*1678 1. Where property is sold subject to a mortgage the amount of which exceeds the basis to the seller, the excess must be considered as a part of the "initial payments" in determining whether or not section 212(d) applies.
2. Unamortized bond discount is deductible when the mortgaged property is sold subject to the mortgage. Following S. & L. Building Corporation,19 B.T.A. 788">19 B.T.A. 788.
3. Interest is not a part of the cost of a building.
*220 The Commissioner determined a deficiency of $7,594.23 in the petitioner's income-tax liability for the calendar year 1926. The petitioner assigned as errors: (1) The Commissioner's treatment of the sale of a building as a closed transaction in 1926 instead of 1927; (2) if the sale took place in 1926, (a) his computation of the portion, if any, of the taxable profit thereon properly to be reported in 1926 by using five-thirds instead of five-elevenths of the initial payment, (b) his failure to reduce the profit*1679 by $85,000 representing worthless notes received as part of the purchase price, (c) his failure to allow a deduction of $79,345.46 representing unamortized bond discount on bonds secured by a mortgage on this building; (3) his failure to allow a deduction of $150,000 representing interest accrued in 1926. At the hearing the Commissioner amended his answer to allege that he had erred in including in income for 1926 only $166,778.96, on the basis of an installment sale, when he should have included the entire profit of $500,336.88, since it was not an installment sale.
FINDINGS OF FACT.
The petitioner is a corporation organized and existing under the laws of Texas. Its books were kept on an accrual basis during 1926 and subsequent years.
A contract, dated December 31, 1926, between the petitioner and the Marine Bank & Trust Company was in part as follows:
Know all men by these Presents: That Metropolitan Properties Corporation, a Texas Corporation, domiciled in Harris County, Texas, for and in consideration of $300,000 paid in installments as follows:
One Hundred Thousand Dollars in cash, receipt of which is hereby acknowledged, and $115,000.00 in cash within one year*1680 from date hereof, and $85,000.00 in sundry notes within one year from date hereof, has granted, *221 bargained, sold and conveyed and by these presents does hereby grant, bargain, sell and convey unto Marine Bank and Trust Company, also a Texas Corporation domiciled in Harris County, Texas, the following: * * *
The instrument contained a description of the property, and the usual warranties of title. It provided that "the grantee herein takes the title herein conveyed subject to those certain liens preserved in two deeds of trust bearing date the first day of December, A.D., 1926, from the grantor herein to Melvin L. Strauss, Trustee * * *." It further provided that 8/33 of the indebtedness secured by the trust deeds was properly allocable to the property conveyed. There were further provisions with respect to the rights of the petitioner in case of default in payments by the purchaser. The instrument concluded as follows: "Executed at Houston, Texas, this 31st day of December, 1926."
Another instrument dated December 31, 1926, the parties to which were the petitioner and the Marine Bank & Trust Company, was in part as follows:
That, WHEREAS, heretofore on December*1681 31st, 1926, the Bank purchased from the Seller what is known as the Keystone Building, improvements, and the Ninety-nine (99) year leasehold estate upon which the same is situated, in the City of Houston, Harris County, Texas, the leasehold estate being created by that certain lease contract of date July 1st, 1922, from N. D. Naman to J. W. Colvin, recorded in the Contract Records of Harris County, Texas, in Volume 77, page 565, at and for the consideration of the sum of Three Hundred Thousand Dollars ($300,000.00), payable:
* * *
WHEREAS, said purchase was made subject to, and the Deed of Conveyance from Seller to the Bank recites that the purchase was made subject to the liens, requirements and obligations of those two certain Deeds of Trust executed by the Seller to S. W. Straus & Company, and of date December 1st, 1926, to secure the payment of THREE MILLION, THREE HUNDRED THOUSAND DOLLARS ($3,300,000.00) of bonds; and
WHEREAS, it is desired that the recitation in said Deed of Conveyance that same was made subject to the liens, requirements and obligations of said Deeds of Trust should be construed by the parties: * * *
The instrument then provided that, as between the*1682 petitioner and the bank, the latter had purchased the Keystone Building subject to 8/33 of the liens, requirements, and obligations of the deeds of trust, which had been executed by the petitioner to S. W. Straus & Company; the bank was to be given notice when payments under the trust deeds were due, and was to deposit 8/33 of the total amount of such payments to the petitioner's account at least five days prior to the time the payments were due; and the petitioner was to remit such deposits to S. W. Straus & Company and furnish the bank with copies of each letter transmitting such deposits to S. W. Straus & Company.
