Townend v. Commissioner

Mae E. Townend, Petitioner, v. Commissioner of Internal Revenue, Respondent Townend v. Commissioner Docket No. 51448 United States Tax Court 27 T.C. 99; 1956 U.S. Tax Ct. LEXIS 64; October 22, 1956, Filed *64 Decision will be entered for the respondent. 1. Petitioner and her brother and sister owned as partners certain inherited real property. Petitioner also owned real property individually. All of such properties were held primarily for rentals, but from time to time sales would be made. There were no purchases or acquisitions to replace items sold, and no general plan to liquidate either the partnership or the individual holdings. In 1945 and 1946 petitioner sold individually owned properties at a loss, while in 1946 the partnership sold properties at a profit. Held, the sale in 1945 was not attributable to the operation of a trade or business regularly carried on by petitioner, and therefore the loss may not be taken against business income in determining a net operating loss carryover to 1946 by reason of section 122 (d) (5), I. R. C. 1939. 2. Petitioner must aggregate her individual losses and her share of partnership gains, in respect of sales of rental properties, and apply section 117 (j) once only, to the net amount of gain or loss so computed. Commissioner v. Paley, 232 F. 2d 915 (C. A. 9), certiorari denied 353 U.S. 838,*65 and Commissioner v. Ammann, 228 F. 2d 417 (C. A. 5), followed. 3. The properties held by the partnership had previously been held by a trustee, in accordance with the devisor's will. Income was currently distributable, and during the years 1913 to 1927 no gains or profits came into the hands of the trustee which were not so distributable, and in respect of which a deduction for depreciation could produce a tax benefit. Held, the deduction was nonetheless "allowable," and although it was not in fact "allowed," the basis of the assets constituting the corpus of the trust, and presently of the partnership, must be reduced accordingly. Frank Townend, Esq., for the petitioner. Jules I. Whitman, Esq., for the respondent. Raum, Judge*66 . Murdock, J., dissents on the second point. RAUM *99 Respondent has determined deficiencies in the income tax of petitioner for the taxable years 1946 and 1947 in the respective amounts of $ 2,014.13 and $ 3,383.34. Only the year 1946 is in issue in this proceeding. The issues are as follows: *100 (1) Did respondent err in determining that a sale in 1945 by petitioner of real property was not attributable to the operation of a trade or business regularly carried on by her, and hence unavailable as a net operating loss carryover to the taxable year 1946? (2) Must petitioner aggregate individual losses and partnership gains in respect of sales or exchanges of section 117 (j) assets, and only then apply that section to the net gain or loss? (3) Was depreciation "allowable" to the trustee during the years 1913 to 1927, inclusive, so as to require a reduction in the basis of such property? FINDINGS OF FACT. A stipulation filed by the parties is incorporated herein by this reference as a part of our findings. 1. Net Operating Loss Carryover. Petitioner is an individual residing in Dallas, Pennsylvania. Her Federal income tax returns for the calendar years 1945 and *67 1946 were filed on the cash basis with the then collector of internal revenue for the twelfth district of Pennsylvania at Wilkes-Barre, Pennsylvania. Petitioner's grandfather, Lawrence Myers, died testate in 1905. His will left his real estate in trust, naming as life tenants two daughters, including petitioner's mother, and designating their children as remaindermen. Petitioner's mother died in 1933, whereupon petitioner and her two siblings, none of whom were then minors, acquired a vested interest in one-half of the trust estate. The trust continued, however, until the death without issue of the other life tenant in 1942, whereupon the other one-half of the trust estate vested in the same three remaindermen. The trustees rendered their final accounting, and the three remaindermen have continuously thereafter operated the real estate of the former trust as partners, pursuant to a written agreement dated May 24, 1944. Thus, petitioner was the owner of one-sixth of the property constituting the principal of the foregoing trust from 1933 until 1942, and of one-third of such property thereafter. The firm of D. T. Scott & Sons had managed the properties for the trustees since the*68 creation of the trust estate. After termination of the estate the same firm continued therein as agents of the partners. It has three full-time and four part-time employees engaged in operating those properties. The number of commercial buildings, apartment buildings, and houses held, the total number of tenants occupying the