Hensley v. Commissioner

Carl Hensley and Eloise G. Hensley, Petitioners, v. Commissioner of Internal Revenue, Respondent Hensley v. Commissioner Docket No. 60275 United States Tax Court 31 T.C. 341; 1958 U.S. Tax Ct. LEXIS 37; November 12, 1958, Filed *37 Decision will be entered for the respondent. T was member of a partnership that constructed an apartment house for a corporation under an F. H. A. commitment. The partnership originally owned most of the stock in the corporation and during the tax year (1952) owned about two-thirds of the stock. After completion of construction T assigned his partnership interest in the stock to his partner in consideration of payment of certain partnership obligations. Held, T's partnership interest in the stock was a capital asset and his loss upon disposition was subject to statutory limitations upon capital losses. Sec. 117 (a) (1) and (d) (2), I. R. C. 1939. Ernest G. Pharr, Esq., for the petitioners. Allen T. Akin, Esq., and Harold D. Rogers, Esq., for the respondent. Raum, Judge. RAUM *341 The respondent determined that the petitioners are liable for a deficiency in income tax and additions to tax as follows: Additions to tax (I. R. C. 1939) Deficiency Year in tax Sec. 294(d)(1)(A) Sec. 294(d)(2) [1952] $ 11,510.94 $ 1,285.70 $ 791.20 The Commissioner's determination of deficiency made the following adjustment, among others, to petitioners' net income for 1952: Unallowable deduction: (a) Loss on forfeiture of interest upon withdrawal from partnership $ 36,670.89 That adjustment, which is the only one presently in controversy, was explained as follows: (a) It has been determined that the loss sustained from disposition of capital stock in Canyon View Apartments, Inc., in 1952 was a long-term capital loss, deductible to the extent provided in Section 117 (d) (2) of the Internal Revenue *342 Code of 1939, and was not a loss on forfeiture of a partnership interest as reported*39 in your return. Therefore, the amount claimed, $ 36,670.89, has been disallowed as a loss on forfeiture of interest. * * * The petitioners do not contest the additions to tax determined by the Commissioner if they should not prevail in their challenge to the basic adjustment. FINDINGS OF FACT. The parties have filed a written stipulation of facts, and have also entered into certain oral stipulations at the hearing. All such stipulations are incorporated herein by reference. Petitioners, husband and wife, are residents of Lubbock, Texas. They filed a joint income tax return for the year 1952 with the director of internal revenue at Dallas, Texas. Carl Hensley will hereinafter be referred to as the petitioner or as Hensley. In September 1950 petitioner and E. D. Lindsey formed an equal partnership known as the H & L Construction Company. At the time it was formed petitioner had been engaged in the construction business for 20 or 25 years. Lindsey had never engaged in that business and was taken into the partnership because of the financial stability and backing he was expected to furnish. Petitioner did not invest any of "his own money" in the partnership which "was capitalized*40 entirely on borrowed money." In October 1950 petitioner and Lindsey, as partners, organized and incorporated Canyon View Apartments, Inc. It was their intention to build an apartment house in Lubbock, Texas, costing about $ 1,000,000, that would be financed by a mortgage loan insured by the Federal Housing Administration. The corporation was organized because F. H. A. regulations required that the property be owned by a corporation. The plan was to have the apartment house constructed by the partnership with interim bank financing, after an F. H. A. commitment had been obtained, and upon completion, to transfer the property to the corporation which would use the F. H. A.-insured loan to pay the partnership which in turn would pay off the interim financing loans. In order to form the corporation, the partnership borrowed $ 150,000 from the Citizens National Bank of Lubbock, Texas. That amount was used by the partnership to purchase 150,000 of the 156,228 issued shares of the corporation's $ 1-par-value common stock. Shortly after formation of the corporation the partnership entered into a contract with it to build the apartment house for the corporation. During the course of construction*41 the partnership borrowed additional amounts from the bank in the aggregate of about $ 850,000. Lindsey's mother was surety on all of the foregoing bank loans that *343 were made to the partnership. The bank insisted that she endorse the notes executed by the parties, and she did so. Upon completion of construction and after applying the proceeds of the F. H. A.