Sterner v. Commissioner

Ellsworth J. Sterner and Helen W. Sterner, Petitioners, v. Commissioner of Internal Revenue, Respondent. David Levy and Jennie Levy, Petitioners, v. Commissioner of Internal Revenue, Respondent. Barney Pivnick and Rose Pivnick, Petitioners, v. Commissioner of Internal Revenue, Respondent. Joseph Feldman and Sarah Feldman, Petitioners, v. Commissioner of Internal Revenue, Respondent Sterner v. Commissioner Docket Nos. 64111, 64115, 64117, 64119 United States Tax Court 32 T.C. 1144; 1959 U.S. Tax Ct. LEXIS 98; August 28, 1959, Filed *98 Decisions will be entered for the respondent. Held, that North and Stanton, Inc., and Hancock Court Apartments, Inc., were collapsible corporations within the definition of section 117(m) of the 1939 Code, and, therefore, that gains realized by petitioners upon sale of their stock in these corporations were gains attributable to property which is not a capital asset. Edwin Fradkin, Esq., for the petitioners. John J. Hopkins, Esq., for the respondent. Raum, Judge. RAUM *1144 Respondent determined deficiencies in petitioners' income taxes for the year ended December 31, 1950, as follows: Docket Petitioner Deficiency No. 64111 Ellsworth J. and Helen W. Sterner $ 3,939.26 64115 David and Jennie Levy 4,267.87 64117 Barney and Rose Pivnick 3,530.18 64119 Joseph and Sarah Feldman 3,322.86 The question is whether gains*99 realized by petitioners upon sale of their stock in North and Stanton, Inc., and Hancock Court Apartments, Inc., are taxable to them as gains attributable to property which is not a capital asset, pursuant to section 117(m), I.R.C. 1939. FINDINGS OF FACT. Certain facts have been stipulated and are incorporated herein by reference. Petitioners, husbands and wives, respectively, filed joint income tax returns for 1950 with the collector of internal revenue at Newark, New Jersey. Ellsworth J. and Helen W. Sterner, and Barney and Rose Pivnick reside in Elizabeth, New Jersey. David and Jennie Levy reside in Orange, New Jersey. Joseph and Sarah Feldman reside in Miami Beach, Florida. Barney Pivnick and Joseph Feldman are brothers-in-law. The aforesaid husbands will sometimes be referred to as the petitioners. Prior to and during 1950, Sterner was a lawyer; Levy was engaged in the lumber and millwork business; and Feldman and Pivnick *1145 were experienced builders. Prior to 1946, Feldman, Pivnick, and Sterner had joined together in a development of one-family homes. In September 1947, petitioners formed a corporation known as Tudor Court, Inc. (hereinafter referred to as Tudor*100 Court), to construct an 85-family apartment house project. Financing was supplied by a conventional mortgage with the Sun Life Insurance Company of Canada. Feldman had general supervision of the construction, ordering materials, and dealing with subcontractors; Pivnick was concerned primarily with bricklaying and masonry work, part of which he did himself. For their services as builders, Feldman and Pivnick each received a salary of $ 150 per week; Sterner and Levy received no salary. Construction of Tudor Court was substantially completed early in 1949 at which time rentals began. Feldman was placed in charge of rental operations. Tudor Court, the corporation, was dissolved on January 1, 1949, and was thereafter operated as a partnership. Feldman suffered two illnesses during or shortly after the construction of Tudor Court, the first occurring in January or February of 1948 and the second in the spring of 1949. Both illnesses resulted in Feldman's absence from Tudor Court; during these absences, Feldman's supervisory duties devolved upon Pivnick. On both occasions Pivnick complained to Sterner and Levy about Feldman's continuing to receive a salary equal to his own while*101 doing no work. Over Pivnick's objections, Sterner and Levy decided to continue paying $ 150 per week to Feldman. Additional disputes between Pivnick and Feldman occurred during the period between Feldman's illnesses and subsequent to the second illness. Although Feldman had returned to work, he devoted less than his full energies to completion of the project. Pivnick thought that Feldman was shirking his responsibilities and told him to "stick to the job." During 1949, petitioners formed two corporations -- North and Stanton, Inc. (hereinafter sometimes referred to as North and Stanton), and Hancock Court Apartments, Inc. (hereinafter sometimes referred to as Hancock Court) -- to purchase land and construct multiple-dwelling apartment houses under the FHA "Section 608" mortgage insurance program. Each petitioner owned 25 per cent of the stock of the two corporations. North and Stanton was formed on July 1, 1949, to construct a 33-family apartment house on land to be acquired from North Court, Inc., a corporation whose stock was equally owned by Pivnick, Feldman, and Levy. North Court, Inc., had owned the land since August 10, 1948, had applied for FHA mortgage insurance on January*102 27, 1949, and had secured an FHA mortgage insurance commitment as of May 11, 1949. The commitment was changed on or about June *1146 24, 1949, to substitute North and Stanton