various properties, and gross income, net income (loss), and petitioner's share thereof in each year from 1933 to 1945 were as follows: *101 Year Gross rent Net Petitioner's Commercial Apartment Houses Total income share bldgs. bldgs. tenants [1933] $ 75,425.03 ($ 4,847.93) ($ 403.99) [1934] 85,379.04 (19,062.81) (3,177.13) [1935] 83,211.01 (44,378.41) (7,396.40) [1936] 86,277.75 (32,107.56) (5,351.26) [1937] 85,766.77 (24,097.95) (4,016.32) [1938] 81,856.76 (28,156.24) (4,692.70) [1939] 82,550.24 (21,801.48) (3,633.58) [1940] 81,328.37 (19,216.84) (3,202.80) [1941] 80,513.12 (17,756.32) (2,959.38) [1942] 78,803.35 (18,510.85) (3,085.14) [1943] 75,396.83 (59,692.11) (19,897.37) [1944] 84,100.59 (18,704.81) (6,234.93) [1945] 89,717.25 (13,373.65) (4,457.88) [166] *69 After 1945 gross rentals continued to increase each year until 1950, when the amount thereof was $ 117,647.57. A net loss in the amount of $ 5,419.96 was suffered in 1946, of which petitioner's share was $ 1,806.65. After 1946, the partnership realized profits each year through 1954. In 1936 a warehouse, representing a part of the estate, was sold for $ 60,000; in 1937, 2 vacant plots were sold for $ 500; in 1938 a commercial property was sold for $ 36,750; and in 1946, 2 commercial properties were sold for $ 40,000. In 1947 and subsequent years various other properties were sold, 10 properties being disposed of in 1947 for a total of $ 58,100. In addition to the foregoing, petitioner individually sold for $ 1,000 a one-half interest in a vacant lot in 1934, a double stucco dwelling for a purchase price of $ 5,000 in 1945, and in 1946 she sold a one-third interest in a brick dwelling for $ 5,000. These properties were acquired from the estate of petitioner's mother as a result of her death on July 2, 1933. Petitioner did not acquire any real estate by purchase until 1953. The property sold by petitioner in 1945 was never occupied by her. Between 1933 and 1945 it was rented to*70 individuals as a dwelling, except that for a part of the time it was rented as a tearoom. It was income-producing property held by petitioner for the purpose of producing rental income. It was sold at a loss of $ 15,347. On her 1946 return she claimed a net operating loss carryover in respect of that loss. The property sold by petitioner in 1946 was sold at a loss of $ 3,600.50. Petitioner's original basis therein was $ 10,066.67 and her expenses of sale were $ 233.83. Since receiving the property in 1933 she had been allowed to deduct depreciation in the amount of $ 1,700. In 1942 and until after May 24, 1944, there was a bank mortgage in the amount of $ 201,000 against the properties of the partnership. This mortgage was paid off partly from proceeds from sales of real estate and partly, to the extent of $ 90,000, from proceeds of bonds *102 which were redeemed in 1947. An agreement between the partners, the firm of D. T. Scott & Sons, and the Miners National Bank of Wilkes-Barre, dated May 24, 1944, provided that 80 per cent of the proceeds of sales be applied to reduce the mortgage indebtedness, and that the remaining 20 per cent, unless used for the purpose of making*71 permanent improvements to the remaining property, be likewise applied in reduction of such indebtedness. The purpose of some of the sales of the partnership real estate was to reduce the mortgage indebtedness. It was also deemed advisable to dispose of portions of the partnership assets less productive of income. The partnership properties were held at all times as an investment for rental purposes. The major portion of the assets of the estate trust, and later of the partnership, has never been placed on the real estate market. Only certain specific properties or groups of properties were selected and offered for sale. After the foregoing sales the partnership continued to do business. No part of the proceeds from such sales was reinvested in other parcels of real estate. That portion of such proceeds which was not applied in reduction of the mortgage was distributed to the partners. The scope and magnitude of the firm's business accordingly contracted to the extent that sales of real estate took place. On the advice of its attorney and accountant, the partnership reported gains resulting from its sales in 1946 and subsequent years as capital gains. Petitioner reported her*72 distributive share of such profits in 1946 as a long-term capital gain. The properties sold by the firm in 1946 had been held for over 6 months and depreciation taken thereon. 2. 