through 1945 constituted a loss under section 23 (e) (1) or (2), or a bad debt under section 23 (k) (1) of the Internal Revenue Code. 1
*277 *1441 Respondent contends that decedent was not an accommodation maker, that he was primarily liable on the note, that the note evidenced his own personal indebtedness to the Bank, and that a taxpayer cannot deduct as a loss or bad debt the amount he repays on his own indebtedness.
56 Pa. Stat. § 66 (N. I. L. § 29) provides:
An accommodation party is one who has signed the instrument as maker, drawer, acceptor or indorser, without receiving value therefor, and for the purpose of lending his name to some other person.
Who is the accommodated party is a question of fact, and, except in certain instances not present here, parol evidence can be introduced to show lack of consideration between the accommodated and accommodating parties. See Hess v. Gowen, 11 A. 2d 787 (Super. Ct. Pa. 1940); Western National Bank of York v. Levin, 200 A. 71">200 A. 71, 331 Pa. 113">331 Pa. 113 (1938). The original note for the debt of $ 125,000 between decedent and the Bank was executed by decedent as the maker, and was evidence of a loan decedent obtained from the Bank on October 10, 1927. This was a demand note, and, as security, decedent*278 pledged to the Bank the Kornfeld mortgages aggregating $ 180,000. A recital of these pledged mortgages was contained in the note. Petitioners maintain that when these mortgages were not paid on their due date, and decedent received an offer for the purchase of the four parcels from a real estate broker in Atlantic City, decedent agreed not to foreclose the mortgages and accept the offer if Kornfeld, Needles, and Sundheim would undertake to pay off decedent's liability to the Bank.
We feel that petitioners have failed to prove that this was the exact nature of the transaction. Decedent's testimony on this point was as follows:
Q. Was that offer rejected by the owners of the property?A. Rejected by me, because simple as it is, these people down there didn't want me to foreclose because they wanted to pay it off in the installment plan, see, and they said that it wouldn't be fair to those men because they were samaritans and very good people, very liberal, and I should not foreclose on them because --
Q. Let me ask you: Did you give consideration to foreclosing on the property?
A. Oh, yes. Oh, yes. I had until --Q. Just answer my questions. But you refrained from foreclosing, *279 I understand?
A. I did on account of they gave the $ 40,000 to start with, see.
Q. Well, now, did they make any promises to you?A. They promised me that they would pay it, whatever it was, that they would pay it. I would never have to worry about it because they would see that they paid it.
*1442 Q. That they would pay what, Mr. Schwehm?
A. The mortgages.Q. The mortgages? Was anything said about your note to the bank?A. Why, yes. They went up the bank and done all this work -- all this work was done by the Broad Street Trust Company.
Q. Was their promise to pay your note to the bank?A. That is right.Q. Now, we speak of "they". Whom do you mean by "they"?A. You see, what they had to do is to pay --Q. Who is "they", Mr. Schwehm?A. The bank, they had the notes.Q. Yes, but the owners of the property were Mr. Sundheim and Mr. Needles and Mr. Kornfeld?
A. Yes; and they are the ones that agreed to pay for it. They said, "It is nothing to worry about, we will pay for it. And we will see that you get the money."
Q. After they made that promise to you you refrained from foreclosing, is that correct?
A. That is right, yes.Q. Did they put their promise in writing?A. No, *280 they did not. I know that Mr. Salus, he was the man that was there, and he said it would be all right because they have been reputable men and they will pay it.
Q. And who gave you the promise to pay? Did Mr. --A. Mr. Sundheim, Mr. Needles, and Mr. Salus too, he said that he would --
Such statements as are indicated by the above testimony as having been made to decedent may be interpreted in one of two ways: On the one hand, they could indicate that those parties were undertaking to pay the Bank, and, on the other, that they were undertaking to pay off the mortgages, and that such money would be available to reduce the indebtedness to the Bank. We feel that the record of this case indicates that the latter interpretation is the one which was meant by the parties involved.
The minutes of a meeting of the board of directors of the Bank held on June 18, 1930, show the following:
Upon motion, resolved that we grant an extension of six months on loan of Ernest Schwehm for $ 125,000, providing $ 40,000 reduction be made and renewal note bear the endorsements of Max Kornfeld, Harry Sundheim and Needles, and also that receipted, the tax bill for the first half of 1930 be produced.
*281 The treatment of the entire transaction by the Bank also indicates that it still considered decedent the primary obligor for the debt. The notes still were drawn with decedent as the maker, and recited on the face that the Kornfeld mortgages were pledged as collateral security for the debt. As payments were made on these mortgages by Kornfeld, Sundheim, and Needles, the Bank applied the payments to the principal due under the mortgages, and then also credited such amounts against the indebtedness appearing on the notes. The Bank's *1443 records listed the indorsement of Kornfeld, Needles, and Sundheim, and subsequently Needles and Sundheim, as collateral.
While it is true that the Bank in 1936 instituted proceedings against Sundheim and Needles on the promissory note dated May 5, 1932, it must be remembered that from at least 1927 through the date of the hearing in the instant case decedent was a director of the Bank. Sundheim and Needles each affirmatively alleged in his affidavit of defense that he had indorsed the note for the accommodation and benefit of the decedent and impleaded the decedent as a defendant. Such suit never came to trial and dragged on until finally*282 settled in 1945 by a payment of $ 3,250 by Sundheim and Needles. Needless testified that this amount was paid on Sundheim's advice merely to forego the expense of a law suit.
Under all the facts discussed above, plus all others appearing in the record, we feel that petitioners have failed to show that decedent, in fact, was an accommodation maker of the note. The debt arose from a loan by the Bank to decedent which was not paid, and time for payment was extended when decedent obtained the indorsements of Kornfeld, Sundheim, and Needles. The evidence has failed to show that there ever was a substitution of the party or parties primarily liable on the debt, and petitioners have failed to show that decedent did not, at all times, remain the primary obligor. Under such circumstances, we feel that respondent did not err in refusing to allow any deduction for the year 1945 based on the payments to the Bank by decedent on said note, since a taxpayer may not deduct payments made on his own debt.
Decision will be entered for the respondent.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
* * * *
(e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise --
(1) if incurred in trade or business; or
(2) if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *
* * * *
(k) Bad Debts. --
(1) General Rule. -- Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. This paragraph shall not apply in the case of a taxpayer, other than a bank, as defined in section 104, with respect to a debt evidenced by a security as defined in paragraph (3) of this subsection. This paragraph shall not apply in the case of a taxpayer, other than a corporation, with respect to a nonbusiness debt, as defined in paragraph (4) of this subsection.↩