*244 Decision will be entered under Rule 50.
Held, upon this record, sales of rental vehicles which had been leased for about one-fourth of their useful life were sales of property held primarily for sale to customers in the ordinary course of petitioner's trade or business, and gains from such sales are taxable as ordinary income. Sec. 117(j)(1)(B), I.R.C. 1939.
*961 Respondent determined deficiencies in petitioners' income taxes for the fiscal years ended June 30, 1952, and June 30, 1953, in the respective amounts of $ 28,614.95 and $ 52,394.50. The sole issue remaining for determination is whether gains realized on sales of certain motor*245 *962 vehicles held for more than 6 months are taxable as capital gains or ordinary income pursuant to section 117(j), I.R.C. 1939.
FINDINGS OF FACT.
Certain facts have been stipulated and are incorporated herein by reference.
Petitioners, husband and wife, reside in Fort Worth, Texas, and filed joint returns for the fiscal years ended June 30, 1952, and June 30, 1953, with the district director of internal revenue at Dallas. Charlie Hillard will hereinafter be referred to as petitioner.
During each of the taxable years involved herein petitioner was engaged in Fort Worth, Texas, as a sole proprietor in the business of renting cars and trucks, in the business of selling used cars, and in the business of financing the sale of cars. These businesses were respectively designated Hillard's Rent-A-Car, Charlie Hillard Motor Company, and Charlie Hillard Finance Company (hereinafter referred to respectively as Rent-A-Car, Motor Company, and Finance Company). In addition petitioner owned all the stock of two corporations engaged in the vehicle rental business in Austin, Texas, and Beaumont, Texas.
Separate sets of books and separate bank accounts were maintained for Rent-A-Car, Motor*246 Company, and Finance Company. Motor Company was operated from a used-car lot located 1 mile from the operational office of Rent-A-Car. Rent-A-Car was not licensed to sell cars whereas Motor Company held a dealer's license for many years, including the taxable years involved herein. Rent-A-Car maintained a garage on its premises for the servicing of rental vehicles and an open lot next to the garage for the storage of unleased or retired rental cars and trucks. Finance Company maintained a branch office at Motor Company's used-car lot and financed many of the used cars sold by Motor Company.
Petitioner devoted the bulk of his time to the management of Rent-A-Car. Although Rent-A-Car employed an office manager, petitioner devoted considerable personal effort to the purchase of new cars to be used in the rental business, to the negotiation of leases for rental vehicles, and to the sale of rental cars no longer used for rental purposes.
Petitioner, doing business as Motor Company, began the business of selling used cars at retail to the public in 1937 and continued that business through the taxable years involved herein. He employed Alston Ellis as manager of Motor Company, paying*247 him a salary and *963 a flat commission of $ 15 on each car that Ellis sold. Ellis served Motor Company for a period of 10 years up to and including the taxable years in question, 8 of them as manager; he did most of the buying for Motor Company in competition with other used-car dealers and had authority to sign checks on behalf of Motor Company in matters pertinent to its business.
Rent-A-Car commenced operations in 1941 and operated continuously through the taxable years involved herein. Its leasing arrangements were of two types:
(a) Local rental of cars for any period less than 1 year, that is, daily, weekly, or monthly rentals. A daily rental agreement ordinarily required the lessees to pay approximately $ 8 per day plus cost of all oil and gas used. About 15 per cent of all automobiles and trucks rented were used in the local rental business; they might be leased more than 100 times in the course of a year to 100 different persons.
(b) Rental by lease agreement for a term of 1 year. About 85 per cent of all automobiles and trucks rented were rented under such lease agreements. A typical 1-year automobile lease agreement provided for leasing from 1 to 100 cars to *248 the lessee at a rental of $ 75 per month, the 1-year term to begin on the date of delivery of the automobile(s) to the lessee. The agreement further provided that all cars leased thereunder be "new"; the trucks so leased were not always new. At the end of the 1-year term lessor reserved "four consecutive annual options of replacing said automobiles leased by lessee under this contract, provided it is the policy of the lessee to lease automobiles generally at that time; the rental rate to be mutually agreed upon at the time of replacement"; in addition, lessor was obligated to replace any automobile that might be totally destroyed with "another automobile of equal or better condition." Lessee did not acquire any right or option to purchase the rented vehicles at the end or during the term, the lease providing that "this is a contract of leasing only, and that lessee by these presents acquires no ownership, title, or property right or interest in or to the property described in this agreement." Except in two instances, neither occurring in the taxable years involved herein, petitioner never granted a lessee an option to purchase vehicles leased under agreement.