117 (j) Issue. As a result of the foregoing transactions petitioner suffered a loss in 1946 in the sale of property used by her in trade or business, and subject to the allowance for depreciation, but during the same year the partnership realized gains from its sales of like property. In her income tax return for 1946, petitioner treated her share of partnership gain and her individual loss as two separate items, and applied the provisions of section 117 (j) of the Internal Revenue Code of 1939 separately to each figure. As a consequence, she treated her individual loss as an ordinary loss, and her share of the partnership gain as a capital gain. 3. Allowability of Depreciation 1913-1927. In 1930 the then Commissioner of Internal Revenue, in answer to a request by the then trustee for a ruling, informed the trustee that deductions for depreciation in respect of trust corpus could not be taken by the beneficiaries on their individual returns, nor deducted by *103 the trustee in computing*73 net income distributable to the beneficiaries. The letter quoted from I. T. 2218, IV-2 C. B. 61, the following language: In the case of estates and trusts, the fiduciaries may take adequate deductions for the depreciation of property belonging to the estate or trust used in trade or business, provided the estate or trust has net income, taxable to the estate or trust as an entity from which the deduction may be taken. In no case may beneficiaries, entitled to the income only during the taxable year, take deductions for depreciation of trust property on their individual returns either as a general deduction or as an effect [sic] to the full amounts of income distributed or distributable to them. From 1913 to 1927, inclusive, the estate had net income varying between $ 33,000 and $ 78,000. In each year all of the net income was reported as distributable to the beneficiaries. At no time during those years did the estate have income of a type against which an allowance for depreciation could have been deducted, and no amount was in fact deducted. 4. Ultimate Findings of Fact. Petitioner was not in 1945 in the trade or business of selling real estate. Her sale of a parcel*74 of real property in that year was not made in the regular course of her trade or business of renting real property, but constituted instead an incidental and casual sale. The loss suffered by her in that transaction was not attributable to any trade or business in which she was regularly engaged. Depreciation was "allowable" to the trustee during the years 1913 to 1927, inclusive, despite the absence of any actual tax benefit therefrom, and the basis of the properties held must be reduced accordingly. OPINION. 1. Petitioner claims a net operating loss carryover to 1946 because of a loss sustained in 1945 in the sale of certain real property. Respondent has disallowed such deduction on the authority of section 122(d)(5) of the Internal Revenue Code of 1939. 1 *75 In order for petitioner to prevail she must prove that the foregoing loss was attributable to the operation of a trade or business regularly carried on by her. She contends, alternatively, that either she was in the business of selling real estate, or that the sale in 1945 was attributable to the operation of her trade or business of renting real property. Neither of these positions is supported by the record. *104 Petitioner was not in the trade or business of selling real property. Such sales, both as a member of the partnership and individually, were few in number and sporadic. They were casual and occasional, and do not establish a trade or business regularly carried on by petitioner. There is no evidence of frequency, regularity, or continuity of sales, advertising for sales, sales office, or other indicia normally associated with the business of selling real estate. Cf. Charles Weill, 17 T. C. 318. Nor is the result changed by the greater number of sales made by the partnership in 1947, even assuming events in that year to be factually relevant. The principal purpose of such sales was to reduce a mortgage indebtedness. There was also*76 a desire to "prune" unproductive assets. No part of the proceeds of such sales was used to acquire new properties, and amounts not used to reduce the indebtedness were distributed to the partners. Thus, although the partnership continued in business after such sales, its activities were permanently reduced in scope and magnitude to the extent to which it had disposed of a part of its assets. This does not evidence a selling business; to the contrary, it affirmatively shows that selling was not the regular course of business, for every sale resulted in a partial liquidation. The same is true of individual sales by petitioner. Walter G. Morley, 8 T. C. 904, cited by petitioner, is distinguishable on its facts. There the evidence did show the taxpayer to have been in the trade or business of selling real estate. In the instant proceeding it does not. We agree that petitioner was in the trade or business of renting real estate during the period in question. We cannot find, however, that