*738 1. Taxpayer corporation was indebted to two individuals jointly in the amount of $182,188.06. The amount was paid in full by the transfer to the two individuals by the taxpayer of all the stock of X corporation, which taxpayer had just received from X corporation in exchange for assets having an adjusted cost basis to the taxpayer of $100,000. Held, that taxpayer realized capital gain in the amount of $82,188.06 as the result of the transaction with the two individuals.
2. In the fiscal year 1936 taxpayer was indebted to Y corporation in the sum of $52,247.30, but was relieved of this debt by a compromise settlement by virtue of which taxpayer paid only $11,250. Held, that, there being no satisfactory proof of taxpayer's insolvency at the time of the settlement, the difference between the two sums is ordinary taxable income to the taxpayer in the fiscal year 1936.
3. In the fiscal year 1937 the taxpayer bought in for full face value plus interest certain of its own bonds. The taxpayer retired these bonds. Held, that taxpayer realized no taxable income thereby.
*85 The Commissioner has determined a deficiency in income and excess profits taxes for the fiscal years ended April 30, 1936 and 1937, in the following amounts:
| Fiscal year | Income tax | Excess profits tax |
| 1936 | $24,520.98 | $8,761.16 |
| 1937 | 1,961.51 |
Petitioner has waived one contention raised by the petition, i.e., that there should be allowed a bad debt deduction in the amount of $113,102.48 for the fiscal year 1936. The remaining issues involve: first, whether petitioner realized either capital gain or ordinary income on the satisfaction of a debt by the transfer of certain stock carried on petitioner's books at a lesser value than the amount of the debt; second, whether certain income was realized by petitioner by virtue of the compromise of debt owed by petitioner, which debt included principal and accrued interest, already deducted by petitioner in prior years (overpayment claim raised by amendment to petition); third, whether petitioner realized income from the purchase and retirement of 56 of its corporate bonds.
FINDINGS OF FACT.
*740 For the sake of brevity we incorporate herein by reference all our findings of fact in the cases of , and L. J. Miller and Estate of L. G. Monroe, deceased, . In addition to these facts, we find the following additional facts material to the disposition of the issues herein involved.
Petitioner is a California corporation. Its books of account were kept and its income tax returns for the fiscal years ended April 30, 1936 and 1937, were prepared on the accrual basis. The income tax returns were filed with the collector of internal revenue for the first district of California.
*86 Prior to petitioner's incorporation, certain properties were owned by Monroe, Lyon & Miller, Inc. (Rio Del Mar property), Belmont Country Club Properties, Inc. (San Mateo property), and the Los Altos Country Club Properties (Santa Clara property). For the purpose of issuing bonds the petitioner, sometimes hereinafter referred to as Penproco, was incorporated and took over the assets of those corporations, giving them in exchange their pro rata shares of Penproco stock. This accounted*741 for all petitioner's capital stock except a small minority issued to 12 individuals. The title of Monroe, Lyon & Miller, Inc., was changed to Monroe & Miller, Ltd., when Lyon quit the business at the end of 1930 or early in 1931. Miller and monroe each owned one-third of its stock and Lyon's one-third was transferred to a bond house. Monroe & Miller, Ltd., had acquired all of the stock of the Belmont and Los Altos Country Club corporations and consequently owned or controlled practically all the Penproco stock.
Sometime prior to 1935 Penproco caused a Nevada corporation, Peninsula Properties Improvement Co. (sometimes hereinafter referred to as Impco) to be organized for the purpose of improving certain of the Rio Del Mar land and issuing bonds secured by a mortgage thereon, the money to be used for the erbection of the improvements. Penproco transferred to Impco 123 1/2 lots and certain realty upon which Impco erected a main clubhouse, which was run as a hotel for some years prior to 1935. In exchange Penproco received all of Impco's stock. Impco mortgaged the properties to secure a loan of $200,000. On May 1, 1935, there remained an unpaid balance of $136,500 on this*742 mortgage indebtedness.
Petitioner's original investment in Impco stock was $237,300. Subsequent to Impco's incorporation petitioner from time to time advanced moneys to Impco for the maintenance and operation of the main clubhouse until on May 1, 1935, Impco was indebted on this account to petitioner in the sum of $178,050.22, less a credit of $368.52.
