Stern Trust v. Commissioner

Henry L. Stern Trust, Allan M. Loeb and Gardner H. Stern, Successor Co-Trustees, Petitioners, v. Commissioner of Internal Revenue, Respondent Stern Trust v. Commissioner Docket No. 58334 United States Tax Court 26 T.C. 1213; 1956 U.S. Tax Ct. LEXIS 74; September 28, 1956, Filed *74 Decision will be entered for the respondent. In 1945 and 1946, the Henry L. Stern Trust realized losses upon the sale of certain improved rental properties. Held, that the losses were not capital losses, and did not result in a capital loss carry-forward to the years 1950 and 1951. Albert K. Orschel, Esq., for the petitioner. J. Bruce Donaldson, Esq., for the respondent. Fisher, Judge. FISHER *1213 The respondent determined deficiencies in income tax of the Henry L. Stern Trust in the amount of $ 136.45 for the year 1950 and $ 3,710.77 for the year 1951. *1214 The sole question presented is whether the trust realized capital losses upon the sale of certain rental properties in 1945 and 1946. It is stipulated by the parties that if we determine that the losses are not capital losses, the respondent's determinations are correct, *75 but if we determine that the losses are capital losses, petitioner is entitled to capital loss carry-forwards to the years 1950 and 1951 in amounts agreed upon by the parties. FINDINGS OF FACT. Part of the facts are stipulated and are incorporated herein by reference. Allan M. Loeb and Gardner H. Stern are the duly qualified and acting co-trustees of a trust (hereinafter referred to as the Henry L. Stern Trust) created in 1928 under the last will and testament of Henry L. Stern, late of Chicago, Illinois, deceased. Allan M. Loeb and Gardner H. Stern reside in Chicago, Illinois. As fiduciaries of the Henry L. Stern Trust they filed timely Federal income tax returns (Form 1041 FY) for the years 1950 and 1951 with the collector of internal revenue for the first district of Illinois. The Bank of America, which had also been designated as a cotrustee, has ceased to function as such. Article Seventh of the will is as follows: SEVENTH: I give and devise to said Trustees and to my Executors, hereinafter named, full power of management and control of the trust funds and estates herein provided for, to invest and reinvest the same, and to vary the securities and property in which from time*76 to time such trust funds or estates may be invested, and to sell, transfer, convey, let or otherwise dispose of any part of said estate for the purpose of investment, distribution, disbursement, or for any other purpose germane to said trusts, intending hereby to give, and hereby giving to them, the same power of disposition, management and control in the handling of said trust estate as I would have if living; provided, however, that said Executors and said Trustees shall not reinvest any part of the trust estate in any leasehold estate, or in any bonds or notes secured by a mortgage or trust deed, upon a leasehold estate, or theatre, garage, hotel, factory, warehouse, church, hospital or club; nor shall they invest more than the sum of Twenty-five Thousand Dollars ($ 25,000.00) in any single mortgage, or more than the sum of Ten Thousand Dollars ($ 10,000.00) in the bonds of any single issue. I recommend that said Executors close, as soon as possible after my death, any margin accounts on stocks which I may be carrying, and that they sell shortly after my death any stocks which I own which they regard as speculative; it being my aim and desire that said Executors and said Trustees*77 shall cause my estate to be invested and reinvested under their management in a more conservative class of investments than I thought it necessary to carry in my lifetime while I was able to give my investments my personal attention and judgment. After closing the testator's margin account and making investments in some common stock, the trustees proceeded with an investment program. *1215 During 1928 and 1929, the trust invested portions of its corpus in various first mortgages on improved real estate located in Lake and Cook Counties, Illinois. A total of approximately 25 mortgages, almost all on 3-story apartment buildings and residences, were acquired. The top limit of each mortgage was $ 25,000, as required by the trust instrument. The principal asset of the taxpayer was stock in Hillman's, Inc. (of which trustee Stern is presently the president), common stocks, and the mortgages. The over-all management of the affairs of the trust was handled by the trustees, who supervised the investment policy and distributed the income. The management and supervision of the real estate were left largely to Emil Horween, a real estate man, who had an office in Chicago. A bookkeeper*78 of Hillman's, who handled the personal books of the executives of that company, undertook the bookkeeping for the taxpayer. For a period of 2 or 3 years following the investments in the mortgages, the mortgages remained in good standing, but after that time it was necessary to foreclose most of them because of defaults in taxes and interest payments. A total of 20 improved properties securing the mortgages were acquired by the trust through foreclosure of the defaulted mortgages or through purchase of the equity from the mortgagor for a nominal consideration. No real estate was acquired by the trust in any other way. The following schedule shows the location, date of acquisition of title, and general description of improvements of each of the acquired properties which were disposed of in 1945 and 1946: Year of Location acquisition General description of improvements 151 North Austin Avenue, [1932] Brick 8-room residence; 2 stories and Chicago, Illinois. basement. 2522 West Division St., [1932] Brick apartment; 3 stories, 3 apartments Chicago, Illinois. consisting of 7 rooms each. 2749 Sunnyside Avenue, [1935] Brick 8-room residence; 2 stories and Chicago, Illinois. basement. 34-36 East Division St. [1936] Brick rooming house consisting of 3 stories and containing 24 rooms. 