The 1-year leases were*249 primarily of a commercial nature, the lessee being a business firm or a utility company. Rent-A-Car's largest lease contract was with B. F. Goodrich Company, to which it had leased about 150 to 200 cars at one time.
Rent-A-Car purchased new cars for use in its rental business from licensed new-car dealers; petitioner personally handled all purchases for Rent-A-Car. Because petitioner purchased in volume he was *964 able to secure substantial discounts on new-car purchases, in the amount of about $ 200 or more per car during the taxable years in question; such discounts were bargained for and negotiated between petitioner and new-car dealers and varied in amount according to the laws of supply and demand as they operated in the new-car market as of the time of purchase.
On June 7, 1948, Rent-A-Car entered into a "Fleet-User Agreement" with General Motors Corporation. On February 16, 1949, Rent-A-Car entered into a similar agreement designated a "Fleet Owner's Agreement," with Ford Motor Company. Both agreements were in effect during 1952 and 1953. The stated purpose of these agreements was to encourage volume purchasers of new vehicles for their own use to purchase vehicles*250 of the signatory automobile manufacturers. Each agreement stipulated that fleet user or fleet owner expected to purchase for its own use each year a minimum of 20 new motor vehicles from the signatory manufacturer. Manufacturer agreed to identify purchaser as a fleet user or fleet owner, to furnish purchaser with certain uniform list prices for motor vehicles and parts, and to supply other descriptive literature pertaining to the acquisition and servicing of vehicles and parts. As a result of being a fleet owner, Rent-A-Car obtained a price advantage with respect to parts. Both agreements were limited in their application to products of the manufacturer to be used in the trade or business of the purchaser, and not to be held for resale. The Ford agreement in terms applied only to Ford products to be "owned and operated by Fleet Owner in the United States, including Alaska and the Hawaiian Islands, and not for resale." The agreement with General Motors similarly provided that --
All motor vehicles to which this Agreement is applicable shall be company-owned by User, that is, owned by User, its designated branches, divisions or subsidiaries. Such motor vehicles shall not be *251 purchased for purpose of resale nor be exported from the United States.
During each of the years involved herein Rent-A-Car had available for renting or leasing an average of approximately 380 cars and trucks; approximately 90 per cent were rental cars and approximately 10 per cent were rental trucks. When it was determined that a vehicle would no longer be used for rental purposes, it would ordinarily be replaced by a new vehicle and retired from use in the business as rental property. Cars rented on a daily, monthly, or less-than-1-year basis were seldom held out for rental longer than 14 to 16 months for the reason that competitive conditions during the years in question required Rent-A-Car to have available for leasing late model cars in good running condition. Vehicles under lease agreement were customarily replaced with new units after 1 year, if the lease agreement was renewed at that time.
*965 Replaced and retired vehicles were customarily disposed of within a year after replacement or retirement, although some vehicles may have been held for more than a year after retirement. During the period between retirement from rental and ultimate sale, vehicles were stored*252 on the Rent-A-Car property, either in its service garage or on an open lot next to the garage. Used-car dealers, interested in purchasing the vehicles thus retired from rental use, visited Rent-A-Car's lot on a daily, every other day, or similarly frequent basis. Rent-A-Car never advertised its vehicles for sale, employed no salesmen other than petitioner himself, and kept no inventory of vehicles for sale; however, used-car dealers knew that Rent-A-Car would have cars up for sale from time to time. If a dealer found a vehicle he wished to purchase, he submitted a bid to petitioner. Petitioner, who personally handled all sales from the Rent-A-Car lot, then selected a bid from among those he had received and sold the car or truck in question. Vehicles no longer used for rental purposes were usually sold in the manner hereinabove described rather than traded in on the purchase of new vehicles; new-car dealers would not agree to numerous trade-ins on volume purchases.