On May 1, 1935, petitioner effected a liquidation of Impco and took over that company's assets, assuming its outstanding liabilities. The net value of the assets received by petitioner as a result of this liquidation was $62,579.22. On its corporate books of account and in its income tax return petitioner treated this sum as a credit against the unrepaid advances and treated the difference as a bad debt, resulting in a deduction on its return of $115,102.48. The respondent held that the advances were additional contributions to capital and that, the transfer of the assets being a liquidation, the loss was a capital loss, the deduction for which is limited to $2,000. At the hearing petitioner stipulated that the loss was, as determined by respondent, a capital loss, but did not concede the correctness of respondent's calculations*743 in disallowing it in the amount of $113,102.48.
*87 In 1930 the county of Santa Cruz made certain highway improvements in the Rio Del Mar area and formed a special assessment district for the purpose of financing the improvements. By virtue of a California statute, the county had in March 1930 issued approximately $317,157 worth of 7 percent improvement bonds to finance the work. Petitioner was unable to pay the assessments on its property out of liquid assets and soon the bond issue became in default. L. J. Miller and L. G. Monroe, petitioner's officers, purchased all of the outstanding improvement bonds from a financial house. The bonds were purchased on behalf of the individuals themselves.
On December 29, 1934, the petitioner offered to transfer title to all its property within the assessment district to an escrow agent who should use 10 percent of the proceeds of all sales of such properties for the payment of taxes and assessments. It was also provided that any improvement bonds turned in by petitioner for cancellation should be accepted in payment of assessments against petitioner's property, the specific properties to be released to be designated by petitioner. *744 The offer was accepted on January 3, 1935, and the Santa Cruz Land & Title Co. was selected as escrow agent. Petitioner then deeded all its Rio Del Mar property to the escrow agent in accordance with the terms of the agreement.
The total face amount of the outstanding bonds which were due or in default on January 5, 1935, together with interest thereon, was $182,188.06. Miller and Monroe turned over bonds in this amount to petitioner and a credit was set up to their account on petitioner's books, the account being set forth as "L. G. Monroe and L. J. Miller, Special Account - Credit, January 31, 1935 - folio 102 - $182,188.06."
On May 2, 1935, petitioner caused the incorporation of the Aptos Land & Water Co. (hereinafter referred to as Aptos) and transferred to Aptos in exchange for its total capital stock issue (500 shares) all of the so-called Rio Del Mar recreational facilities, consisting of 5 parcels. Parcel No. 1 consisted of the main club building and its furniture and fixtures. Parcel No. 2 consisted of the land occupied by holes Nos. 1 to 9, inclusive of the golf course and three other lots. Parcel No. 3 consisted of four acres with improvements, including a two-story*745 golf lodge and all equipment and fixtures therein contained. Parcel No. 4 contained a private beach. Parcel No. 5 consisted of the golf course equipment, including tractors, trucks, and machinery used in the maintenance of the golf course. Of these five parcels, only No. 1 had been acquired by petitioner upon the liquidation of Impco.
Parcel No. 1 was carried on petitioner's books at $60,682.65 on May 1, 1935, being the original cost plus cost of improvements ($208,022.53), less depreciation ($38,282.31), less the proportion of the total mortgage indebtedness allocable thereto ($109,037.57), which Aptos assumed. Parcels Nos. 2 and 3 were carried at $38,431.29, being *88 cost of land, improvements, and inventory ($159,460.66), less a portion of the land charged to subdivided land in unit No. 1 ($39,139.36), less appropriations credited to improvement reserve ($81,890.01). No cost at all was allocated to parcel No. 4 in the transfer. Improvements thereto had been charged to improvement reserve. Parcel No. 5 was carried at $886.06, being the cost ($11,527.49) less depreciation ($10,641.43). All appropriations credited to improvement reserve were charged to costs of subdivided*746 land and were considered as part of land costs.
Petitioner's basis for gain or loss as to this Aptos stock was $100,000, this being the basis in petitioner's hands on May 1, 1935, of the assets transferred to Aptos in exchange for its stock.
The recreational properties and facilities transferred to Aptos by petitioner were not properties held primarily for sale to customers in the ordinary course of its business but were properites which petitioner, and later Aptos, agreed with customers to maintain for recreational purposes.
Sometime in May 1935 petitioner transferred all the newly acquired Aptos stock to Monroe and Miller as individuals and, without further consideration passing between the parties, canceled completely the credit in the special account of Monroe and Miller in the amount of $182,188.06 which had arisen from the transfer of improvement bonds by the individuals to petitioner. The petitioner reported as ordinary income on its return for the fiscal year 1936 the difference between the amount canceled ($182,188.06) and the cost to petitioner of the Aptos stock ($100,000).