1244 North LaSalle St., [1938] Brick rooming house consisting of 3 Chicago, Illinois. stories and containing 30 rooms. 130 Euclid Avenue, [1939] Brick 7-room residence; 2 stories and Glencoe, Illinois. basement. 5635 Blackstone St., [1939] Brick rooming house consisting of 3 Chicago, Illinois. stories and containing 36 rooms. Lincoln & Addison [1935] One-story commercial rental building consisting of 8 stores, a garage and a repair shop. *79 After acquiring title, the trust procured tenants and rented the properties for appropriate residential or commercial use. As tenants *1216 quit use of the property, new tenants were procured; electricity, water, and heat were provided for the apartment properties; repairs to the respective properties were made as they became necessary. When he was engaged by the trust, Horween was advised that the trust was desirous of liquidating its real estate holdings as speedily as it could be done without sacrificing the properties. The trustees, in each case, were to pass upon the bids secured by Horween. The trustees' main interest was in getting the cash and reinvesting it. Some properties were sold at prices which were considered to be low. Horween first tried to sell the properties himself and succeeded in a few instances. When he was unsuccessful, he put the properties up for sale with the agents who managed the properties in the neighborhood in which the properties were situated. These agents did what advertising was done on a single-property basis. There was no project for over-all advertising. At such times as offers for purchase of the properties were received by Horween*80 he communicated them to the co-trustees. The co-trustees exercised final judgment as to any disposition. The co-trustees did not always agree with Horween as to whether certain properties should be sold. In certain instances he advised them that the real estate market was about to rise and that the property should be held for a higher price. Such advice was not accepted by the co-trustees since they were anxious to dispose of the properties whenever a reasonable price was obtainable. In 1945 the trust sold the following properties and realized the following gain (or loss) on sale: Property sold Gain (or loss) 151 North Austin Avenue ($ 3,507.14) 2749 Sunnyside Avenue ( 8,203.54) 34-36 East Division Street ( 7,399.38) 1244 North LaSalle Street 2,949.33 130 Euclid Avenue ( 2,679.68) 5635 Blackstone Street ( 1,727.25) In the year 1946 the trust sold the following properties and realized the following loss on sale: Property sold Loss 2522 West Division Street ($ 2,882.01) Lincoln & Addison ( 5,927.97) The Henry L. Stern Trust, during the respective periods it held each of the above-listed properties, filed a Federal income tax return reporting the rental*81 income from each of the above-listed properties and claiming deduction for the expenses incident to maintaining and renting the properties. Included among the deductions were deductions for depreciation of the respective buildings and improvements, repairs *1217 to the buildings, rental costs, the cost of providing electricity, water, and heat to the residential properties, and compensation paid to Emil Horween. The properties sold during 1945 and 1946 had been held and rented by the trust for an average period of 9 1/2 years. OPINION. The sole issue presented is whether the losses of the Henry L. Stern Trust upon sale of certain improved rental properties in 1945 and 1946 were capital losses or not. This, in turn, depends upon whether the properties were capital assets within the meaning of section 117 (a) (1) of the Internal Revenue Code of 1939. The provisions of section 117 (j) are not applicable because the losses were in excess of any gains. Leland Hazard, 7 T. C. 372 (1946). The relevant provisions of section 117 are as follows: SEC. 117. CAPITAL GAINS AND LOSSES. (a) Definitions. -- As used in this chapter -- (1) Capital assets. *82 -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include * * * property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l) * * * 1 As set forth in our Findings of Fact, the properties sold in 1945 and 1946 had been held and rented out by the trust over substantial periods of time, averaging in excess of 9 years, from the time of acquisition until the time of sale. We have repeatedly held that use of real estate for rental purposes constitutes use of the property in trade or business. Rosalie W. Post, 26 T. C. 1055; Anders I. LaGreide, 23 T. C. 508, 512 (1954);*83 John D. Fackler, 45 B. T. A. 708, 713 (1941), affd. 133 F. 2d 509 (C. A. 6). See also Gilford v. Commissioner, 201 F. 2d 735 (C. A. 2, 1953) affirming a Memorandum Opinion of this Court. It is clear that the properties sold were of a character which was subject to the allowance for depreciation provided in section 23 (l) which expressly includes a "reasonable allowance for the exhaustion, wear and tear * * * (1) of property used in the trade or business, * * *." From the foregoing, it is apparent that the properties sold, in 1945 and 1946, are expressly excluded from the term "capital assets," as defined in section 117 (a) (1) and the losses suffered are therefore not to be taken as capital losses. In view of this holding, it is unnecessary for us to discuss the further question of whether or not the properties *1218 were held by the taxpayer primarily for sale to customers in the ordinary course of business under section 117 (a) (1). The parties have stipulated that in the event we determine that the sales in question did not result in capital losses, the respondent's determinations*84 for the taxable years 1950 and 1951 are correct. The effect of the stipulation, in the light of our holding, is that the losses in question did not result in a capital loss carry-forward to 1950 and 1951. Decision will be entered for the respondent. Footnotes 1. Section 117 (a) (1)↩ was amended by the Revenue Act of 1950. The amended section is applicable to the taxable year 1951 involved herein, but changes neither the wording nor the substance of that portion of the section here applicable.