Gilman v. Commissioner

Frank E. Gilman, Transferee of Roxbury Heights Developers, Inc., Petitioner, et al., 1 v. Commissioner of Internal Revenue, Respondent Gilman v. Commissioner Docket Nos. 18633, 18634, 20092, 20093, 20094 United States Tax Court 14 T.C. 833; 1950 U.S. Tax Ct. LEXIS 204; May 15, 1950, Promulgated *204 Decisions will be entered for the petitioners. A corporation owning a one-half interest in a joint venture real estate project was dissolved on December 30, 1942, and its assets were all distributed to its two stockholders. In January, 1943, the former stockholders sold their interest in the project to the third coadventurer, an individual owning the other one-half interest. At the time of the dissolution of the corporation, no contract had been entered into and no agreement had been reached regarding such sale. Held, that there was no sale by the corporation of its interest in the joint venture; held, further, that the former stockholders realized no gain on the sale of their interest in the joint venture in 1943, the sale price which they received not being in excess of the value of such interest at the time of its distribution to them, and their gain on the liquidation in 1942 having been reported in their returns for that year. A. R. Kehoe, Esq., H. B. Jones, Esq., R. B. Hooper, Esq., and Albert Olsen, Esq., for the petitioners. John H. Pigg, Esq., and R. G. Harless, Esq., for the respondent. Le Mire, Judge. LE MIRE *833 Transferee liabilities have been determined against petitioners Frank E. Gilman, Docket No. 18633, and I. Joe Hornstein, Docket No. *834 18634, for deficiencies in income tax, declared value excess profits tax, and excess profits tax, and for delinquency penalties due from Roxbury Heights Developers, Inc., for 1942, as follows: Frank E. Gilman I. Joe Hornstein Docket Docket No. 18633 No. 18634 Income tax $ 875.59 $ 2,237.53 Declared value excess profits tax 4,648.90 11,880.00 Excess profits tax 23,580.41 60,258.47 Delinquency penalty 5,895.10 15,064.62 Also, income tax deficiencies for 1943 have been determined against Frank E. Gilman, Docket No. 20092, Henrietta Gilman, Docket No. 20094, and I. Joe Hornstein*206 and Elsie Hornstein, Docket No. 20093, in the respective amounts of $ 3,165.91, $ 3,162.55, and $ 27,785.27. The year 1942 is also involved in each of the last mentioned three proceedings by reason of the forgiveness feature of the Current Tax Payment Act of 1943. The 1942 transferee liabilities are based upon respondent's determination that the transferor, Roxbury Heights Developers, Inc., realized a gain in 1942 on the sale of its interest in the real estate development which it operated until about the time of its dissolution, near the close of 1942, as a joint venture with an individual, Paul Keller-Block. The 1943 individual tax liabilities are based upon respondent's determination that the former stockholders of the dissolved corporation realized ordinary income in 1943 from their interests in the joint venture which they received upon the dissolution of the corporation in 1942. The petitioners reported gains on the sale of their interests in the project in 1942 as long-term capital gains. The respondent's inconsistent positions are presented in the alternative. He makes no contention that the gain on the sale of the corporation's interest in the joint venture is taxable both*207 to the corporation in 1942 and to the individual stockholders in 1943. There are also several collateral issues raised by the pleadings which need not be discussed, in view of our rulings on the principal issues. FINDINGS OF FACT. Petitioners are residents of Seattle, Washington. They filed their income tax returns for the years involved with the collector of internal revenue for the district of Washington. Roxbury Heights Developers, Inc., hereinafter referred to as Roxbury, was a corporation organized under the laws of the State of Washington in 1942 for the purpose of developing and operating a low cost housing project in the suburbs of Seattle. It was organized *835 by Paul Keller-Block and two of his associates, neither of whom has any connection with these proceedings. The organizers contributed originally only $ 5,000 cash, with the expectation of financing the undertaking largely with Federal Housing Administration insured loans. It later developed, however, that FHA would require a minimum contribution by the promoters of at least $ 50,000 of risk capital. To raise this additional capital Keller-Block obtained the assistance of petitioners Frank E. Gilman and I. *208 Joe Hornstein. These three persons on May 8, 1942, entered into a preliminary agreement which provided that they would execute and perform certain other agreements relative to the purchase by Gilman and Hornstein of all of the stock of Roxbury and the formation of a joint venture by Roxbury and Keller-Block to develop the project. This agreement was conditioned upon satisfactory financial arrangements being made by Keller-Block