On or about August 1, 1935, petitioner owed $52,247.30 to the Pacific States Construction*747 Co. Of this amount $34,064.96 represented principal and $18,182.34 represented interest. In years prior to the fiscal year 1936 all of the principal had been charged to the reserve for improvements and added to the cost price of the subdivided lots held for sale by petitioner, and the full amount had been deducted on prior income tax returns as part of the cost offset against the sales prices which were includible in petitioner's taxable income in those prior years. The interest, although unpaid, had been deducted in full in returns for prior years. It is stipulated that, although in some of those years petitioner had no taxable net income, nevertheless, by virtue of having taken into account on its returns the additions to the reserve and the accrued interest, petitioner received a tax benefit. The principal amount of $34,064.96 represented expenditures for roads, sidewalks, sewers, golf course, water system, land clearance, and improvements in connection with the beach at Rio Del Mar.
On or about August 1, 1935, petitioners compromised this liability by the payment of $11,250, this amount being accepted by the Pacific *89 States Construction Co. in full satisfaction*748 of the greater amount. On its income tax return for the fiscal year 1936 petitioner listed as ordinary income the difference ($40,997.30) between the total indebtedness ($52,247.30) and the lesser amount for which the debt was compromised ($11,250).
On March 6, 1936, Monroe and Miller, as individuals, owned $494,500 out of a total outstanding face amount of $632,000 of Penproco 6 1/2 percent sinking fund gold bonds. These bonds had been acquired by the two individuals at an average cost of 11 cents on the dollar. In March 1932, as a condition precedent to a certain bondholders' adjustment agreement, a bondholders' committee secured the consent of Penproco to an agreement whereby bondholders might at their option secure, through the exchange of their bonds therefor, lands held by Penproco subject to the trust lien. The exchanges were to be made on an approved schedule of valuation known as the Underhill appraisal.
The bond house which held one-third of the stock in Monroe & Miller, Ltd., and thereby had an interest in Penproco, objected to Monroe and Miller participating in exchange transactions with Penproco, inasmuch as the two individuals were Penproco's officers. But, *749 since Monroe and Miller, as individuals, had received the entire stock of the Aptos corporation in May 1935, the two individuals indirectly engaged in exchanges by transferring bonds to Aptos which Aptos turned in to Penproco for retirement. In the fiscal year 1936 Aptos was buying these bonds from Monroe and Miller at 70 cents on the dollar and receiving full face value plus interest from Penproco when Aptos turned the bonds in to Penproco in payment for lots sold to Aptos by Penproco and immediately resold by Aptos to the public. Both individuals treated the difference between the cost to them of the bonds (11 cents on the dollar) and the price at which Aptos accepted them (70 cents on the dollar) as income and reported these amounts in their personal income tax returns.
Between June 1 and December 31, 1936, Monroe and Miller jointly transferred 44 1/2 Penproco 6 1/2 percent bonds, each of $1,000 face value, to Monroe & Miller, Ltd. In the calendar year 1937 but prior to April 30, Monroe and Miller transferred 11 1/2 more to Monroe & Miller, Ltd. These transfers were made pursuant to an option agreement between the two individuals, jointly, and Monroe & Miller, Ltd., drawn*750 up May 15, 1936, whereunder the corporation agreed to accept bonds and give in return all Penproco stock then or thereafter to be held by Monroe & Miller, Ltd. The rate of exchange set by the agreement was one share of the stock for each $4.56 of the face amount (plus accrued interest) of the bonds. The accrued interest on the 44 1/2 bonds at the time of the transaction was $13,016.25; on the 11 1/2 *90 bonds, $3,363.75. The cost to each of the individuals of the 44 1/2 bonds was $2,447.50; of the 11 1/2 bonds, $632.50.
The value of $4.56 attributed to each share of Penproco stock for purposes of transactions under the option agreement was determined by the book value of the shares of Penproco stock on the general ledger accounts of Monroe & Miller, Ltd., at the time the agreement was entered into.
No individual other than a bookkeeper participated in these transactions on behalf of Monroe & Miller, Ltd., besides Miller and Monroe.
Monroe & Miller, Ltd., transferred the 56 bonds to Penproco and received therefor a credit on a running account between the two corporations. This credit was subsequently paid off. At some time prior to May 1, 1937, these 56 bonds were*751 retired by Penproco. On April 30, 1937, a transfer of 15,873 shares of Penproco stock was made on the books of Monroe & Miller, Ltd., to the credit of the joint account of Monroe and Miller in consideration of the 56 bonds already transferred.
