*853 DEDUCTION - LOSS; ABANDONMENT OF REAL ESTATE. - Where the interest of the petitioners in improved real estate owned by them subject to a mortgage became worthless in 1934, they are entitled to deduct their loss in that year under section 23(e)(2), Revenue Act of 1934, although title remained in them until foreclosure was completed in the following year, despite their efforts to abandon their interest in the property during 1934.
*459 The Commissioner has determined deficiencies in income tax as follows:
| Petitioner | Docket No. | Year | Deficiency |
| W. W. Hoffman and Katherine M. Hoffman | 92414 | 1934 | $25,349.96 |
| Katherine M. Hoffman | 96741 | 1935 | 640.40 |
| W. W. Hoffman | 96742 | 1935 | 809.39 |
The sole issue for decision pertaining to 1934 is whether the petitioners sustained a deductible loss in that year upon the abandonment of certain real property owned by them jointly. If the loss was sustained in the year 1935, as the Commissioner contends, then*854 other issues arise.
FINDINGS OF FACT.
The petitioners are husband and wife. They filed a joint income tax return for 1934 and individual returns for the year 1935, with the collector of internal revenue for the second district of New York. They kept their accounts and reported their incomes on the basis of cash receipts and disbursements.
The petitioners, on April 30, 1928, purchased real property at 1602-04 Second Avenue, in the Borough of Manhattan. The purchase was made subject to a first mortgage of $40,000 and a second mortgage of $85,000. The cash consideration paid for the property was $35,000. The deed was made to the petitioners as husband and wife and was recorded on May 1, 1928. Each petitioner had an equal *460 interest in the property. The transaction was entered into for profit.
The petitioners did not assume any personal liability to pay either the interest or principal of the mortgages. The petitioner, W. W. Hoffman, paid the $40,000 first mortgage in full on January 29, 1929, and, some time prior to January 1, 1934, made two payments of $2,500 each on the principal of the other mortgage.
The property was improved with two five-story brick*855 buildings known as "old law tenements." They contained stores and apartments. The petitioners operated the buildings at a profit of about $10,000 in 1928. They continued to operate them at a profit during the years 1929 to 1933. The profit was small in 1933. The property was operated at a loss of about $4,000 during the year 1934. About one-half of the apartments in each building were vacant during that year. The leases made in 1934 were at substantially reduced rentals.
The Legislature of the State of New York passed an amendment to the Multiple Dwelling Law, effective May 14, 1934, which required certain structural changes of a fire retarding nature to be made in the petitioner's buildings. The approximate cost of making those alterations would have been $8,000. The petitioners did not comply with the 1934 amendment because they felt that their investment in the property had declined to such an extent that an additional outlay of capital was unwarranted. The petitioners' buildings needed other repairs, which would have cost approximately $2,000. The petitioners did not make those repairs.
The petitioners paid the interest due on the mortgage up to and including July 1, 1934. *856 Sometime after July 1 the mortgagees demanded a $5,000 principal payment on the $80,000 mortgage. The mortgage was past due. The mortgagees demanded at the same time that the petitioners pay the back taxes and water rents on the property, which amounted to approximately $5,500, exclusive of interest. The petitioners did not make any further payments on the mortgage, the back taxes, or the water rents.
The real estate agent handling the property for the petitioners advised them, prior to October 1, 1934, to abandon the property. Acting upon this advice they refused to make the interest payment due on October 1, 1934, although they were financially able to pay the interest, principal, and all amounts required under the law. The mortgagees refused to reduce the interest and principal payments due. They also refused the gratuitous offer of the petitioners of a deed to the property because they were advised that a foreclosure would be necessary to clear the title. The petitioners decided to abandon the property and so advised the mortgagees in 1934.
The property had steadily declined in value since the petitioners had purchased it. They believed that their equity was worthless*857 in *461 the fall of 1934 and that any attempt to sell for the amount of the mortgage and interest would be unsuccessful. The fair market value of the property in the fall of 1934 was not in excess of $65,000.
The mortgagees instituted foreclosure proceedings in the Supreme Court of New York, County of New York, on November 28, 1934, and, on the same day, the court appointed a receiver who took over the property and managed it pending the termination of the proceedings. The order appointing the receiver enjoined the petitioners from collecting rent or exercising any rights of ownership over the property. They entered their appearances in the foreclosure proceedings for the sole purpose of preventing a deficiency judgment being asserted against them.
The petitioners canceled the insurance on the property immediately following the institution of foreclosure proceedings, and received a refund of a part of the premium. They canceled at the same time their contracts with the public utilities companies which supplied the buildings with gas and electricity, and received a refund of the deposits made on such contracts. The petitioners collected whatever rents were paid by*858 the tenants of the buildings until the receiver was appointed on November 28, 1934. They did not exercise or attempt to exercise any ownership or control over the property after the appointment of the receiver. They did not make any effort to retain the property, to reacquire it, or to find a purchaser for it.