Alston Ellis, manager of Motor Company, was one of the used-car dealers who regularly visited the Rent-A-Car lot and submitted bids on vehicles available for purchase. In numerous instances petitioner selected Ellis' *253 bid as against those of competing dealers. Ellis "paid" for the cars thus acquired by Motor Company's check signed by himself and made out to Rent-A-Car as payee; the title papers were then endorsed over to Motor Company. In the fiscal years ended June 30, 1952, and June 30, 1953, Rent-A-Car disposed of 255 and 264 vehicles respectively, as follows:
| Fiscal year ended June 30 | ||
| 1952 | 1953 | |
| "Sold" to Motor Company | 97 | 97 |
| Sold to Austin and Beaumont corporations | 16 | 39 |
| Sold to others | 142 | 128 |
| 255 | 264 |
Eighteen of the 255 vehicles sold by Rent-A-Car in 1952 were held by Rent-A-Car for less than 6 months and 237 were held for more than 6 months; 49 of the 264 vehicles sold in 1953 were held for less than 6 months and 215 were held for more than 6 months. The 97 vehicles "sold" each year to Motor Company were those bid in by Ellis for purposes of resale to the general public from Motor Company's used-car lot. In the fiscal year ended June 30, 1952, Motor Company sold 342 used cars including the 97 cars acquired from Rent-A-Car; in the fiscal year ended June 30, 1953, Motor Company sold 296 used cars, including 97 acquired from Rent-A-Car. The 16 vehicles sold in*254 1952, and the 39 vehicles sold in 1953, to petitioner's *966 wholly owned corporations in Austin and Beaumont were new cars purchased by Rent-A-Car as a matter of convenience to petitioner. Petitioner preferred personally to select the vehicles to be used in his rental businesses and found it more convenient to do all his purchasing in Fort Worth, the center of his operations, rather than divide his purchasing activities between Fort Worth, Austin, and Beaumont. All the cars sold to the Beaumont and Austin corporations were held by Rent-A-Car for less than 6 months. The 142 vehicles sold to others in 1952, and the 128 sold in 1953, were in large part held for more than 6 months and sold to used-car dealers through the bidding procedure above described; 2 of these vehicles in 1952, and 10 in 1953, were sold to unidentified persons after a holding period of less than 6 months.
Petitioner's income from his Fort Worth businesses, as reported on his income tax returns for 1952 and 1953, is shown by the following tables:
| Motor Company | |||
| Fiscal year ended June 30 | Sales | Gross profit | Net income |
| (loss) | |||
| 1952 | $ 342,872.18 | $ 33,069.69 | $ 4,777.53 |
| 1953 | 261,443.80 | 28,309.66 | (4,321.33) |
| Finance Company | |||
| Fiscal year ended June 30 | Gross income | Net income | |
| 1952 | $ 157,749.46 | $ 67,350.68 | |
| 1953 | 194,159.79 | 67,282.70 |
*255 The operations of Rent-A-Car, as reported in petitioner's returns, are shown below in two tables; the first shows net income from rental activities and the second shows net gains from the sale of cars and trucks no longer used for rental purposes.
| Rent-A-Car | |||
| (1) Rental activities | |||
| Net income | |||
| Fiscal year ended June 30 | (loss) | ||
| Gross | Business | ||
| income | deductions | ||
| 1952 | $ 357,836.08 | $ 387,881.59 | ($ 30,045.51) |
| 1953 | 375,868.12 | 415,995.16 | (40,127.04) |
As a result of certain adjustments appearing on the returns, the foregoing net losses were reduced to $ 29,835.51 and $ 39,520.04 for the fiscal years 1952 and 1953, respectively. The figures for gross income from rental activities in the above table included profits of $ 1,031.13 in 1952 and $ 175 in 1953 from the sale of new cars which petitioner, through Rent-A-Car, occasionally purchased for friends and business *967 acquaintances as a matter of "accommodation" to them; petitioner reported these profits as ordinary income of Rent-A-Car.
| (2) Sales of Rental Vehicles | ||
| Net gains from units | Net gains from units | |
| Fiscal year ended June 30 | held for less than | held for more than |
| 6 months | 6 months | |
| 1952 | $ 1,542.07 | $ 92,708.68 |
| 1953 | 5,447.84 | 91,025.95 |
*256 The amounts reported as net short-term gains in large part represent gains on the sale of unused, but slightly depreciated, cars to the Austin and Beaumont corporations. Petitioner usually sold these cars to the corporations for the same amount which he paid for them, realizing a small profit to the extent of depreciation taken; with respect to some cars no depreciation had been taken and no profit resulted. In one instance, on October 3, 1952, petitioner sold a new undepreciated car to his Beaumont corporation for $ 260.85 more than he paid for it. On the basis of the figures reported by petitioner in his income tax returns for 1952 and 1953, Rent-A-Car's gains on the sale of vehicles held for more than 6 months and no longer used for rental purposes ranged from $ 4.19 to $ 1,151.70 per sale in 1952, and from $ 23.55 to $ 980.63 in 1953; average gain per sale was $ 394.46 in 1952 and $ 423.38 in 1953. The only long-term loss reported in 1952 and 1953 from the sale of a vehicle was in the amount of $ 16.19 in 1953.