In their individual income tax returns for 1936 both Monroe and Miller claimed losses of $2,447,50 as the result of worthlessness of Penproco stock received in exchange for the 44 1/2 bonds transferred to Monroe & Miller, Ltd., in that year. Respondent in each instance disallowed the deduction. In addition respondent added $24,920 capital gain to the income of each individual for 1937 as profit from the sale of the 56 bonds.
OPINION.
KERN: The first issue for our disposition is whether the respondent correctly determined that petitioner realized ordinary income in the amount of $148,653.04 during the fiscal year 1936 as the result of a settlement of an account with Miller and Monroe jointly. The facts reveal that petitioner had become indebted in the amount of $182,188.06 to the individuals. During the fiscal year this credit was offset by the transfer to the individuals of 500 shares in the Aptos Corporation. This stock had been*752 carried on the books of petitioner at a value of $100,000. Petitioner reported the difference between the total debt and the $100,000 stock paid as ordinary income.
Respondent's determination is based upon the assumption that the stock was not worth $100,000, but only $33,535.02. Our findings of fact, however, show that the 500 shares, which constituted Aptos' total issue, were worth $100,000 when issued. This conclusion is sufficient to dispose of respondent's primary contention.
There is, however, a secondary issue still to be disposed of. Petitioner, by amendment to its petition, claims that it erred in reporting the $82,188.06 difference as ordinary income; and that it should be found to be capital gain which may be offset by any capital losses *91 suffered by petitioner within the fiscal year. Respondent and petitioner have already stipulated that petitioner suffered a capital loss in excess of the deduction claimed on its return upon the dissolution of the Improvement Co. Petitioner had erroneously reported this amount as a bad debt. Respondent argues that this amount is deductible only to the extent of $2,000, however, by virtue of the capital loss provisions*753 of the revenue acts and, since petitioner has not established any capital gains to act as offsets, that the balance of this loss can not be taken into account for income tax purposes. Petitioner, on the other hand, in its amended petition claims that the $82,188.06 gain was a capital gain and when balanced against the $115,102.48 loss results in a net capital loss of $32,914.42, which amount is deductible to the extent of $2,000. If petitioner prevails, the result will be, in effect, the removal of the $82,188.06 figure from petitioner's taxable income.
If the transaction whereby the two individuals acquired the stock from petitioner is to be regarded as a sale or exchange of the stock in return for the extinguishment of its preexisting debt in the sum of $182,188.06, then the difference between the cost to petitioner of the stock and the amount of its liability thus discharged must be regarded as capital gain. Petitioner was not a dealer in securities and did not hold the stock primarily for sale to customers in the ordinary course of its business. Therefore, it must be considered as a capital asset. *754 ; .
If a capital asset is transferred in consideration for the extinguishment of a liability of the transferor in an amount less than the cost basis to the transferor of the asset so transferred, the resulting loss to the transferor is a capital loss within the meaning of the revenue act. ; certiorari denied, . Conversely, where the capital asset so transferred is held at a basis less than the amount of the transferor's debt extinguished by such transfer, the resulting gain to the transferor must be considered as a capital gain. In each case the transaction is treated as if the transferor had sold the asset for cash equivalent to the amount of the debt and had applied the cash to the payment of the debt. See ; .
Respondent, however, contends that the transaction here involved should be considered as having been, in reality, two transactions. According to his construction petitioner transferred*755 the Aptos stock, as to which its cost basis was $100,000, in satisfaction of $100,000 of the claim of Miller and Monroe, and then in a later and separate transaction Miller and Monroe gratuitously forgave the balance of petitioner's obligation to them. Thus, as respondent interprets the facts, there was *92 a transfer which might have resulted in capital gain or loss, but which resulted in neither, since the amount received was exactly equivalent to the cost basis of the asset transferred; and this was followed by the gratuitous forgiveness of the remainder of the indebtedness of petitioner, which resulted in the receipt of ordinary income. In support of this contention respondent points out that petitioner, on its books, treated the excess of the debt extinguished over the cost basis of the Aptos stock as miscellaneous income, and that petitioner treated it in its return as ordinary income. Respondent also relies upon part of an answer of one witness who was a party to the transaction, who referred to the transfer of the Aptos stock as a part payment of petitioner's indebtedness. We do not agree with respondent's interpretation of the facts. A careful consideration of*756 all of the facts and circumstances disclosed by the record compels us to the conclusion that the transaction should be treated as one transaction, not two; that petitioner transferred the Aptos stock, a capital asset, to Monroe and Miller in return for their forgiveness of its debt to them of $182,188.06; and that, since petitioner's basis as to this stock was $100,000, it realized a gain thereby in the sum of $82,188.06, regardless of what the fair market value of the stock was; and that this was a capital gain against which could be offset capital losses.