the sale by her in 1945 was attributable to the operation of that business. Cf. Jay Burns, 21 T. C. 857, 870-871, reversed on other*77 issues 219 F. 2d 128 (C. A. 5). Petitioner's reliance on Helen Goble, 23 T. C. 593, is misplaced. In that case a taxpayer engaged in farming had sold certain livestock and farm implements, which were no longer economically useful in her business. However, the evidence disclosed that such sales were made regularly and habitually, and that such property when sold was with equal regularity replaced with new property used for the same purpose as that disposed of. In the instant proceeding there is no such regularity of sales, and it affirmatively appears that property disposed of was not replaced. Petitioner never purchased real estate individually until 1953, and the partners never did. All sales, whether of partnership or individually owned property, represented permanent reductions in the assets of the rental business, and a partial liquidation thereof. The opinion in the Goble case explicitly distinguished situations involving total or partial liquidations. 23 T. C. at p. 598. Such transactions constitute sales of property used in the trade or business, but are not attributable to the *78 operation of that trade or business. *105 Joseph Sic, 10 T. C. 1096, affirmed 117 F. 2d 469 (C. A. 8), certiorari denied 339 U.S. 913; Lazier v. United States, 170 F. 2d 521 (C. A. 8). Accordingly, petitioner is not entitled to a deduction for a net operating loss carryover in 1946 as a result of the loss sustained by her during the year 1945. 2. In 1946 petitioner suffered a loss as the result of a sale of property held by her in her rental trade or business. In the same year the partnership of which she was a member enjoyed gains from two such sales. Both parties agree that all of the foregoing property is of the type described in section 117 (j) of the Internal Revenue Code of 1939. 2 *79 We have here a clear-cut question of law: Must petitioner aggregate her individual losses and share of partnership gains and apply 117 (j) once to the net result, or may she separately apply 117 (j) to each series of transactions, resulting in an ordinary loss deduction in respect of her individual loss, and at the same time a capital gain in respect of her share of partnership gains? We have recently had occasion twice to deal with this problem. Jacob ( Jay) Paley, 22 T. C. 1236; Jack Jordan Ammann, 22 T. C. 1106. We decided both cases in accordance with the contentions of the petitioner in the instant proceeding. In the Ammann case the gains were from individual and the losses from partnership transactions, but the essential question is the same. The Paley case was decided by us on the authority of the Ammann case. Subsequently, our decision in Jack Jordan Ammann was reversed. Commissioner v. Ammann, 228 F. 2d 417 (C. A. 5). And still later our decision in Jacob (Jay) Paley suffered a similar fate. Commissioner v. Paley, 232 F. 2d 915*80 (C. A. 9), certiorari denied 352 U.S. 838. Both Courts of Appeals relied strongly on Neuberger v. Commissioner, 311 U.S. 83, where the taxpayer, a member of a partnership dealing in securities on the floor of the New York Stock Exchange, suffered losses in individual noncapital security transactions while his firm enjoyed gains in such transactions during the same taxable year. The Court permitted the taxpayer to reduce his partnership gains to the extent of his individual losses, saying at pages 85-86: Nowhere does there appear any intention to deny to a taxpayer who chooses to execute part of his security transactions in partnership with another the right to deductions which plainly would be available to him if he had executed all of them singly. Nowhere is there any suggestion that Congress intended to *106 tax noncapital security gains until they exceeded similar losses. The language of section 23 (r) (1) does not require such a construction. Nor do the available evidences of Congressional intent indicate such a purpose. While the Neuberger case dealt with section 23 (r) of the Revenue Act of 1932 rather*81 than section 117 (j) of the 1939 Code, it is difficult to see why a similar result should not be reached here, in the absence of any persuasive legislative history to the contrary. 3 Having reviewed the foregoing reversals of our previous position, *82 we have decided to follow the rule as set forth by the Courts of Appeals for the Fifth and Ninth Circuits. We therefore hold that petitioner may not separately treat her partnership share of gains and her individual losses so as to apply section 117 (j) of the Internal Revenue Code of 1939 two different times with respect to one taxable year. She must first aggregate all of such gains and losses, and must thereafter apply the provisions of that section to the net result. 