1938 BTA LEXIS 1043">*1043 Petitioner is a corporation which in 1931 took over the assets and liabilities of a partnership, including real estate purchased by the partnership in 1920 for the sum of $80,000, subject to a mortgage at the time of petitioner's incorporation in the sum of $40,000. In November 1931 petitioner reduced the amount due on the mortgage to $22,500 and a new mortgage was executed by petitioner in this amount. In January 1933 there was due thereon the sum of $19,250. This amount was fully satisfied by petitioner by the payment of $12,000. The real estate at that time was worth $20,000, having greatly decreased in value between 1925 and 1933. The petitioner was solvent. Held, petitioner thereby received taxable income of $7,250 in the year 1933.
37 B.T.A. 393">*394 This proceeding involves the correctness of respondent's determination of a deficiency in the income taxes of petitioner for the year 1933 in the sum of $1,009.49, and his determination of a deficiency in petitioner's excess profits taxes for that year in the amount of $244.23.
1938 BTA LEXIS 1043">*1044 FINDINGS OF FACT.
In 1920 Louis D. Coddon, Nathan Coddon, and Charles Coddon were engaged as copartners in the clothing manufacturing and jobbing business in the city of St. Paul, Minnesota, under the firm name of L. D. Coddon & Co. On March 1, 1920, this partnership purchased the land and building occupied by it as its place of business from the McQuillan Realty Co., a Minnesota corporation, for the sum of $80,000, $30,000 of which was paid by that date, the balance of the purchase price being evidenced by note dated February 1, 1920, and due March 1, 1930, with interest at the rate of 5 percent per annum and secured by a purchase money mortgage. The real estate involved was a five-story brick building in the jobbing district of downtown St. Paul, located at 180-184 East Fourth Street.
Thereafter, the McQuillan Realty Co. was dissolved, and, as a step in its dissolution, it assigned and transferred the mortgage on this property to Mary Fitzgerald, Allen McQuillan, Philip F. McQuillan, and Anna McQuillan, all of the stockholders of this corporation, on March 10, 1920. On June 28, 1924, Philip F. McQuillan assigned and transferred his interest in the mortgage to Anna McQuillan.
1938 BTA LEXIS 1043">*1045 On July 15, 1929, Louis D. Coddon, one of the partners in the firm of L. D. Coddon Co., died and his widow was thereafter appointed administratrix of his estate. The partnership was continued as a going business after the death of Louis Coddon, pursuant to the consent of the surviving partners and to the order of the probate court administering the affairs of the estate of Louis D. Coddon. On March 3, 1930, the partnership paid to the assignees of the mortgage upon the real estate of the partnership the sum of $10,000, leaving a balance of $40,000 due and owing by the partnership on account of the purchase of this real estate, evidenced by the note and mortgage above described.
On March 20, 1930, an agreement was entered into between the surviving partners and the administratrix and heirs of Louis D. Coddon, the deceased partner, to the effect that the partnership business should be incorporated under the laws of the State of Delaware, and the corporation thus formed should issue preferred stock to the estate of the deceased partner and common stock to the surviving partners. On April 24, 1930, such a corporation was organized under the name of L. D. Coddon & Bros. Inc., the1938 BTA LEXIS 1043">*1046 petitioner herein, which acquired 37 B.T.A. 393">*395 the assets and assumed the liabilities of the partnership. The corporation issued 1,150 shares of its common capital stock, having no par value, to Charles Coddon, and 920 shares of like stock to Nathan Coddon. It issued preferred stock of the par value of $75,000 to the administratrix of the estate of Louis D. Coddon in return for the transfer to the corporation of all the interest of Louis D. Coddon in the partnership, subject to the liabilities of the partnership applicable against his interest in the assets thereof. In connection with this transaction and the proceedings of the probate court authorizing it on the part of the administratrix, an appraisal was made, on behalf of the surviving partners, of the real estate owned by the partnership and covered by the mortgage, which disclosed that the value thereof at that time was the sum of $58,000, while appraisers appointed by the probate court valued the property at $60,000. In order to pass title to the corporation the administratrix of the estate of Louis D. Coddon sold her interest as such administratrix in said real estate to Charles Coddon and Nathan Coddon for the sum of $3,333, 1938 BTA LEXIS 1043">*1047 being one-third of the equity belonging to the partnership over and above the $50,000 balance of the mortgage according to the appraisal of the probate court which valued the property at $60,000. This occurred on December 9, 1930. On January 2, 1931, Charles and Nathan Coddon deeded the real estate to petitioner by quitclaim deed.
