Hallbrett Realty Corp. v. Commissioner

Hallbrett Realty Corporation, Petitioner, v. Commissioner of Internal Revenue, Respondent Hallbrett Realty Corp. v. Commissioner Docket No. 22630 United States Tax Court 15 T.C. 157; 1950 U.S. Tax Ct. LEXIS 104; August 29, 1950, Promulgated *104 Decision will be entered under Rule 50. Deductions -- Accrual -- Interest -- Unpaid -- Section 24 (c). -- Interest accrued but unpaid deductible where payees were not joint venturers and did not own more than 50 per cent of stock of the petitioner. James A. Ronayne, Esq., for the petitioner. Joseph F. Lawless, Esq., for the respondent. Murdock, *105 Judge. MURDOCK *157 The Commissioner determined a deficiency in income tax in the amount of $ 19,783.31 and a deficiency in declared value excess profits tax in the amount of $ 1,066.15 for the fiscal year ended November 30, *158 1945. The only issue for decision is whether interest accrued by the petitioner on a second mortgage for the fiscal years 1943 and 1944 was deductible in computing a net operating loss deduction for 1945. FINDINGS OF FACT. The petitioner was organized as a corporation in 1932. Its return for the taxable year was filed with the collector of internal revenue for the third district of New York. Sam Rosen and Jacob Brickman are not related by blood or marriage, but they had known each other for a number of years prior to 1934. Rosen at that time was employed as manager of the Hotel Bretton Hall, owned by the petitioner. The properties of the petitioner were encumbered at that time by a first mortgage in the amount of about $ 1,500,000 and a second mortgage in the amount of $ 280,000. Rosen and Brickman negotiated for the purchase of all of the stock of the petitioner and the second mortgage in the latter part of 1934. They purchased all of the*106 stock and the second mortgage for the lump sum of $ 100,000 in December 1934. Each paid one-half of that amount. Each held a certificate for one-half of the stock of the petitioner during 1943 and subsequent years. They had the second mortgage assigned to a nominee who held it for them until after the taxable year. Each had an undivided one-half interest in that mortgage. Rosen became president of the petitioner and continued to manage the hotel. Brickman was not an officer of the petitioner and took no part in the management of the hotel. The petitioner, using an accrual method of accounting, deducted on its returns for the fiscal years 1943 and 1944 accrued interest on the second mortgage. It did not pay any of that interest within 2 1/2 months after the close of the year for which it was accrued. Rosen and Brickman used a cash method of reporting income and they did not report that interest on their returns. The Commissioner, in determining the deficiency, explained that in computing the net operating loss deduction for 1945 he had not allowed deductions of $ 16,800 for 1943 and $ 16,706.25 for 1944 representing interest accrued on the second mortgage claimed as deductions*107 for those years. OPINION. The Commissioner attempts to justify his action on one ground only -- that the interest was not deductible because of the provisions of section 24 (c). He reasons that a partner is defined in section 3797 to include a member of a joint venture through or by means of which any business, financial operation, or venture is carried on; Rosen and Brickman were joint venturers in the ownership *159 of the second mortgage and the common stock of the petitioner and, therefore, were partners for all purposes of Title 26, U. S. Code; section 24 (b) (2) (C) provides that an individual owning stock in a corporation shall be considered as owning the stock owned by his partner; Rosen and Brickman must both be considered as owning the stock of the petitioner owned by the other and each must be considered as owning more than 50 per cent of that stock; section 24 (b) (1) (B) provides that no deduction shall be allowed for losses from sales of property between a corporation and an individual owning more than 50 per cent of its stock; no deduction would be allowed for a loss from a sale between the petitioner and Rosen or Brickman under section 24 (b) (1) (B); section*108 24 (c) provides that no deduction shall be allowed under section 23 (b) for interest accrued (1) if the interest was not paid within the taxable year or within 2 1/2 months after the close thereof, and (2) if the person to whom the interest is to be paid would not include it in his income for the taxable year in which the taxable year of the taxpayer ends under the accounting method used by him, and (3) if at the close of the taxable year both the taxpayer and the person to whom the payment is to be made are persons between whom losses would be disallowed under section 24 (b); the facts in the case come within section 24 (c) and, therefore, the interest in question was not deductible by the petitioner. That reasoning fails unless Rosen and Brickman were engaged in a joint venture by means of which some business, financial operation or venture was carried on. They paid a lump sum for the stock of the petitioner and the second mortgage. Each paid one-half of the total amount. Each had a certificate for one-half of the stock. The mere ownership of stock under such circumstances would not make them joint venturers. One was the president of the petitioner and operated the hotel. *109 The other was not an officer of the petitioner and had nothing to do with the operation of the hotel. There was no joint venture there. They had the second mortgage assigned to a nominee. They were ready to receive payments of interest on the second mortgage but none was paid for 1943 or 1944, during which years the operation of the petitioner resulted in losses. Such holding of an undivided one-half interest in a second mortgage would not constitute carrying on a business, a venture, or a financial operation but would constitute merely the holding of property. It would not require the filing of a partnership return even if the interest were paid. The two men were not partners within the meaning of section 3797, the respondent's whole line of reasoning falls, and he concedes that if each can be charged only with the ownership of 50 per cent of the stock of the petitioner, then the statute upon which he relies does not apply and he should have allowed the deductions. Decision will be entered under Rule 50.