The court entered a final decree in June 1935, ordering a foreclosure sale of the property. The decree provided for a deficiency judgment against the mortgagors, but made no provision for a deficiency judgment against the petitioners. The foreclosure sale was held on July 5, 1935, and one of the mortgagees bid in the property for $1,000 and received a referee's deed conveying title.
The adjusted cost basis of the property to the petitioners was $66,833.34. The petitioners deducted that amount in their joint return for 1934 as a loss resulting from the abandonment of the property in that year. The respondent disallowed the loss and restored the amount claimed to income. The petitioners did not claim any deductions for losses on property in their individual returns for 1935. The respondent, in his notice of deficiency for the year 1934, gave the following explanation:
*859 The deduction of $66,833.34, claimed as a loss sustained through the foreclosure of a mortgage, has been disallowed, since the foreclosure proceedings did not terminate until 1935. Board of Tax Appeals in the case of J. C. Hawkins v. Commissioner published in Volume 34, page 918 held:
LOSS - MORTGAGE FORECLOSURE. - A mortgagor of real estate in California upon foreclosure sale in 1931 thereunder, sustains a deductible loss, if and when the mortgaged property is unredeemed at the expiration of the 12-month period during which such property can be redeemed.
*462 In this case, the foreclosure proceedings were terminated in June 1935, and the referee's deed given in July, 1935. Under these circumstances, the loss cannot be allowed as a deduction in 1934. The mere commencement of foreclosure proceedings in November 1934 is not sufficient to establish the loss in 1934.
The petitioners' interest in the property became worthless during 1934.
All facts stipulated are incorporated in these findings by this reference.
OPINION.
MURDOCK: The petitioners claim a deduction for 1934 under section 23(e)(2) of the Revenue Act of 1934. Although the respondent is*860 willing to concede a capital loss in 1935, when title was lost, he contends that there could be no loss from the ownership of real estate while title was retained. The statute allows a deduction for any loss sustained during the taxable year, if incurred in a transaction entered into for profit and not compensated for by insurance or otherwise. It does not distinguish between real and personal property.
The fact is clearly established that the interest of these petitioners in the property became completely worthless in 1934. The mortgage, a first lien, was greatly in excess of the value of the property. There were, in addition, delinquent taxes and water rents. If ownership were to continue, repairs costing about $10,000 would have to be made. The total of these items was about one and one-half times the value of the property. The property had been operating at a loss and renting conditions were growing worse. Foreclosure proceedings were instituted during 1934 and it was known that they would be pressed to permit the mortgagees to gain title. The petitioners fully realized that their equity was completely and permanently lost. Indeed, they considered further ownership*861 a liability and tried to give away their title. There was no reasonable hope that their equity would ever again have any value. The respondent does not call attention to any evidence indicating that the petitioners retained anything of value at the close of 1934. They did retain title to the premises, but that title was devoid of value to them. The mortgagees would not even take it as a gift. Subsequent events corroborate worthlessness in 1934.
The Board said in , that title to real estate can not be lost by abandonment alone. The statute does not make either abandonment or loss of title a condition precedent to the allowance of a deduction for loss. Still, evidence of abandonment may be material here, as in the case of personal property, to show that a permanent and complete loss has occurred from which there is no escape. These petitioners did about everything that they could *463 to abandon their interest in the property. Cf. . They notified the mortgagees of their intention to abandon. They refused to make the payments and repairs necessary to continued*862 operation, although they were able to do those things. They surrendered possession and canceled all contracts with insurance and public utilities companies. They did all of those things voluntarily because they no longer desired to possess any interest in the property. They were moved, of course, by their knowledge that their interest was no longer of any value and, if retained, would require them to make additional expenditures which they deemed entirely unwise. These acts indicate clearly that they were attempting to terminate their ownership, possession, and control and that they no longer cared what became of the property. They had no intention to renew their interest in any way. No way has been suggested whereby they could have abandoned their interest more effectively. Even if there was not a complete legal abandonment, nevertheless, the evidence shows that these petitioners lost their investment in the property in 1934.
The Supreme Court has said that the loss provisions call for a practical, not a legal, test, and, where losses are reasonably certain in fact and ascertainable in amount, their deduction may be justified before they are absolutely realized. *863 . Another court said that a sale is unnecessary in establishing a loss where value has become extinct and there is no variable to determine. . Those two cases involved losses upon personal property. Deductions for loss upon the abandonment of worthless real estate have been allowed by the Sixth Circuit Court of Appeals even though the taxpayer retained title. , reversing ; . A loss upon a mineral lease is sustained when it is abandoned as worthless, ; , and the same is true of a mine owned in fee. . Even the diminution in value of real property resulting from a casualty has been allowed as a loss. ; *864 ; ; . But under other circumstances a mere diminution in value has been disallowed as a loss. ; affd., ; certiorari denied, .