On November 7, 1931, petitioner made a payment of $10,000 on the existing mortgage obligation and received an allowance of $7,500 by the assignees of the mortgage, leaving a balance due on this obligation of $22,500 on that date. This allowance was obtained by petitioner as a result of negotiations with Allen McQuillan, one of the former stockholders and assignees of the dissolved McQuillan Realty Co., and the same individual with whom negotiations leading to the original purchase of the real estate were conducted. This allowance was granted to petitioner because of the fact that the property had materially depreciated in market value. It was entered on the books of petitioner under date of November 9, 1931, by debiting the account "mortgage payable" and crediting the "real estate" account with $7,500, with the following explanation: "To write off1938 BTA LEXIS 1043">*1048 of reduction in value of assets to correspond with the same allowance for reduction in mortgage, $7500."
On November 7, 1931, petitioner executed and delivered a new mortgage to Allen McQuillan, Anna McQuillan, and Mary Fitzgerald, who at that time were the holders by assignment of the original mortgage, to secure the payment of its promissory note in the principal sum of $22,500, with interest at the rate of 5 1/2 percent per annum, payable semiannually, the note and the mortgage providing for monthly payments of the principal in the sum of $250, commencing 37 B.T.A. 393">*396 on the 1st day of December 1931, the balance becoming due on the 1st day of March 1936. This new mortgage contained the following provision: "This mortgage is given to secure part of the purchase price of said real estate and is a purchase money mortgage." Principal payments of $250 per month were made on this mortgage from December 1931 to December 1932, inclusive, in a total sum of $3,250, and the balance thereon which was due and owing on December 3, 1932, was the sum of $19,250.
In January 1933 petitioner failed to pay certain interest which was due on the mortgage, and negotiations were entered into between1938 BTA LEXIS 1043">*1049 petitioner and Allen McQuillan, one of the mortgagees, and the representatives of the others, which resulted in the payment by petitioner of the sum of $12,000 in complete settlement of the balance due on the mortgage, the petitioner receiving an allowance of $7,250. This allowance was granted to petitioner by the mortgagees because of the great decrease in the market value of the real estate subsequent to its sale in 1920, and also because of the fact that petitioner was delinquent in the payment of interest. At about this time petitioner was offered the adjoining building, which was of the same size and age, at a price of $22,500. It was better constructed and had heavier walls than the building owned by petitioner.
The full value for taxation purposes of the real estate owned by petitioner and subject to the mortgage, according to the records of the county assessor of Ramsey County, Minnesota, for the year 1920, was $76,500, while the full value for taxation purposes, according to the same records, in the year 1933, was $33,750. This property was located in the so-called jobbing district of St. Paul, and the value of property located therein decreased materially from and1938 BTA LEXIS 1043">*1050 after 1925, and after that date there were many vacancies in the district and little market existed for real estate located therein. In 1933 the value of this real estate was $20,000.
As of December 31, 1932, this real estate was carried on petitioner's books at a total valuation of $71,500.47, the value placed upon the land being $36,413.14 and upon the building being $35,087.33. Petitioner, as of December 31, 1932, had taken a depreciation of $9,824.45 since its acquisition. The petitioner took deductions for depreciation on a valuation of the building at $40,000. Petitioner also deducted interest on the full amount of its indebtedness in its income tax returns.
Petitioner, although hard-pressed for cash in 1933, was solvent during that year. Its books of account showed a credit balance of $4,991.89 in surplus and undivided profits account as of December 31, 1932, and a credit balance of $16,093.85 in the same account as of December 31, 1933.
37 B.T.A. 393">*397 OPINION.
KERN: In 1933 petitioner satisfied an indebtedness which it owed in the sum of $19,250, and which was secured by a mortgage on real estate of the value of $20,000 used by it in its business, for the sum1938 BTA LEXIS 1043">*1051 of $12,000. It is the contention of the respondent that $7,250, the amount of the obligation of petitioner in excess of the $12,000 which was satisfied by agreement of petitioner and its mortgagees by this payment, should be included in the gross income of petitioner as defined in section 22(a) of the Revenue Act of 1932, set out in the margin.1 This contention is based upon the principle enunciated in the opinion of the Supreme Court in , to the effect that the retirement by a corporation of its obligations at less than the issue price results in taxable income to the corporation in the amount of the excess of the issue price of the obligations over the amount paid for their purchase and retirement. The petitioner contends that this amount does not represent gross income, for the following reasons: (1) That the transaction by which the original debt was satisfied at less than its face value was merely an adjustment of purchase price and therefore a capital transaction; (2) that even if income were presently recognizable, the settlement was accompanied by a shrinking of assets and consequently resulted in no "freeing1938 BTA LEXIS 1043">*1052 of assets" which would otherwise have been subject to the lien of the obligation; and (3) that the shrinkage was, in fact, so great that the transaction as a whole resulted in loss and not in gain to petitioner. Petitioner's contentions are based respectively on ; ; and .