-insured loan against the foregoing partnership bank loans, there still remained a note of the partnership (with Lindsey's mother as surety) to the Citizens National Bank of Lubbock, Texas, with an unpaid balance of $ 34,682.02. The property was transferred to the corporation by the partnership prior to August 26, 1952. The partnership received rental income during its fiscal year ending June 30, 1952, in the amount of $ 27,736.95. On August 26, 1952, the partnership owned stock of the corporation, having a book value or cost to the partnership of $ 104,332.09. That stock was shown on its balance sheet as an "investment." Also, on August 26, 1952, the partnership owned depreciable assets having a book value of $ 1,012.55 and accounts receivable of $ 649.21. On August 26, 1952, petitioner executed a written assignment*42 of his partnership interest in the stock to Lindsey, in consideration of the payment by Lindsey and his mother of the partnership's $ 34,682.02 indebtedness. That instrument reads as follows: Whereas, the said Mrs. J. D. Lindsey and E. D. Lindsey have heretofore signed a note to the Citizens National Bank, of Lubbock, Texas, in the sum of $ 34,682.02, and, Whereas, the said note above referred to has been paid by said Mrs. J. D. Lindsey and E. D. Lindsey, who now own and hold same; Now, Therefore, in consideration of the payment by the said Mrs. J. D. Lindsey and E. D. Lindsey of said note, the said Carl Hensley does hereby sell, transfer and deliver to the said E. D. Lindsey all of the shares of stock owned by him in that certain corporation, to-wit: CANYON VIEW APARTMENTS, INC., of Lubbock, Texas. This instrument is intended as a full and complete transfer and delivery of all right, title and interest in and to said shares of stock shown upon the records of said corporation, as being owned and held by the said Carl Hensley, and the said Carl Hensley does hereby authorize the transfer upon the books of said corporation all of the said shares of stock to the said E. D. Lindsey. *43 In consideration of the sale, transfer and delivery of the above described shares of stock, the said Mrs. J. D. Lindsey and E. D. Lindsey do hereby release the said Carl Hensley from any further liability upon said note originally made, executed and delivered by the H. & L. Construction Company, to the Citizens National Bank, of Lubbock, Texas, including all accrued interest thereon; and the said Carl Hensley does hereby release any and all claim to any interest in said corporation or its properties. The petitioner sustained a loss in the amount of $ 34,825.04 in 1952 upon the disposition of his partnership interest in the Canyon View stock. In the joint income tax return of petitioners for the calendar year 1952, they reported income from the partnership in the amount of $ 44,451.97 and claimed as a deduction for "Loss on Forfeiture of *344 Interest Upon Withdrawal From Partnership -- H & L Construction Company" the amount of $ 36,670.89. In the notice of deficiency the respondent disallowed the claimed loss of $ 36,670.89, and determined that the petitioner sustained a loss of $ 34,825.04 and that this loss was a long-term capital loss deductible to the extent provided in section*44 117 (d) (2) of the Internal Revenue Code of 1939. OPINION. We encountered considerable difficulty in this case by reason of the lack of clarity as to the precise nature of petitioners' claim and the vagueness of the evidence. Our repeated efforts, in the interests of justice, to obtain clarification at the trial, were only partly successful. At the outset, it must be remembered that petitioners' returns claimed a deduction in the amount of $ 36,670.89 as "Loss on Forfeiture of Interest Upon Withdrawal From Partnership -- H & L Construction Company." But the evidence nowhere could support any finding that Hensley forfeited an interest in or withdrew from the partnership. Indeed the evidence shows that the partnership owned certain depreciable assets as well as accounts receivable in addition to the Canyon View stock, and that the transaction relied upon as generating the deductible loss was merely an assignment by Hensley of his partnership interest in the Canyon View stock in consideration of the payment of the partnership's obligation to the bank. There was no "forfeiture" nor is there any evidence that he withdrew from the partnership. Any deduction based upon "forfeiture" must*45 be disapproved upon this record. However, the Government does recognize that Hensley sustained a loss in the amount of $ 34,825.04 upon disposition of his partnership interest in the stock. That amount appears to have been computed as follows: The cost of the stock to the partnership was $ 104,332.09, of which $ 52,166.05 represented Hensley's one-half. From his supposed basis of $ 52,166.05 there was subtracted his one-half of the bank indebtedness ($ 34,682.02) paid off, namely, $ 17,341.01, representing in substance the "sales