3. We come now to the final issue to be decided, whether during the years 1913 to 1927 depreciation was "allowable" to the trust estate, so as to require an appropriate reduction in the basis of the assets held by it, and subsequently by the partnership. There is no issue as to the proper amount of depreciation if it should be held allowable in those years. The ruling of the Commissioner, insofar as it denied such allowance to the beneficiaries, is not in point. The trust was the owner of the property in question, and in the absence of express statutory provision, that fact alone would necessarily preclude such deduction by the beneficiaries. The issue properly before us is whether during those years the deduction*83 for depreciation was allowable to the trustee. The regulations then in effect provided that such deduction was allowable to the trustee "where the terms of the will or trust * * * provide for keeping the corpus of the estate intact and where physical property * * * has suffered depreciation through its employment in business" if "the deduction is applied or held by the fiduciary for making good such depreciation." T. D. 2267, promulgated Nov. 5, 1915. Thus, the position of the Commissioner was to the effect that depreciation deductions were allowable to a trustee only if such trustee was required by the trust instrument to keep the corpus intact. The problem was involved in Pennsylvania Co. For Insurance, Etc., Trustee, 10 B. T. A. 428, but the will was not in evidence, and it was *107 held that even assuming the validity of the foregoing regulations the taxpayer-trustee had failed to prove that it was not under a duty to conserve the principal of the estate. The opinion expressly avoided a decision as to such validity (p. 432), and at page 433 we find the following language: The instrument creating the trust is*84 not before us and we are unable to determine from the record the character of the limitations of the trust estate. Therefore, even if the regulations prior to the 1918 Act were valid, and we pass no opinion in regard thereto, the petitioner has failed to show that it was denied the right to depreciation deductions. * * * However, in Fidelity-Philadelphia Trust Co., Trustee, 18 B. T. A. 43, affirmed 47 F. 2d 36 (C. A. 3), the foregoing regulations were held to be invalid insofar as they purported to deny the deduction in the case of a trustee not under a duty to conserve the estate. Accordingly, we need not pass upon the arguments presented as to whether the trustee in the instant proceeding was under a duty to conserve the corpus of the estate. The deduction for depreciation was "allowable" notwithstanding the inability of the trustee to obtain a tax benefit therefrom merely because all income received by him was currently distributable. In this respect the trustee stands in no different a position from that of any taxpayer who has no net income or a net loss and is similarly unable to derive a benefit from the deduction*85 for depreciation. United States Trust Co. of New York, 31 B. T. A. 54. Cf. Virginian Hotel Corporation v. Helvering, 319 U.S. 523. Decision will be entered for the respondent. Footnotes 1. SEC. 122. NET OPERATING LOSS DEDUCTION. (d) Exceptions, Additions, and Limitations. -- The exceptions, additions, and limitations referred to in subsections (a), (b), and (c) shall be as follows: * * * * (5) Deductions otherwise allowed by law not attributable to the operation of a trade or business regularly carried on by the taxpayer shall (in the case of a taxpayer other than a corporation) be allowed only to the extent of the amount of the gross income not derived from such trade or business. * * *↩ 2. SEC. 117. CAPITAL GAINS AND LOSSES. (j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. -- * * * * (2) General rule. -- If * * * the recognized gains upon sales or exchanges of property used in the trade or business * * * exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. If such gains do not exceed such losses, such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. * * *↩ 3. Indeed, section 183 (b) of the 1939 Code appears to support rather than to detract from the applicability of the Neuberger case here. It provides that in computing the net income of a partnership the gains and losses from sales or exchanges of capital assets shall be segregated. See John G. Scherf, Jr., 20 T. C. 346, 348-349. The obvious purpose of such segregation is to facilitate the blending of a partner's share of his firm's capital gains and losses with those realized by him in his individual capacity. And no conceivable reason appears why Congress would want different treatment in this respect for sales or exchanges governed by section 117 (j). See Commissioner v. Paley, 232 F. 2d at p. 918↩.