*274 Decision will be entered for the petitioner.
Petitioner's acquisition of property from two transferor-stockholders in exchange for its obligation to pay for the properties what it received upon sale up to an agreed amount, held to create a basis of its cost, the transaction not constituting a tax-free exchange under Internal Revenue Code, section 112 (b) (4) or (b) (5), nor a capital contribution under Internal Revenue Code, section 113 (a) (8) (B).
*175 Respondent determined deficiencies of $ 1,092.14 and $ 1,136.83 in petitioner's income and declared value excess profits taxes, respectively, for the year 1939.
The single issue is the proper basis for computing petitioner's gain or loss from the sale or other disposition of certain properties obtained under a contract dated January 22, 1931.
The record consists of a stipulation of facts and exhibits thereto and some oral testimony.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
Petitioner, a Florida corporation, filed *275 its tax return, prepared on an accrual-calendar year basis, with the collector for the district of Florida.
It was created as a result, and pursuant to the terms, of a written contract dated January 22, 1931, the parties to which were the Highway Construction Co. of Ohio, Inc., an Ohio corporation, hereinafter sometimes referred to as Highway, and Mercantile Investment & Holding Co., a Florida corporation, hereinafter sometimes referred to as Mercantile. The purpose of the contract was to reconcile the apparently conflicting rights of the contracting parties to various properties situated in Hollywood,Florida.
Hollywood is a city which was planned and developed by J. W. Young some time prior to 1925; in this effort he created various corporations to perform specific services. The major developmental work was accomplished in three or four years, and in 1925 the city had a "year-round" population of from 25,000 to 30,000.
Highway, through an assignment of contracts, was engaged to construct various sidewalks and street pavements in the city. Immediately after the hurricane of September 1926, the Florida "boom" having collapsed, defaults occurred in payments due under the contract. *276 Highway's attorneys advised it to file liens to secure the amounts unpaid. That procedure was followed and Highway also filed foreclosure *176 suits in chancery and common law actions in damages for breach of contract. Young, acting for his companies, asked for an extension of time. It was granted on his promise to make certain specified payments. He defaulted in these payments and after many conferences he agreed that a certain amount of damages had been sustained by Highway; that Highway should file a suit setting forth the amount then due for work performed and the amount of such damages; and that he would sign answers admitting the amounts alleged in the petitions. The answers were delivered to a trustee to be filed upon Young's further default.
Young and his companies continued to default. Thereupon, after considerable litigation designed to prevent the delivery and filing of the answers, the answers were filed and two judgments were entered in favor of Highway for $ 1,532,654.56 and $ 608,569.14, respectively, in the Broward County (Florida) court. When these judgments were entered the defendants held title to 25,000 or more lots in Hollywood and additional acreage*277 adjoining that city.
Mercantile was organized in 1929 primarily to purchase mortgages on, and through foreclosure to acquire the Hollywood Beach Hotel, one of Florida's largest, and the Hollywood Golf Course. Later its activities were enlarged by securing tax certificates and mortgages on other properties, which were subject to Highway's judgment liens.
Because of these conflicting interests, and the resulting differences, each realized that some plan for their mutual benefit should, if possible, be formulated. Mercantile thereupon offered to purchase Highway's interest in the Young properties for $ 2,000,000, or to sell its interest for $ 1,250,000. Highway was not financially able to purchase and was unwilling to sell, as it considered its interest in the properties it had already acquired and in the additional properties to be acquired through its judgment liens to be worth much more than the offered sum.