price" of his interest, thus leaving a net loss of $ 34,825.04. An oral stipulation made at the trial fixes the amount of the claimed loss at that amount. Section 117 (a) (1) of the Internal Revenue Code of 1939 defines "capital assets" as "property held by the taxpayer (whether or not connected with his trade or business)" with certain exceptions, one of which is "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." The Commissioner's position is that Hensley's partnership interest in the *345 Canyon View stock was a capital asset within section 117 (a) (1) and that the loss sustained*46 upon the sale is deductible only in accordance with the limitations set forth in section 117 (d) (2) with respect to such assets. Petitioners, on the other hand, contend that the loss was not a capital loss, and that it is deductible in full as an ordinary loss or as an ordinary and necessary expense incurred in carrying on his trade or business. Reading the statute literally, Hensley's partnership interest in the Canyon View stock certainly falls within the statutory definition of capital assets, and does not qualify for any of the exceptions spelled out in the various subparagraphs of section 117 (a) (1). Petitioners do not argue that any of those subparagraphs other than (A) is applicable, 1 and they concede on brief that the only clause in (A) upon which they rely is the one relating to "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." *47 The quoted language plainly does not appear to cover Hensley's partnership interest in the Canyon View stock. That interest was not held by him primarily for sale to customers in the ordinary course of his trade or business, and the attempt to bring it within the exclusionary clause of (A) would stretch the statutory language beyond the breaking point. Petitioners undertake to support their position by referring to three cases: Gilbert v. Commissioner, 56 F. 2d 361 (C. A. 1); Harry Dunitz, 7 T. C. 672, affirmed 167 F. 2d 223 (C. A. 6); and Edwards v. Hogg, 214 F. 2d 640 (C. A. 5). In these cases the courts held that bonds or shares of stock were not capital assets, the sale of which gave rise to capital gain or capital loss, because they constituted property held primarily for sale by the taxpayers in the ordinary course of their trade or business. They involved instances where stock received by a partnership in lieu of cash for services rendered in the construction of an apartment house was held by it for resale (Gilbert v. Commissioner); where*48 the purchase and sale of mortgage bonds was regarded as an essential part of the business of taxpayers (Harry Dunitz); and where a partnership engaged in the wholesale whisky business was required to purchase stock in order to acquire whisky for sale to its customers (Edwards v. Hogg). The facts of the instant proceeding are sharply distinguishable from those in the foregoing cases. Hensley did not sustain a loss *346 from the sale of stock of Canyon View. That stock was owned by the partnership which purchased it and carried it on its balance sheet as an investment. The stock was a capital asset of the partnership even though it was purchased with the object of obtaining the job of constructing the apartment project and deriving profit therefrom. Exposition Souvenir Corporation v. Commissioner, 163 F. 2d 283 (C. A. 2). Hensley's partnership interest in the stock was also a capital asset as defined in section 117 (a) (1), inasmuch as it was property held by him and did not fall within the classes of property specifically excluded. Cf. Commissioner v. Shapiro, 125 F. 2d 532 (C. A. 6); Commissioner v. Smith, 173 F. 2d 470*49 (C. A. 5), certiorari denied, 338 U.S. 818. Petitioners have not proved that it was not held by Hensley for more than 6 months. In the circumstances we hold that the respondent did not err in his determination that the loss sustained upon the sale of the partnership interest was a long-term capital loss as defined in section 117 (a) (5) of the Internal Revenue Code of 1939 which was deductible only to the extent provided in section 117 (d) (2). Petitioners' further claim to a deduction as an ordinary and necessary business expense is not amplified or discussed by them, and we are unable to see how section 23 (a), which deals with such deductions, could govern here. Section 23 (a) contemplates deduction for expenditures, and the record is utterly devoid of proof that petitioner made an expenditure in 1952 that would form the basis for the applicability of these provisions. There is no merit to the contention. Decision will be entered for the respondent. Footnotes 1. SEC. 117. CAPITAL GAINS AND LOSSES. (a) Definitions. -- As used in this chapter -- (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include -- (A) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;↩