for North Court, Inc., as mortgagor, and to add the name of Sterner as a stockowner and sponsor. The land itself was conveyed to North and Stanton on July 6, 1949. Pivnick was reluctant to launch North and Stanton in view of his dissatisfaction with Feldman's performance in the construction of Tudor Court; however, Sterner and Levy persuaded Pivnick to continue the relationship. Construction of North and Stanton began on or about July 6, 1949. Pivnick had general supervision of the construction; Feldman was primarily concerned with rentals at Tudor Court, but he also ordered materials for North and Stanton. Feldman and Pivnick continued to draw salaries of $ 150 per week, although, in Pivnick's view, Feldman was still not earning his salary. Feldman's salary was paid by Tudor Court; he received no salary from North and Stanton. Pivnick's salary from Tudor Court had ceased, but he received his salary from North and Stanton. Petitioners formed Hancock Court on June 21, 1949, to construct a 100-family*103 apartment house. On June 28, 1949, it entered into an agreement to purchase the necessary land and it subsequently employed Stalford Mortgage Co. to secure a "Section 608" mortgage loan to finance the construction. On or about July 29, 1949, Hancock Court retained Erwin Gerber, an architect, to draw plans for the proposed project. Hancock Court, through Stalford Mortgage Co., applied to FHA for mortgage insurance on August 1, 1949. The standard FHA application for "Section 608" mortgage insurance required that certain architectural exhibits be attached, including a topographical survey of the site, perliminary drawings, and outline specifications sufficient (a) comprehensively to delineate the project design, planning, materials, and construction and (b) to serve as a basis for preparation of an accurate cost estimate. The plans required to be attached to the application were prepared by Gerber and comprised approximately 40 per cent of the total plans required by FHA; the remaining 60 per cent were to be submitted after the issuance of an initial commitment by FHA. Tudor Court, North and Stanton, and Hancock Court were simultaneously listed for sale in or around November 1949. *104 At that time the application of Hancock Court to FHA was still pending. North and Stanton was 98 per cent complete as of November 30, 1949. On November 22, 1949, petitioners entered into an agreement for sale of their Hancock Court stock to Jack J. Holland and Bernard Rogow for $ 82,000. It was provided that the purchasers would also pay for all architectural services rendered by Gerber, including the sketches and preliminary plans originally filed with FHA. In the event FHA did not issue its commitment by March 1, 1950, it was *1147 provided that the purchasers would be relieved of their obligation to purchase, but that they would thereafter have an option to purchase exercisable by notice to petitioners on or before March 5, 1950. Similarly, the purchasers could refuse to proceed with the agreement if the commitment issued but was for an aggregate amount less than $ 7,750 per apartment unit, plus $ 1,500 per garage space, or if construction was prohibited by an intervening zoning change by the City of Elizabeth. Petitioners agreed to assist the purchasers secure a building permit. When Rogow became interested in the project he requested Gerber to revise his preliminary*105 plans (40 per cent of the total plans) to provide for an increase in the size of the rooms. Gerber, accordingly, drew and submitted revised plans to FHA prior to February 6, 1950. On January 13, 1950, petitioners notified Stalford Mortgage Co. that they had assigned their interest in the project to Rogow and Holland. On February 1, 1950, the names of Rogow and Holland were substituted for those of petitioners as sponsors on the mortgage insurance application and Hancock House, Inc., a corporation to be formed by Rogow and Holland, was substituted for Hancock Court as mortgagor. On February 6, 1950, on the basis of the revised plans submitted by Gerber, FHA issued its commitment to insure a mortgage loan to Hancock House, Inc. On March 27, 1950, Hancock Court acquired title to the land it had contracted to purchase on June 28, 1949. On April 25, 1950, petitioners transferred their Hancock Court stock to Rogow and Holland for $ 82,000, representing an aggregate gain to petitioners of $ 36,643.65. Hancock House, Inc., was incorporated on April 28, 1950, and proceeded to construct an apartment house which it still owned and operated in 1958. On December 28, 1949, petitioners entered*106 into an agreement to sell their stock in North and Stanton to Warren I. and Winifred S. Reinhardt. Construction of North and Stanton was approximately 99.4 per cent complete as of December 30, 1949. The agreement provided that petitioners would complete the work remaining to be done on the project and would secure FHA's final endorsement on the mortgage note before closing the sale of stock. The sale of North and Stanton stock was consummated on March 29, 1950, for $ 60,116.76, representing an aggregate gain to petitioners of $ 31,116.76. Tudor