After about a year of further bargaining, the parties in 1931 finally agreed to organize a new company -- the petitioner -- and entered into the aforesaid agreement, in which petitioner's function was described as follows:
Sub-Par. (I) That the new company shall, as soon as*278 may be after its formation and organization, proceed, without sacrifice of its assets and property, to liquidate the properties and assets which shall be transferred, set over and delivered to it hereunder; and that the proceeds of such liquidation shall, when and as available for such purpose, be disbursed and distributed in accordance with the following schedule:
First: There shall first be repaid to the Mercantile Company and the Construction Company pro rata in proportion to the sums advanced or expended by them, such sum or sums, from time to time, as will reimburse them for the amount or amounts already or hereafter advanced or expended by them pursuant to the provisions of paragraph (H) hereof. As an illustration of what is meant by "pro rata proportion," if it be assumed that the Mercantile Company has advanced *177 or expended $ 110,000.00 and the Construction Company has advanced or expended $ 10,000.00, then for every $ 1.00 repaid or reimbursed to the Construction Company, there shall be repaid or reimbursed to the Mercantile Company $ 11.00. There shall also be repaid all money borrowed pursuant to the provisions of paragraph (H) hereof. The repayment of the*279 money so borrowed may precede the repayment or reimbursement to the parties hereto, provided both parties mutually agree thereto. All sums of money expended and advanced prior to the date of the execution of this agreement shall bear interest at six per cent per annum from December 1, 1930. All other sums hereafter advanced by both parties pursuant to paragraph (H) shall bear interest at the rate of six per cent per annum from the date of the advancement thereof.
Second: After repayment provided for in the next preceding sub-paragraph designated "First" shall have been fully made, there shall be paid to said Mercantile Company the principal sum of $ 115,461.12, together with interest on said principal sum at 6 per cent per annum from the 1st day of December, 1930, until paid, (which principal sum is the total amount, for principal and interest, remaining unpaid and due to said Mercantile Company on the three mortgages described in sub-paragraphs (a), (b) and (c) of paragraph 8 hereof) and which sum, whether true or not, is agreed to as the principal sum for payment to the Mercantile Company on said mortgages under the provisions of this paragraph; and to said Construction Company*280 the principal sum of $ 171,100.50, together with interest on said principal sum at 6 per cent per annum from the 1st day of December, 1930, until paid, (which principal sum is the aggregate amount of the sums for principal and interest remaining unpaid on the liens of the Construction Company described in paragraphs numbered 4, 5 and 6 hereof,) and which sum, whether true or not, is agreed to as the principal sum for payment to the Construction Company on said liens under the provisions of this paragraph; the payments to be made pursuant to this sub-paragraph shall be made on a pro rata basis.
Third: There shall, after the payments provided for in the preceding subparagraphs designated "First" and "Second" have been fully made, be paid to the Construction Company the sum of $ 2,000,000.00, without interest, (which is the agreed amount of the judgments described in paragraphs 2 and 3 hereof), and which sum, whether true or not, is agreed to as the sum for payment to the Construction Company under the provisions of this paragraph; and to the Mercantile Company the sum of $ 500,000.00, without interest, (which is one-fourth of the agreed amount of said judgments), and which sum, *281 whether true or not, is agreed to as the sum for payment to the Mercantile Company under the provisions of this paragraph; the payments to be made pursuant to this sub-paragraph, however, shall be made on a pro rata basis.
After the payment in full of all such sums Mercantile agreed to secure the assignment to Highway of the capital stock owned by it but held by its nominees upon the reimbursement to Mercantile, or its representatives, of the amounts paid for such stock.
Pursuant to the terms of the agreement, petitioner was formed, with an authorized capital of 100 shares of no par value. The price of the stock thereafter being set at $ 20 per share, Mercantile and Highway each received 50 shares upon the payment of $ 1,000 therefor. Highway, on or about February 18, 1931, delivered to petitioner a fee simple deed conveying many hundreds of lots identified on the map accompanying the stipulation in this proceeding. Highway acquired title to this land by sheriff's deeds under judgments as set forth in *178 the contract of January 22, 1931. Highway, on or about July 6, 1932, also transferred to petitioner all of the capital stock of New Rivers Enterprises, Inc.
Highway did *282 not report on its tax returns as income any amount represented in the judgments for anticipated profits or damages.