*222 The bonds and mortgages provided that the Keystone Building could be released from their lien by a payment of $800,000 or 8/33 of the total debt.
The parties stipulated the following facts:
| The selling price of the | $1,100,000.00 | |
| Keystone Building was | ||
| Its original cost was | $633,095.75 | |
| Additions cost | 4,720.57 | |
| 637,816.32 | ||
| Depreciation amounted to | 38,153.20 | |
| Depreciated cost to 12/31/26 | 599,633.12 |
In reporting its income for the year 1926, the petitioner included therein the sum of $30,808.43 as profit from the sale*1683 of the Keystone Building. That amount was computed by taking one-eleventh (the $100,000 which it reported as received in 1926 over the selling price of $1,100,000) of the total profit to be reported, which it computed to be $338,892.79. Upon audit of the petitioner's return the Commissioner increased the $30,808.43 to $166,778.96, computed as follows:
| Selling price | $1,100,000.00 |
| Less: | |
| Cost of building depreciated to date of sale | 599,663.12 |
| Profit to be realized | 500,336.88 |
| Selling price | $1,100,000.00 |
| Less: | |
| Bonds assumed | 800,000.00 |
| Contract price | 300,000.00 |
| Percentage of profit to contract price equals | 166.7789% |
| 1926 cash received $100,000.00 X 166.7789% equals | $166,778.96 |
In 1925 the Southern Loan & Investment Company contracted to build, or cause to be built, the Lamar Hotel and Theater Building. The petitioner agreed to buy this building and pay therefor with the proceeds from the issuance of certain notes and bonds. Under the contract the amount paid for construction work was to bear interest from April 1, 1926. The bond issue was not sold and the amount to be paid was not available until December, 1926. The Southern Loan & Investment Company*1684 contended that it was entitled to interest from April 1, 1926. The petitioner resisted this contention, but agreed to a settlement, and on December 21, 1926, gave the Southern Loan & Investment Company a note for $150,000. By an entry dated December 31, 1926, the amount of the note was credited to "Notes Payable" on the petitioner's books, and charged *223 as a part of the cost of the Lamar Hotel and Theater Building. In 1927 the one to whom the petitioner leased the building agreed to pay the note, the amount was at some time credited to the lessee's account with the petitioner and reported as income by the petitioner. The lessee paid the note.
The petitioner's bond issue of $3,300,000, secured by the Keystone Building and the Lamar Hotel and Theater Building, was sold to S. W. Straus & Company at a discount of 10 per cent, or a total discount of $330,000. This amount was entered on the petitioner's books as a debit to unamortized bond discount. In its income-tax return for 1926 the petitioner deducted and was allowed $2,750 on account of such discount, representing amortization for one and one-half months of the total discount of $330,000 on 15-year bonds. In later*1685 returns the same method was used.
With the exception of that portion of the $2,750 deduction for bond discount allocable to the Keystone Building, none of the deductions here in controversy were taken by the petitioner on its income-tax return for 1926. The return showed a loss for the year of $54,967.05 and no tax due.
OPINION.
MURDOCK: We can not agree with the petitioner that the sale of its interest in the Keystone property took place in 1927. The petition contains in allegation that the sale was consummated in accordance with the terms of the contract. The respondent admitted this allegation and treated the conveyance as a sale made in 1926. The conveyance is dated December 31, 1926, and there is no evidence that it was not executed on that date. There is some evidence that another instrument dated December 31, 1926, construing a provision of the conveyance, was not executed until 1927, but this proves nothing in regard to the conveyance.