with FHA and others. One of the agreements referred to in the preliminary agreement of May 8, 1942, was executed on June 23, 1942, 2 by Keller-Block, as the "Builder," and Securities Mortgage Co. The agreement contained 35 typewritten pages and covered, in considerable detail, all matters pertaining to the financing of the project by Securities and the issuance of mortgages thereon by FHA. It provided, among other things, that Securities would lend the builder, Keller-Block, $ 892,800, for which the builder would execute and deliver to Securities a demand note in that amount, secured by a first lien "Blanket Mortgage," said amount to represent all of the individual notes and mortgages to be issued on the 279 proposed dwelling units; that the proceeds of*209 this loan, together with $ 51,000 of funds to be furnished by the builder, would be held in a special noninterest-bearing account to be maintained on the books of Securities entitled "Incomplete Loan Account"; and that the builder would draw on this account only for actual development costs and within certain construction progress credit based on the percentage of progress shown by reports to be filed monthly by the builder. All proceeds from the sales of the mortgage properties were to be deposited with Securities as additional collateral on the loan. The blanket mortgage was to be released by Securities when the amount of its loan should become fully issued by FHA under mortgages of a face value equal to the amount of Securities' unpaid advances. Upon discharge of the mortgage Securities was to pay to the builder the balance of the funds in the account. There was a further provision that the builder would not voluntarily assign his rights under the contract. *210 By subsequent agreements the amount of the mortgage loan was *836 increased from $ 892,800 to $ 1,031,250, due to a revision of the specifications to include heaters, electric ranges, and other equipment, with a corresponding increase in the loan values. Gilman and Hornstein knew of the agreement between Keller-Block and Securities and were familiar with all of its provisions, although they were not parties to the agreement. A joint venture, to be known as "Roxbury Heights Housing Project," was created by an agreement 3 entered into by Roxbury, a party of the first part, and Keller-Block, a party of the second part, on June 27, 1942, but was dated April 20, 1942. It was organized for the purpose of "acquiring, developing and selling" the Roxbury Heights property. The capital stock of Roxbury was then all owned by Gilman and Hornstein, as contemplated by the preliminary agreement of May 8, 1942, Gilman owning 25 shares*211 and Hornstein 75 shares. Under the provisions of the joint venture agreement Roxbury was to contribute $ 50,000 in cash or property, some of which had already been expended, plus a small amount of equipment, and Keller-Block was to contribute $ 1,000, represented by a note executed jointly by Gilman and Hornstein. Keller-Block was to have "sole and general supervision" over the project. He was to devote his full time thereto, with exceptions not here material, and was to have a personal drawing account of $ 400 per month which was to be charged ultimately against his share of the profits. Roxbury was to furnish one representative to serve in an executive capacity without compensation. After the payment of all debts and the return to the organizers of their capital investment, $ 50,000 to Roxbury and $ 1,000 to Keller-Block, the first $ 50,000 of profits was to be divided equally between Keller-Block and Roxbury. Keller-Block was then to receive the next $ 6,000 and thereafter all of the profits were to be divided equally. Work on the project was begun soon after execution of the above described agreements and progressed rapidly. By the end of 1942 construction on most of the*212 units had been started and many of them had been finished. Both Keller-Block and Hornstein devoted full time to the project, the latter acting as representative of Roxbury. One of Hornstein's duties under the joint venture agreement was to countersign all checks for expenditures in connection with the project. About the last of December, 1942, Gilman and Hornstein decided to dissolve Roxbury and distribute its assets to themselves. The financial success of the project was then assured, so that they were no longer concerned about their personal liability in connection with it. *837 They were advised by their attorneys that it would be to their tax advantage to dissolve the corporation. At a meeting of the stockholders of Roxbury held for that purpose on December 30, 1942, a resolution was adopted setting forth a plan for the complete liquidation of Roxbury. Under this plan, Gilman and Hornstein were to surrender all of their stock and the corporate assets were to be distributed to them pro rata. The resolution provided that Gilman and Hornstein should act as trustees in winding up the affairs of the corporation and that the