Respondent made adjustments in recomputing petitioner's income tax liability for the years involved, three of which are relevant to this proceeding: (1) Petitioner *257 depreciated his rental cars, including those cars still used for rental purposes and those no longer used for such purposes, on the basis of a 3-year useful life; respondent determined that depreciation should be based on a 4-year useful life and petitioner agreed to the resulting adjustments in net income reported from his rental activities and in net gains reported from sales of vehicles no longer used for rental purposes. (2) Respondent next determined that two cars sold by petitioner in 1952 which petitioner had claimed were held for less than 6 months were in fact held for more than 6 months; petitioner also agreed to this adjustment.
The effect of these adjustments was (a) to decrease petitioner's deduction for depreciation and, as a result, to increase petitioner's net income from rental activities to $ 15,574.41 for 1952 and to $ 10,290.85 for 1953; (b) to increase the depreciated cost basis of vehicles no longer used for rental purposes, and thereby decrease petitioner's net gains on disposition of those vehicles. Petitioner's net gains on units held for more than 6 months were thus decreased to $ 54,673.97 in 1952 and to $ 48,530.02 in 1953; net gains on units held for *258 less than 6 months were reduced to $ 433.28 in 1952 and to $ 3,802.95 in 1953. *968 Applying the adjusted figures, the average profit per unit on sales of vehicles held more than 6 months was $ 230.52 in 1952 and $ 225.72 in 1953.
(3) Respondent's final adjustment was to include petitioner's net gains on the sale of vehicles, both long-term and short-term, in ordinary income. Amounts previously reported by petitioner as long-term and short-term capital gain were excluded. Petitioner conceded that vehicles held for less than 6 months were noncapital assets within the exceptions to section 117(a), I.R.C. 1939, and that gains on the sale thereof were ordinary income. However, petitioner contends that his long-term gains were entitled to capital gains treatment pursuant to section 117(j).
Petitioner's primary motive in the acquisition of motor vehicles for Rent-A-Car was ultimately to sell them for profit.
OPINION.
Petitioner's sales of his used rental cars were neither occasional nor casual. They were not a mere incident of his business. They were a steady and continuous source of recurrent income to him and represented an integral part of his so-called rent-a-car business. *259 Cf. John W. Williamson, 18 T.C. 653">18 T.C. 653, 656, affirmed 201 F. 2d 564 (C.A. 4), certiorari denied 345 U.S. 970">345 U.S. 970. These considerations are highly relevant when examined in the light of the congressional purpose in giving preferential treatment to capital gains and in the light of the proper judicial approach to the problem, as set forth by the Supreme Court in Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46, 52:
But the capital-asset provision of § 117 must not be so broadly applied as to defeat rather than further the purpose of Congress. Burnet v. Harmel, 287 U.S. 103">287 U.S. 103, 108. Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss. The preferential treatment provided by § 117 applies to transactions in property which are not the normal source of business income. It was intended "to relieve the taxpayer from * * * excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent *260 effect of those burdens on such conversions." Burnet v. Harmel, 287 U.S., at 106. Since this section is an exception from the normal tax requirements of the Internal Revenue Code, the definition of a capital asset must be narrowly applied and its exclusions interpreted broadly. This is necessary to effectuate the basic congressional purpose. This Court has always construed narrowly the term "capital assets" in § 117. * * *
Cf. S.E.C. Corporation v. United States, 140 F. Supp. 717">140 F. Supp. 717 (S.D.N.Y.), affirmed per curiam 241 F. 2d 416 (C.A. 2), certiorari denied 354 U.S. 909">354 U.S. 909. 1
*969 Turning*261 to the governing statutory provisions herein we find that the benefits of the capital gains rates are available with respect to certain property used in the taxpayer's trade or business, but that such benefits are withheld in the case of "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." Sec. 117(j)(1)(B). Were the vehicles herein held by petitioner primarily for sale to customers in the ordinary course of his trade or business? We think, upon an appraisal of all the evidence, that the answer must be in the affirmative.