As one of its obligations under the agreement, Mercantile proceeded to foreclose the mortgages and other liens described therein during the period from January 22, 1931, to about September 17, 1935. As such foreclosures were completed and as it acquired title to the lots encumbered by its liens, it delivered fee simple deeds conveying title to the lots to petitioner, with the sole exception of the Hollywood Golf Course.
Mercantile acquired city of Hollywood tax certificates of the face value of $ 174,302.16 and, under the terms of the contract of January 22, 1931, it, on or about July 4, 1932, transferred such tax certificates to Mercantile Certificate Corporation, a Florida corporation, as the nominee of petitioner. These certificates covered lots scattered throughout the city of Hollywood.
Further, Mercantile, in order to assist petitioner in commencing its operations, lent petitioner the sum of $ 25,457.99, which petitioner charged on its books to an account designated "Capital-New Money," and an offsetting entry was made to "Donated Surplus."
Petitioner's receipt*283 of the assets under the 1931 agreement was recorded on its books by a journal entry dated February 18, 1931, in which the account "Unsold Lots" was debited with $ 1 and "Capital (New Money)" was credited with $ 1. No other entry was made until May 31, 1939, when petitioner for the first time attempted to record on its books the cost of the assets; but all expenditures of a capital nature made by petitioner in connection with these holdings were charged to the account, which contained a balance at the end of 1938 of $ 170,575.01.
Differences having arisen between petitioner and Mercantile, as a means of settlement a contract had been entered into between petitioner and Mercantile dated September 9, 1937. Under that contract Mercantile sold to petitioner all its rights under the contract of January 22, 1931, and all its interest in advances made by it and in the assets of petitioner and Mercantile Certificate Corporation; and Mercantile also sold an aggregate of 63 1/2 shares of stock in those three corporations. Petitioner agreed to pay to Mercantile $ 250,000 in ten years, with certain conditional payments of interest, and to convey to Mercantile a golf course (not the Hollywood*284 Golf Course heretofore mentioned). Elaborate provisions governing default were established. If such default were not cured or removed as specified, Mercantile would resume its rights under the January 22, 1931, contract.
*179 Thereafter, in 1939, petitioner recorded on its books the acquisition of the assets under the 1931 contract by the following entry:
| Journal Voucher No. 1117 | ||||
| Date May 31, 1939 | ||||
| Description of Entry | Detail | Debit | Account | Credit |
| No. | ||||
| Lots and Acreage | $ 1,729,702.80 | 141 | ||
| Donated Surplus | 253 | $ 1,729,702.80 | ||
| To set up value of lots and | ||||
| acreage, as per contract of | ||||
| January 22, 1931, as detailed on | ||||
| attached sheet. |
It then set up the "original acquisition value" of the lots and acreage which were conveyed to Hollywood Land Co., as its nominee, at $ 770,457, and the original acquisition value of the lots and acreage which were conveyed to it at $ 1,729,702.80. The present values of such lots and acreage were determined to be $ 770,457 and $ 1,900,277.81, respectively. No liability from Land to petitioner was set up on the books of the latter on account of a conveyance of $ 770,457 in property to the former, but when the*285 $ 1,729,702.80 was charged to "Lots and Acreage" on petitioner's books, an offsetting entry was made thereon to "Donated Surplus."
During 1939 petitioner sold certain described lots which it acquired from Highway and Mercantile. Petitioner determined its cost of the properties sold in the following manner:
The sum of $ 170,575.01, already mentioned, representing petitioner's capital expenditures, was added to the sum of $ 1,729,702.80. Then the total of those two sums, namely, $ 1,900,277.81 was allocated to the lots and acreage, as set forth in the stipulation, upon the basis of the valuation of such lots and acreage for state and county ad valorem taxes. Using that method, that portion of the $ 1,900,277.81 which was allocated to the lots sold during the calendar year 1939 is shown on the schedule attached to the tax return under the heading "Original Valuation" opposite the description of the lot to which the allocation was made. This totals $ 32,247.97 for all of the lots sold during the year. The amounts shown on that schedule under the heading "Cost of Improvement," namely, $ 28,467.25, represent sums which petitioner expended in constructing houses and/or making other *286 improvements on the particular lots opposite the description of which such amounts appear. The amounts shown on that schedule under the heading "Taxes and Closing Costs," totaling $ 17,673.25, represent the sums petitioner expended for the following purposes on the lots opposite the description of which those amounts appear, to wit:
(a) Taxes paid since acquisition of lots and capitalized;
(b) Paving liens paid since acquisition of lots and capitalized;
(c) Costs of abstracts delivered to purchaser;
(d) Commission paid to brokers for selling lots.