The Commissioner states that the Board has held consistently that no loss can possibly be sustained as a result of the ownership of real estate as long as title is retained. Despite statements made in A. J.*464 , and in , supporting the Commissioner, we think the rule contended for by the Commissioner is too broad. . Yet it is not necessary to overrule the Schwarzler case or any other which followed it. ; ; *865 ; (relied upon in the notice of deficiency); ; ; and , are easily distinguishable from the present case, either on the ground that they presented a failure of proof as to worthlessness and abandonment or because they involved an entirely different point. The Rhodes case was distinguished in the Bosquett case and the Brumback case was distinguished in the Greenleaf case. There was no worthlessness in the Coalinga-Mohawk Oil Co. case, merely a shrinkage in value.
The evidence in the Greenleaf case likewise showed only shrinkage in value, not worthlessness. Loss of title was not imminent and the evidence of abandonment was not strong. The Rhodes case was similar in many respects. There the property had been sold for taxes, but there was a period of redemption outlasting the taxable year. No finding of worthlessness of the taxpayer's interest was made and the evidence of abandonment was not convincing. *866 Nevertheless, the Board was reversed and a deduction was allowed.
Perhaps the most difficult case to distinguish is the Schwarzler case. There, as here, the liens exceeded the value of the property. However, the excess is not disclosed in the report. It may have been too slight to offset a possible increase in value of the property. This may have had added significance, since loss of title was not imminent. The report merely says in regard to abandonment that the taxpayer "attempted to abandon" the vacant lots. The present case is stronger for the taxpayer than any of the cases cited, including the Schwarzler Brumback, and Rhodes cases.
Some of the language used by the Board in the Schwarzler case tends to support the broad rule which the Commissioner now proposes. It was there said that "losses from dealing in real or personal property, growing out of the ownership thereof, are deductible only when ascertained and determined upon an actual, completed, and closed transaction during the taxable year, and are not sustained through the mental process by which a taxpayer determines that the property is worthless and charges it off on his books while he still*867 retains the title to the property itself." But thereafter many deductions were allowed for losses on worthless personal property while the taxpayer still *465 retained title, and in some cases the loss was allowed upon abandonment. See Law of Federal Income Taxation, Paul and Mertens, § 26.71 and cases there listed in footnotes. See also , where a loss was allowed upon the abandonment of mortgaged real estate. The allowance of a deduction for loss upon worthless property is not really an exception to the rule that losses are deductible only upon closed transactions.
The respondent argues that the petitioners did not abandon their interest since they did not expressly waive their right to any proceeds of foreclosure over and above the debt and costs. They never thought either of releasing or retaining those rights because they knew there was not even a remote possibility of there being any excess. The respondent also argues that a practical difficulty would arise if losses were to be allowed while title to real property remained in the taxpayer, since every case could be*868 settled only by litigation. No such difficulty has arisen in regard to losses on personal property, although they have been allowed when property became worthless and was abandoned. The Government frequently disallows losses on personalty in one year on the ground that the property was worthless in a prior year.
The interest of these petitioners in the property actually became worthless within the taxable year 1934. The events of that year were sufficient to identify the occurrence of a loss in that year. They thus sustained an ordinary loss of $66,833.34 in that year from a transaction entered into for profit and are entitled to a deduction of that amount for 1934. Cf. ;The issue for 1935, raised in the alternative, need not be discussed.
Reviewed by the Board.
Decision will be entered under Rule 50.
HILL dissents.
LEECH, dissenting: Beginning with A. J. Schwarzler Co.,3 B.T.A. 535">3 B.T.A. 535, followed by many other cases, including Greenleaf Textile Corporation,26 B.T.A. 737">26 B.T.A. 737; Frederick Krauss,30 B.T.A. 62">30 B.T.A. 62, and*869 Morris Polin,39 B.T.A. 951">39 B.T.A. 951, the Board has consistently held that no deductible real estate loss is sustained by a taxpayer so long as he retains title to the real estate. The correctness of this ruling has been affirmed, at least, in Greenleaf Textile Corporation, supra, and no case, of which I know, is contradictory, except possibly Rhodes v. Commissioner, 100 Fed.(2d) 966.
Proceeding upon the basis of that long established and consistently followed theory, the Board then held that no such loss could be sustained *466 by the mortgagor of real estate, upon foreclosure, so long as an equity of redemption existed. ; affd., . This holding has likewise been consistently followed and affirmed. ; ; . 1
*870 Despite the factual distinction between the first mentioned line of cases and this one, which the majority attempts to draw, I think the basic issue is the same in both and that the holding here is directly contra to the rule adopted and followed here.
Undoubtedly there are impressive reasons for the application of the so-called "practical test" in determining when a real estate loss is sustained. But such reasons, as well as those supporting our original position, existed and were considered by the Board and courts before that original position was adopted. I see no reason now to change that position. But, if it is to be reversed, I think that reversal should be clear and unmistakable.
DISNEY agrees with this dissent.
Footnotes
1. Although obviously immaterial here in my judgment, there appears to be no period of redemption in the State of New York. Sec. 548, Real Property Law of New York, McKinney's Consolidated Laws of New York, vol. 49, p. 876. ↩