Court was sold on May 1, 1950. Subsequent to the sale of these properties, Pivnick conducted his construction activities separately from those conducted by the other petitioners. Sterner, Levy, and Feldman continued to associate among themselves in the construction business. Petitioners reported their gains on the respective sales of stock in North and Stanton and Hancock Court as capital gains. Respondent *1148 determined that such gains should be considered as attributable to property which is not a capital asset, pursuant to section 117(m), I.R.C. 1939. OPINION. The question to be decided is whether North and Stanton and Hancock*107 Court, or either of them, were collapsible corporations as that term is defined in section 117(m), I.R.C. 1939. North and Stanton. -- It is stipulated that petitioners agreed to sell their stock in North and Stanton prior to completion of construction. Thus, no question arises as to whether or not the sale was prompted by a "post-construction motive." Cf. Max Mintz, 32 T.C. 723. Petitioners' only argument is that the decision to sell their North and Stanton stock was attributable to the disharmony between Pivnick and Feldman rather than to a desire to convert ordinary income into capital gain. We think petitioners have not proved the facts necessary to sustain their argument. Construction of North and Stanton was commenced more than a year after the Pivnick-Feldman dispute first arose and in spite of it, demonstrating that petitioners did not regard the dispute as serious enough to require disassociation at that time. No convincing evidence has been presented which would indicate that the dispute grew more severe during the construction of North and Stanton. Moreover, section 117(m) is applicable even if it be assumed that petitioners sold their*108 North and Stanton stock because of shareholder disharmony. In terms, section 117(m) requires only that the corporation be availed of for construction with a view to the sale of its stock prior to the realization by the corporation of a substantial part of the net income to be derived from the property. These conditions apply precisely to the instant case. Petitioners not only sold their stock prior to the realization of any income from the property, but they concede that the decision to sell was reached prior to completion of construction. In light of these circumstances, the fact that shareholder dissension prompted the sale is immaterial. Regulations 111, section 29.117-11(e), example (3), relied upon by petitioners, does not support their argument. In that example, "the sale of the stock by B was caused by his retiring from all business activity as a result of illness arising after the second building was constructed." (Emphasis supplied.) Thus, the occasion for the sale of B's shares did not arise until after completion of construction. In the case at bar, however, both of Feldman's illnesses occurred before the construction of North and Stanton was even commenced, *109 and the Pivnick-Feldman dispute was well advanced by that time. Hancock Court. -- Section 117(m)(2)(B) provides that a corporation shall be deemed to have constructed property if it engaged in the *1149 construction of such property "to any extent." Petitioners take the position that the purchase of land by Hancock Court, the hiring of a mortgage broker and an architect, the application to FHA for mortgage insurance accompanied by the architect's preliminary sketches and plans, and the negotiation of a contract to sell their stock in Hancock Court contingent on the issuance of an FHA commitment, did not constitute "construction" within the intendment of the statute. We disagree. The record is clear that the steps undertaken by Hancock Court with regard to securing an FHA commitment were preliminary to the building of a housing project. Furthermore, what evidence there is on the point indicates that the increased value of petitioners' stock was entirely attributable to these preliminary steps and to issuance of the FHA commitment upon which consummation of the sale depended. Had petitioners pursued the construction of Hancock Court to its completion with a view to sale*110 of their stock at that time, any gains realized by petitioners upon sale would clearly have been subject to section 117(m) treatment. But such gains would have included the very same increment in the value of petitioners' stock which they now argue should not be subject to section 117(m). Max Mintz, supra; see Glickman v. Commissioner, 256 F. 2d 108, 111 (C.A. 2), affirming a Memorandum Opinion of this Court; Elizabeth M. August, 30 T.C. 969, 987; Leland D. Payne, 30 T.C. 1044, 1058, affirmed 268 F. 2d 617 (C.A. 5). As stated in J. D. Abbott, 28 T.C. 795, 805, affirmed 258 F. 2d 537 (C.A. 3), "the term 'construction' was intended to have its broadest scope." In accordance with these views, we hold that both North and Stanton and Hancock Court were "collapsible" corporations and that the gains realized by petitioners on sale of their stock were gains attributable to property which was not a capital asset. Decisions will be entered for the respondent.