corporation should cease to function as such at*213 the close of business on that date, December 30, 1942. Acting as liquidation trustees, Gilman and Hornstein on December 31, 1942, executed an assignment to themselves as stockholders of their respective interests in Roxbury's assets. Copies of this resolution were filed in the office of the Secretary of the State of Washington and with the auditor of King County, Washington, on December 30, 1942. The value of Roxbury's assets at the time of their distribution, consisting entirely of its one-half interest in the joint venture, was $ 140,000. From almost the beginning of their association in the Roxbury Heights Developers, Inc., an unfriendly relationship existed between Keller-Block and Hornstein. The situation culminated in an offer by Keller-Block to either buy out Gilman's and Hornstein's interests in the project for $ 140,000, or $ 90,000 net after repayment of their $ 50,000 of capital, or to sell them his interest at the same figure. Keller-Block's offer to purchase was accepted by Gilman and Hornstein and a written agreement was executed either in December, 1942, or January, 1943, 4 setting forth the terms and conditions of the transfer. *214 This agreement provided, in general, that Keller-Block would purchase from Gilman and Hornstein their interest in the joint venture, formerly owned by Roxbury, for $ 140,000, which would be paid out of the first funds to become due and payable to Keller-Block by Securities, and that Keller-Block would execute a written assignment to Gilman and Hornstein of $ 140,000 of such funds. The agreement further provided that "This agreement is expressly conditioned upon the acceptance of said assignment by said Securities Mortgage Company, a corporation, and in the event of its failure so to do this agreement shall have no force or effect." The assignment referred to in the sale agreement was thereafter executed by Keller-Block and was consented to by Securities in writing on February 12, 1943. The assignment is not otherwise dated, but a *838 letter to Keller-Block written by Gilman and Hornstein on February 3, 1943, states: You have this day executed an Assignment to the undersigned for the sum of $ 140,000.00 of certain funds payable under an agreement between you and the Securities Mortgage Company of Seattle, Washington, dated June 23, 1942. It is understood as between us that *215 whenever we have been paid the sum of $ 51,000.00 under said assignment, we will release to you the sum of $ 1,000.00 thereof. It is understood that after said sum of $ 1,000.00 shall have been released to you by us and we shall thereafter receive the further sum of $ 89,000, under said assignment, from the Securities Mortgage Company, we shall then be entitled to receive from the next funds payable by the Securities Mortgage Company under said agreement, or from you, the sum of $ 1,000.00. Thereafter Hornstein kept in close touch with the development of the project and continued to sign all disbursement checks issued in connection therewith until he and Gilman had received $ 140,000 from Securities under the above mentioned assignment. Full payment of that amount was made by a check for $ 140,000 issued by Securities and made payable to Keller-Block, Gilman, and Hornstein, jointly, on June 12, 1943. Gilman received $ 35,000 and Hornstein $ 105,000 of that amount as their shares of the proceeds of the sale. In the 1942 individual income tax returns filed by Gilman and Hornstein and their wives, long term capital gains were reported on the liquidation of Roxbury, based on a valuation*216 of Roxbury's assets at the time of their distribution, December 31, 1942, of $ 140,000. Gilman's interest in Roxbury had a cost basis of $ 12,500 and Hornstein's $ 37,500. Gilman and his wife reported a profit of $ 22,500 and Hornstein and his wife a profit of $ 67,500. Roxbury filed an income and declared value excess profits tax return for 1942 on April 3, 1943, but reported no income thereon. Respondent determined that Roxbury realized a gain in 1942 of $ 90,000 on the sale of its interest in the Roxbury Heights project and that by reason thereof it incurred a tax liability for that year of $ 74,376. A negligence penalty was added under section 291 (a), Internal Revenue Code, amounting to $ 15,064.62, making a total liability of $ 89,440.62. Roxbury was so notified by notice of deficiency mailed to it on March 9, 1948. These are the taxes and penalties involved in the transferee proceedings, Docket Nos. 18633 and 18634. Roxbury did not file a petition to this Court in response to the deficiency notice of March 9, 1948. The respondent mailed notices to Gilman and Hornstein on March 10, 1948, of transferee liabilities of $ 35,000 and $ 89,440.62, respectively. Respondent mailed*217 a notice to I. Joe Hornstein and his wife, Elsie Hornstein, June 8, 1948, of a deficiency in their individual taxes for 1943 in the amount of $ 27,785.27. They had filed a return for that year showing