1938 BTA LEXIS 1043">*1053 Petitioner's first contention is founded on a case decided by us prior to the decision by the Supreme Court in Since the latter decision our conclusions in this general subject have been modified. . In the case of , the doctrine of , was limited to a case in which all of the transactions 37 B.T.A. 393">*398 between vendor and vendee took place in one year. Since, in the instant case, the transactions between the vendor corporation and its successors in interest, the tenants in common, on one side, and the vendee partnership and its successor in interest, the corporation which is petitioner herein, on the other, took place over a period of some thirteen years, the doctrine of , as limited by our opinion in , is not applicable.
The petitioner earnestly contends that the decision of the Supreme Court in 1938 BTA LEXIS 1043">*1054 , is not controlling in the disposition of the instant case because there was a "shrinking of assets", i.e., a loss in the market value of the property covered by the mortgage, equal to the difference between the face value of the mortgage obligation and the amount paid by petitioner to satisfy it. In support of this contention petitioner urges that the language used by the Circuit Court in (C.C.A., 2d Cir.), was not repudiated by the Supreme Court in , although it reversed the lower court's judgment. The Circuit Court took the view that no gain was presently realized by the discharge of an obligation at less than its face value where it was incurred in the purchase of property still retained by the taxpayer; that while cost was determined, the other "term of the equation" necessary to the realization of income was lacking. The Supreme Court, in effect, rejects this view of the postponement of "realization" until disposition of the thing bought, for it finds "nothing to distinguish this cause1938 BTA LEXIS 1043">*1055 in principle from U.S. v. Kirby Lumber Co.", whereas the Circuit Court, in language quoted by the Supreme Court, had distinguished that case as applying only to a money and not a property transaction.
While it may be conceded that the language of the Supreme Court in that case is not altogether free from ambiguity, any doubt we might have has been laid by the case of ; certiorari denied, , the facts of which were fully found by the Board and present a question almost identical with that presented by the instant case. That decision was contrary to the contention of petitioner and to the decision of the Circuit Court in We have also ruled adversely to the contention of petitioner in , and . From an examination of these cases the present state of authority seems to be that where a solvent debtor is under direct obligation to make payments for physical property purchased by him or1938 BTA LEXIS 1043">*1056 by his assignor, which is still held by him, and satisfies this obligation by paying less than the 37 B.T.A. 393">*399 amounts called for by the obligation, the property continuing to be of a value sufficient to pay the indebtedness, the transaction will result in taxable income to the debtor in the amount by which the face value of the obligation exceeds the amount paid by him for its satisfaction. Whether income will be realized at the time of the partial forgiveness of the debt even if the property bought has a value less than the remaining obligation, we do not now decide, but it seems clear that realization should not be postponed until disposal of the property.
The doctrine of , is limited to completed transactions, as the Supreme Court said in the American Chicle case. Since the property mortgaged to secure the obligation which was satisfied by the payment of less than its face value in this case was still held by the petitioner in 1933, the doctrine of that case is not applicable. 1938 BTA LEXIS 1043">*1057 Therefore, the fact that the market value of the real estate of petitioner was considerably less in the taxable year than the original price paid for it is immaterial.
The cases cited by petitioner having to do with similar transactions, in which the debtor is insolvent or in which the debt involved is a mere lien on the property sold and not a personal, direct obligation of the taxpayer, are not pertinent except to give examples of the limitations contained in our statement of the general rule applicable to the instant case, supra.
Judgment will be entered for the respondent.
Footnotes
1. SEC. 22. GROSS INCOME.
(a) GENERAL DEFINITION. - "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever from paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. In the case of Presidents of the United States and judges of courts of the United States taking office after the date of the enactment of this Act, the compensation received as such shall be included in gross income; and all Acts fixing the compensation of such Presidents and judges are hereby amended accordingly. ↩