*180 The amounts shown on that schedule under the heading "Mortgage Release" in the amount of $ 6,489.18 represent the amounts which petitioner paid for the release of the liens of mortgages which encumbered the corresponding lot.In computing its net loss from the sale of real estate during 1939, petitioner reported in its income tax return for that year the sale price of 45 lots of land as $ 70,644 and the "original valuation" of such lots as $ 32,247.97. It enumerated other costs aggregating $ 52,629.68, showed an aggregate gain of $ 3,828.21 on certain lots, an aggregate loss of $ 18,061.86 on the remainder, and a net loss*287 of $ 14,233.65 on the composite transaction.
The net loss of $ 14,233.65, reported on petitioner's tax return, was offset by other income, resulting in gross income for the year of $ 265.33. Since its other deductions totaled $ 29,947.37, a net loss of $ 29,682.04 was reported and no tax was shown to be due.
In his notice of deficiency respondent excluded the sum of $ 32,247.97 on the ground that "The evidence of record does not support a finding that the said amount of $ 32,247.97, or any portion thereof, constituted a part of the cost of the real estate sold."
After the mailing of the notice of deficiency and after the filing of the petition in this proceeding petitioner sought to correct what it thought were certain mistakes and inaccuracies on its books of account, including the entry of May 1939 recording petitioner's acquisition of the various properties transferred by Highway and Mercantile. An accounting firm was employed for this purpose, and as a result of its examination, correcting entries were made on December 31, 1944, including the following:
| Dr. | Cr. | |||
| Contract Payable -- H. C. Co. & M. I. & H. Co | $ 2,938,719.61 | |||
| Contract -- Mer. Inv. & H. Co | $ 740,461.12 | |||
| Contract -- Highway Const. Co | 2,198,258.49 | |||
| To segregate the liability under the contract of 1-22-31 as between each | ||||
| company | ||||
| * * * * | ||||
| Dr. | Cr. | |||
| Donated Surplus | $ 2,010,525.79 | |||
| Contract Payable -- H. C. Co. & | ||||
| M. I. & H. Co | $ 2,010,525.79 | |||
| To charge surplus with | ||||
| following credits made in | ||||
| error: | ||||
| 6-30-38 Tax | ||||
| certificates | $ 247,865.00 | |||
| 6-30-38 Stratton | ||||
| Mortgage | 7,500.00 | |||
| 12-31-38 Loan by M. I. | ||||
| & H. Co | 25,457.99 | |||
| 5-31-39 Lots & Acreage | 1,729,702.80 | |||
| Total | $ 2,010,525.79 | |||
| Above amounts all represent assets acquired under contract of 1-22-31 for which | ||||
| a liability exists. |
*288 *181 OPINION.
The controversy between the parties is as to whether certain properties sold by petitioner in the tax year were acquired by it under such circumstances that the basis for gain or loss to be applied is the substituted basis of petitioner's transferors or its own cost. Without attempting to restate in detail the circumstances under which the properties were obtained, the salient characteristics of the transaction were that petitioner's transferors, who were its stockholders, turned the properties in question over to it, along with many other parcels, under an agreement that it was to sell the properties and pay to them the proceeds of the sales up to a stipulated lump sum.