Petitioner, in his returns, originally treated the rental cars as having a normal useful life of 3 years; and the Commissioner's determination, agreed to by petitioner, fixed that period at 4 years. Yet, it was petitioner's practice to sell the cars after they had been in use for only about a year. Thus, when he purchased the cars in the first instance it was plainly his intention to use them in the rent-a-car operation for a comparatively minor portion of their useful life and then to sell them. This was a dual objective. But was the intention to sell merely an incidental or consequential purpose? *262 Or was it a "primary" purpose that was dominant from the beginning? Our view of the evidence leads us definitely to the conclusion that petitioner held the cars in question primarily for sale. The use of the cars for rental purposes was merely an intermediate stage prior to their final and most profitable use, namely, sale, and we are satisfied that such final use was the dominant consideration that led to their purchase in the first instance. Sale of the vehicles was more than "the natural conclusion of the rental cycle." It was the primary reason for commencing the rental cycle. 2
Petitioner's returns for both taxable years, ending June 30, 1952 and 1953, are in evidence. They show that petitioner reported net losses*263 in the amounts of $ 29,835.51 and $ 39,520.04 for those years with respect to his activities in renting cars, but that in the same years he realized gains in the amounts of $ 92,708.68 and $ 91,025.95 upon sale of rental cars held for more than 6 months. True, these amounts were later revised -- in 1955 -- as a result of a revenue agent's depreciation adjustments, so as to convert the foregoing rent-a-car losses into profits of $ 15,574.41 and $ 10,290.85 for the 2 years in controversy, and to reduce the foregoing gains on sale to $ 54,673.97 and $ 48,530.02 for such years. But the figures reported by petitioner on his own returns are far more relevant in probing his intention at the time of acquisition of the cars than the figures which resulted from a revenue agent's subsequent adjustments.
*970 Petitioner appeared as a witness, and we had ample opportunity to observe him and reach conclusions as to his credibility. He impressed us as being an intelligent, astute, and perceptive businessman. However, he was evasive at crucial points. In response to inquiries which drew his attention to the relative profits from the leasing and sales operations with respect to rental cars*264 and brought into question whether that consideration played any part "in the determination of the acquisition of these cars," petitioner replied merely:
I submit I spent night and day looking after leasing and getting the revenue from, and buying new cars, and replacing them. I don't know what the figures were a year and a half later.
Although the questions were not artfully formulated, we are satisfied that petitioner fully understood what Government counsel was driving at, and that his answer was either deliberately evasive or false.
Another aspect of the evidence will also illuminate the reason for our lack of confidence in petitioner as a witness. The question was raised whether petitioner, as a result of his volume purchasing, was able to buy cars more cheaply than an ordinary purchaser. This had some bearing upon the potential profit at the time of ultimate resale and the part which such potential profit might have played in the petitioner's intention at the time of purchase. He gave vague answers in terms of "supply and demand," and only upon being pressed did he admit with apparent reluctance (which is not reflected in the mere words of the transcript) that he could *265 negotiate a better price per unit as a consequence of his quantity purchasing. However, without specifically stating how great his price advantage might have been, he distinctly left the impression that there was not "much difference" in the comparative prices. Yet, a later witness, who was associated with one of the dealers from whom petitioner purchased cars testified that the discount "would be closer to $ 200" than to $ 100. And upon further questioning he stated that: "I don't think we could have gotten the [petitioner's] business if it [the discount] had run less than that [$ 200]." We find that witness's testimony credible.
We have no confidence in petitioner's testimony or the implication that he sought to have the Court draw therefrom that his purchase of the cars was not motivated predominantly by the anticipated profit upon ultimate resale. It puts too much strain upon our credulity. He is a sagacious businessman, and we do not believe him to the extent that he testified or implied that his principal intention was to engage in a business that was unprofitable, as shown in his own returns, or that was far less profitable than the sales even as measured by the revenue*266 agent's subsequent adjustments. The burden of proof was upon petitioner. It has not been carried here. Of assistance in trying to ascertain petitioner's intention would have been his comparative *971 earnings in the rental and sales aspects of his business for the years prior to 1952 and 1953. An inquiry as to whether the pattern for 1950 and 1951 was materially different from that in 1952 and 1953, the years directly in controversy, brought forth no illuminating response. Bearing in mind that the burden was upon petitioner, it cannot be assumed in his favor without proof that the years before the Court were abnormal in this respect.
We are constrained to conclude that petitioner has not proved that he is entitled to the preferential treatment that he seeks, and we find as a fact on this record that petitioner's primary (although not exclusive) purpose in acquiring the cars in question was to derive a profit upon their ultimate sale. Whatever may be said of the result reached in Philber Equipment Co., 25 T.C. 88">25 T.C. 88, reversed 237 F. 2d 129 (C.A. 3), relied upon by petitioner, we find upon the record herein that petitioner*267 held the cars in question primarily for sale to customers in the ordinary course of his trade or business.
Decision will be entered under Rule 50.
Footnotes
1. In the S.E.C. Corporation case, the court said (140 F. Supp. at 720):
"To carve out of its business for special tax treament gain actually realized as a normal feature of the taxpayer's current business would not be consonant with the meaning and purpose of this statute.↩
2. The fact that petitioner's "fleet user" and "fleet owner" agreements were inapplicable to vehicles purchased for resale is irrelevant in determining the purpose for which petitioner held the vehicles, since the agreements were clearly referring to resale as new cars↩, and not as used cars.