The second main issue raised is whether respondent erred in failing to exclude from petitioner's taxable income for the fiscal year 1936 the sum of $40,997.30 representing the portion of an indebtedness of $52,247.30 to the Pacific States Construction Co. of which petitioner was relieved by a compromise settlement within the taxable year for the lesser sum of $11,250. Petitioner reported the $40,997.30 as ordinary income on its return, but now claims the amount should not have been included because, it alleges, petitioner was insolvent at the time and did not thereby become solvent. The endeavor of petitioner to prove insolvency*757 is not successful. Miller testified that in his opinion the assets were worth over a hundred thousand dollars less than the liabilities. He also read into the record certain figures from sheets he had prepared after examination of the corporation's books. According to his testimony the books disclosed the value of the assets as of the close of the fiscal year 1936 to be $976,994.78, and the liabilities on the same date to be $1,313,444.78. By the close of the next year the assets had fallen to $884,668.48 and the liabilities to $1,179,965.52. The change in these figures was, according to Miller's testimony, occasioned by purchases of land by Aptos and other brokers. When questioned as to whether the value of the assets was calculated with regard to fair market value of the properties held, Miller said that the figures were based on cost from 1925 to 1927. He then went on to say that the financial depression had greatly lessened the value of *93 the properties, so that, in his opinion, the cost figures actually exceeded any fair market value of the lands.
Were it not for one of the exhibits introduced by petitioner without limitation to its application, we might have*758 concluded that petitioner had established a prima facie case of insolvency. But this exhibit sets forth the sales by Aptos within the fiscal year 1937 of certain lands transferred by petitioner to Aptos at cost. The date of the transfer of this property to Aptos is not shown on the exhibit, but from the testimony it appears that it was not all transferred at once. The land was transferred to Aptos at cost, therein stated to be $254,910.90. As a result of hundreds of sales to the public during the fiscal year 1937, gross profits in the amount of $286,729.42 were realized, or over 100 percent. On only three transactions with the public were losses sustained, amounting to $1,353; and on two other sales made not to the public but to Miller and Monroe, large losses in the amount of $86,636.27 resulted. In these sales to Miller and Monroe, however, it is extremely dubious whether fair market value was ever taken into consideration or that the sales price is indicative of fair market value. Thus we see that, while Miller claims that the properties in the hands of the petitioner were not worth cost, some considerable part of them had a fair market value of twice that amount, as*759 the sales records disclose. We do not know from the testimony given what properties comprised the petitioner's assets in the fiscal years 1936 or 1937. While there is much testimony about transfers of property to Aptos, no dates were given from which we can determine the holdings of petitioner at the times material to a finding of insolvency. Upon the facts shown by the record, we can not reach the conclusion that petitioner was insolvent at the time of the compromise, August 31, 1935, and conclude, therefore, that the $40,997.30 saved to petitioner by the compromise of this claim constituted ordinary taxable income to petitioner.
The third main issue, which was raised in part by amendment to the pleadings at the hearing, concerns the transaction involving the 56 bonds. In the cases of Miller and estate of L. G. Monroe, the respondent has claimed that the individuals received taxable income in excess of that reported by them as the result of using Monroe & Miller, Ltd., in the transaction as a "middle-man." Now, as an alternative to this contention, respondent argues that the petitioner realized taxable income in the amounts of $56,000 and $16,380 representing, respectively, *760 the principal amount of the bonds received from Monroe & Miller, Ltd., retired during the fiscal year 1937, and the accrued interest thereon. The amount of $16,380 was included in respondent's original determination of deficiency; as to the $56,000, the issue was raised for the first time at the hearing. Respondent fails to advance any tenable *94 theory for this position and introduces no proof to sustain such a conclusion. The burden of proof is upon the respondent as to any new issues raised in his answer in this case with regard to the taxability to petitioner of the $56,000 principal of the bonds. However, it is not necessary to decide even this phase of this issue on a basis of failure of proof, since the petitioner has introduced corporate records to show credits received by Monroe & Miller, Ltd., from petitioner in the full amount of the principal and interest of the bonds transferred, and there was testimony that these credits were paid off. Upon the facts disclosed by the record, we conclude that the petitioner paid out the equivalent of what it received, and that petitioner realized no taxable income by virtue of the transaction.
Decision will be entered*761 under Rule 50.