Respondent contends that petitioner received the properties as a contribution to its paid-in surplus, and hence is subject to the provisions of section 113 (a) (8) (B), Internal Revenue Code, 1 and, since the transferors' basis is not shown, it must be assumed as zero. The contemporaneous agreements show that the transaction was not a contribution to capital or paid-in surplus, but a transfer for an agreed consideration; and the mere adoption of bookkeeping notations not in accord with the facts*289 and later corrected is insufficient to sustain any such position. Doyle v. Mitchell Bros. Co., 247 U.S. 179">247 U.S. 179, 187; Savinar Co., 9 B. T. A. 465, 467.
Respondent also relies on section 113 (a) (8) (A), 2 which presupposes the application of 112 (b) (5), Internal Revenue Code. 3 The only other section suggested by respondent as being relevant is 112 (b) (4), Revenue Act of 1928, relating to corporate exchanges. 4 None of these sections is applicable under the facts, since the record similarly shows that the properties were not transferred "solely" *290 for petitioner's stock or securities.
*291 *182 If petitioner did not acquire the properties in question subject to its transferors' basis, its basis was its own cost. That was represented by petitioner's agreement to turn over to its transferors the proceeds of the sales. It can not be said that, because petitioner was not in existence at the time of the original agreement and hence does not appear as a contracting party, it was relieved of the obligation to pay the consideration specified in the contract. Its creation pursuant to the contract and its acceptance of the property in accordance therewith imposed upon it an obligation to perform to precisely the same extent as though it had executed the agreement in the first place. Meyer v. Nator Holding Co., 136 So. 636">136 So. 636; Smith v. Loftis, 150 So. 645">150 So. 645.
The nature of the agreement of purchase might justify an argument that petitioner could never suffer a loss except as to costs actually defrayed by it, such as improvements, carrying charges, and selling expenses, since it was never obligated to pay to its transferors more than it received; and that it could enjoy a gain only to the extent that the proceeds*292 of the sale of a particular parcel exceed its actual investment, plus that parcel's allocable portion 5 of the total consideration which it had agreed to pay. Nathan Blum, 5 T. C. 702, 709. On such an approach there would apparently be a gain on the transactions in question of approximately $ 3,800, rather than the loss of $ 14,000 which petitioner deducted on its return and still claims. The latter result is arrived at by assuming a cost for each parcel of a proportionate part of the contract figure, whether or not petitioner succeeded in obtaining it, and notwithstanding that the contract required the payment only of the amount actually received.
We find it unnecessary, however, to choose between these alternatives, since even on the former approach petitioner would have no net income and there would hence be no deficiency. Absent any claim*293 of overpayment, a decision of no deficiency is required in either event, and the result of both approaches in this proceeding is accordingly the same.
Nor would respondent be advantaged were we to hold, in accordance with his suggestion, "that petitioner was created the nominee of Highway and Mercantile for the purpose of holding title, liquidating the assets, and disposing of the proceeds * * *." If petitioner were a mere agent or conduit created with this limited function, any gain or loss from the periodic dispositions of the property would be attributable not to it, but to its principal, the controlling stockholders, who are not before us. North Jersey Title Insurance Co. v. Commissioner (C. C. A., 3d Cir.), 84 Fed. (2d) 898.
Our conclusion is that respondent erred in seeking to attribute to petitioner the basis of its transferors -- which, as we have said, is not *183 shown and hence was assumed by respondent to be zero -- and that his determination must accordingly be disapproved.
Decision will be entered for the petitioner.
Footnotes
1. (8) * * * If the property was acquired after December 31, 1920, by a corporation --
* * * *
(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩
2. (8) * * * If the property was acquired after December 31, 1920, by a corporation.
(A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5)↩ (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities) * * *.
3. SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(b) * * *
(5) Transfer to corporation controlled by transferor. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. * * *↩
4. (4) Same -- gain of corporation. -- No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.↩
5. Petitioner's formula of allocation among the numerous parcels based upon assessed valuations does not appear to be questioned by respondent.↩