a net loss of $ 1,004.44. The deficiency resulted from *839 respondent's addition of partnership income, taxable as ordinary income, in the amount of $ 66,938.33, representing their gain in that year from their interest in the Roxbury Heights joint venture. Separate notices were sent to Frank E. Gilman and his wife, Henrietta Gilman, on June 8, 1948, of deficiencies in their income taxes for 1943 in the amounts of $ 3,165.91 and $ 3,162.55, respectively. In determining these deficiencies the respondent added to the community income of each of the petitioners $ 11,156.39 ($ 11,156.38 in Henrietta Gilman, Docket No. 20094) as partnership income from their interest in the Roxbury Heights joint venture. OPINION. Respondent's principal contention in these proceedings is that Roxbury sold its one-half interest in the Roxbury Heights joint venture to Keller-Block in December, 1942, prior to its dissolution. On that theory, he has determined that Roxbury incurred a tax liability for*218 1942, for which its stockholders, Gilman and Hornstein, and their wives, are liable as transferees. In the alternative, respondent contends that Gilman and Hornstein realized community income in 1943 of $ 90,000 from their interest in the Roxbury Heights joint venture which they acquired upon the dissolution of Roxbury in 1942. Under this theory respondent has determined the deficiencies against Gilman and Hornstein for 1943. In his brief respondent states: * * * There is no controversy between the parties, under the pleadings, as to the fact that there was a sale to Keller-Block of the joint venture interest, or that such sale resulted in a gain or profit to the vendor of $ 90,000.00. * * * Thus, the dominant issue, as stated by the respondent in his brief, is "whether the sale of the joint venture interest was made by Roxbury during the taxable year 1942, or by Hornstein and Gilman, in 1943, after acquisition thereof by liquidation of Roxbury." Respondent contends that the sale was substantially completed about the middle of December, 1942, prior to the dissolution of Roxbury. There is no disagreement as to the fact that Roxbury was dissolved December 30, 1942, and its assets*219 distributed to Gilman and Hornstein on the following day, December 31, 1942. The evidence is clear that the sale was not consummated or the assets transferred to Keller-Block until some time in 1943. The date of the execution of the preliminary agreement between Gilman, Hornstein, and Keller-Block outlining the general terms and conditions on which the transfer was to be made is the matter mentioned above in our findings of fact as to which there is conflicting evidence. The instrument was prepared in typewritten form, with the date of the month left blank, as follows: "This Agreement made and entered into this day *840 of January, 1943, by and between I. Joe Hornstein and Frank Gilman, first parties, and Paul Keller-Block, second party." Later the word January was stricken with pen and ink and the word December written above it. Apparently, at the same time "31st" was written in the blank space. These changes were initialled in the margin by all three parties to the agreement. The only explanation of this change in the instrument is that it was made at the suggestion of Keller-Block at the time the agreement was executed. However that may be, it is apparent that*220 the instrument was executed at some time in January, 1943, and dated back to December 31, 1942. Keller-Block, who appeared as a witness for the respondent, testified, first, that according to his best recollection the negotiations leading up to the purchase by him of Gilman's and Hornstein's interests took place about the middle of December, 1942, and that the sale price was agreed upon at that time. He later testified, however, after refreshing his memory from certain documents, that he could not say definitely whether these negotiations took place in December, 1942, or January, 1943. One of the documents referred to was a memorandum prepared by Keller-Block's attorney which indicates that on December 30, 1942, the parties had under consideration a plan for the dissolution of Roxbury and thereafter a sale by Keller-Block of his interest in the joint venture to Gilman and Hornstein. It was suggested in this memorandum that: * * * whatever the deal may be that will ultimately be worked out in 1943, it will not prejudice Mr. Keller-Block's present position, either on the question of assets or liabilities, or his rights under the existing joint venture agreement and general loan agreement. *221 Reference was also made to "the large tax liability that will have to be paid by Mr. Keller-Block on March 15th" in the event of such sale. This memorandum clearly demonstrates that up to the time it was written, December 30, 1942, there was no agreed plan for the sale by Gilman and Hornstein of their interests to Keller-Block. The respondent's argument on the factual question as to when the sale took place is based largely on