Counsel for the petitioner stated that there was no dispute as to the amount of the gross profit. He also stipulated that the sale price was $1,100,000 and that the basis for determining gain was $599,663.12. Thus, the gross*1686 profit would be $500,366.88. The respondent agrees to this figure. Despite these circumstances the petitioner, by an amendment at the hearing, seeks to have us reduce the profit by $85,000 because of the alleged worthlessness of certain notes which were to be assigned to it as part of the consideration. But the notes were to be selected by the bank and delivered not at once, but within a year from December 31, 1926. Apparently they were not selected or delivered in 1926, and we do not know when they were selected or delivered. Furthermore, there is evidence that the notes as finally delivered were not worthless. This point seems to be an *224 afterthought on the part of the petitioner's counsel. We can not say that the petitioner knew in 1926 that it was to receive worthless notes. Nor can we hold that the purchase price should be reduced by the amount of the notes.
In the alternative, the petitioner contends that the sale was a sale or other disposition of property in which "the initial payments to not exceed one-fourth of the purchase price" within the meaning of section 212(d) of the Revenue Act of 1926, and the income to be reported on the basis of an installment*1687 sale is approximately five-elevenths of $100,000, the alleged initial payment. It claims that the fact that the purchaser took subject to the liens of two deeds of trust does not need to be considered in determining the "initial payments" and cites Schneider, Trustee v. Lucas, decided by a District Court. On its theory the entire profit will not be returned as income until such time as the liens are discharged. Counsel for the petitioner contends that the initial payment of $100,000 was not received in 1926. An employee of the purchaser bank testified that he credited the $100,000 to the petitioner's account on January 3, 1927. But he was not present when the transaction took place on December 31, 1926, the deed acknowledges receipt of the amount on December 31, 1926, and in the return for 1926 there is the statement that the $100,000 was paid in cash in 1926. Therefore, if it is important, we hold that this payment was received in 1926.
The respondent now contends that he made a mistake in treating this as an installment sale. He points to T.D. 4255, Cumulative Bulletin VIII-1, p. 165, which amended article 44 of Regulations 69, as follows:
*1688 In the sale of mortgaged property, the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the "purchase price," but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the "initial payments" or of the "total contract price," as those terms are used in section 212(d), in articles 42 and 45, and in this article.
Here the amount of the mortgage exceeds the basis to the vendor by $200,336.88, so the respondent insists that the "initial payments" include $100,000 in cash and $200,336.88; $300,336.88 is more than one-fourth of $1,100,000, the purchase price; therefore, section 212(d) has no application; and the petitioner, on an accrual basis, should be required to accrue and report as income in 1926 the full amount of the purchase price which the purchaser agreed in 1926 to pay over a period of time. We agree with the respondent. See *1689 Lucas v. Schneider, 47 Fed.(2d) 1006, reversing the case relied upon by the petitioner and distinguishing several Board cases.
*225 In 1926 the petitioner issued $3,300,000 par value of its bonds, which were secured by liens on certain of its property, including the Keystone Building property. The purchaser of these bonds paid 10 per cent less than the par value. The Keystone Building property could be released from the lien of these bonds by payment of $800,000, eight thirty-thirds of the total par value of the bonds. The petitioner contends that, if it sold the property in 1926, it should be entitled to deduct, for 1926, $79,345.46 as unamortized discount on these bonds. The Commissioner has already allowed $2,750 of the amount claimed. Following S. & L. Building Corporation,19 B.T.A. 788">19 B.T.A. 788, which is not distinguishable in principle, we hold that the portion of the unamortized discount allocable to the Keystone Building should be deducted when that building was sold subject to the lien of the mortgage.
The petitioner had agreed to pay interest on some amount beginning April 1, 1926. A dispute arose as to the payment of this interest, *1690 which was compromised by the petitioner giving its note for $150,000, dated December 21, 1926, in full payment of all interest due under the agreement. This amount is a proper deduction for 1926 under section 234(a)(2) for interest accrued.
Reviewed by the Board.
Judgment will be entered under Rule 50.