inferences drawn from the circumstances of what he characterizes the tax avoidance scheme of petitioners and their tax counsel. The direct evidence, both oral and documentary, except for the conflicting testimony of Keller-Block, as pointed out above, all supports the contention of the petitioners that the sale by Gilman and Hornstein of their interests in the joint venture to Keller-Block was not consummated or even agreed upon until some time in 1943 and after the dissolution of Roxbury. We must conclude from this evidence that there was no sale by Roxbury of its interest in the joint venture; that Roxbury incurred no tax liability by reason of such a sale; and that petitioners Gilman and Hornstein *841 are, therefore, not liable as transferees for*222 any taxes due from Roxbury on income realized upon such a sale. The cases relied upon by respondent, such as Commissioner v. Court Holding Co., 324 U.S. 331, and Fairfield Steamship Corporation, 5 T. C. 566; affd., 157 Fed. (2d) 321; certiorari denied, 329 U.S. 774, are not applicable on the factual situation presented here. They are applicable only where there has been a liquidation of the corporation after a sale of its assets has been made, or agreed upon, in an attempt to shift the gain on the sale from the corporation to the individual stockholders. Even if it could be found on the evidence here that Gilman and Hornstein had discussed and had decided upon the sale of their interests in the joint venture but on the advice of tax counsel had decided to defer the actual sale until after dissolution of Roxbury, the facts would be no more favorable to respondent than were those in United States v. Cumberland Public Service Co., 338 U.S. 451, where the Supreme Court affirmed the decision of the Court of Claims which had upheld the*223 taxpayer's contention that the sale was made by the individual stockholders after the corporation had been dissolved and not by the corporation. In its opinion the Court said: Congress having determined that different tax consequences shall flow from different methods by which the shareholders of a closely held corporation may dispose of corporate property, we accept its mandate. It is for the trial court, upon consideration of an entire transaction, to determine the factual category in which a particular transaction belongs. Here as in the Court Holding Co. case we accept the findings of fact of the trial tribunal. Accordingly the judgment of the Court of Claims is affirmed. There remains for determination only the question, in Dockets Nos. 20092, 20093, and 20094, as to whether Gilman and Hornstein realized ordinary income from their interests in the Roxbury Heights project in 1943. Respondent's position on this issue is: * * * that the thing distributed in liquidation by the corporation to its two stockholders was a property right in the nature of a continuing interest in the joint venture, limited, however, in amount, to the latters' share of the joint venture profits *224 as agreed upon by the parties, and that the income in question was derived by those petitioners in the year 1943 from such continuing interest in said joint venture, and not from a sale of the joint venture interest. Petitioners reported long term capital gains on the liquidating distributions received from Roxbury in 1942 and paid taxes thereon. No question is raised in these proceedings as to the amount of the gains, if any, thus realized by them. The respondent has determined, however, that the capital gains reported by the petitioners in their 1942 returns should be eliminated therefrom, on the theory that what petitioners *842 received in 1942 was a continuing interest in the joint venture, from which they realized ordinary income in 1943. It is our view of the situation, as already stated with respect to the first issue, that Roxbury was completely liquidated and its assets distributed to Gilman and Hornstein in 1942. That being so, petitioners properly reported their gain from the liquidation in that year. It is too plain for argument, we think, that petitioners sold to Keller-Block in 1943 the capital interest in the joint venture which they had received on the liquidation*225 of Roxbury in 1942. Since their interest had a cost basis, the value at the time of its distribution to them by Roxbury, equal to the sale price of $ 140,000, no gain was realized on the sale by the petitioners in 1943. Decisions will be entered for the petitioners. Footnotes 1. Proceedings of the following petitioners are consolidated herewith: I. Joe Hornstein, Transferee of Roxbury Heights Developers, Inc.; Frank E. Gilman; I. Joe Hornstein and Elsie Hornstein; and Henrietta Gilman.↩ 2. This agreement, introduced in evidence as Exhibit 5, is incorporated herein by reference.↩ 3. This agreement, introduced in evidence as Exhibit 7, is incorporated herein by reference.↩ 4. There is conflicting evidence as to the actual date of the execution of this agreement, which will be discussed in the opinion.↩