C. G. Willis, Inc. v. Commissioner

C. G. Willis, Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent C. G. Willis, Inc. v. Commissioner Docket No. 95319 United States Tax Court 41 T.C. 468; 1964 U.S. Tax Ct. LEXIS 165; January 13, 1964, Filed *165 Decision will be entered under Rule 50. Petitioner's self-propelled ship, Belvedere, was damaged and petitioner invested the insurance proceeds ($ 100,000) and proceeds from the sale of the damaged ship ($ 100,000 less commission) in a $ 270,000 barge. Held, the sale of the damaged ship (which was completely repairable) was not an involuntary conversion within the meaning of section 1033(a)(3)(A) and hence the gain on the sale of the ship in 1958 was taxable. David P. Brown, Jr., for the petitioner. Stephen P. Cadden, for the respondent. Mulroney, Judge. MULRONEY *468 The respondent determined a deficiency in petitioner's income tax for 1958 in the amount of $ 44,893.21. In an amendment to his answer the respondent claimed an additional deficiency *469 of $ 246.60 in income tax for 1958, which petitioner does not contest. The sole issue is whether the gain realized by petitioner from the sale of its motor vessel in 1958 qualifies under the nonrecognition provisions of section 1033(a) of the Internal Revenue Code of 1954. FINDINGS OF FACT Some of the facts were stipulated and they are so found. C. G. Willis, Inc., hereinafter called the petitioner, is a corporation organized in 1951 under the laws of the State of Delaware, with its office and principal place of business*167 in Paulsboro, N.J. Petitioner filed its corporation income tax return for 1958 with the district director of internal revenue at Camden, N.J. Petitioner is engaged in the business of water transportation. Petitioner operates under the authority of the Interstate Commerce Commission and its operational territory is the Intercoastal Waterway System from Trenton, N.J., to Jacksonville, Fla., and all intermediate points. Petitioner had gross receipts of $ 3,976,294.34 in 1957 and $ 3,757,543.60 in 1958. In 1953 petitioner acquired a vessel, the Belvedere, which was self-propelled and contained the usual propulsion machinery and navigation equipment. Petitioner used the Belvedere until August 11, 1957, to transport freight (either pulpwood or general cargo) on the Intercoastal Waterway System between Trenton, N.J., and Jacksonville, Fla. The Belvedere was a new vessel in 1952. The original cost basis of the Belvedere to petitioner was $ 378,000. The Belvedere had an overall length of about 210 feet, with a beam of 40 feet and a gross tonnage of 1,023 tons. The vessel did not have cargo winches, but was loaded and unloaded with shore-based cranes. Cargo was carried both in the holds*168 and on deck. The heaviest cargo carried by the Belvedere was 1,466 tons. With an average cargo, the Belvedere could make about 8 or 9 knots in deep water. Normally the Belvedere had a crew of 14 men, which included 2 deck officers and 2 engineroom officers. Prior to August 11, 1957, the Belvedere had run aground on several occasions which had caused some damage to the propellers. On June 19, 1957, the Belvedere hit bottom and damaged the port propeller shaft; on June 20, 1957, the Belvedere ran aground at another point. At the end of June 1957 the Belvedere was placed in drydock, where the vessel underwent repairs. On June 30, 1957, after repair, the vessel was surveyed and approved by the American Bureau of Shipping. Prior to August 11, 1957, the petitioner owned another motor vessel, the Vermont, and also owned seven barges and five tugs. In 1958 the *470 petitioner tied up the Vermont because of business reasons. At present the Vermont is not in use. Prior to August 11, 1957, the petitioner had made attempts to dispose of the Belvedere. On August 11, 1957, the Belvedere, under Capt. James T. Gaskill, was bound from Trenton, N.J., to Jacksonville, Fla., and hit a submerged*169 object in the Stono River (a part of the Interstate Waterway System) south of Charleston, S.C. At the time of the collision the Belvedere was carrying about 971 tons of cargo. The collision caused a breach in the vessel's hull, and the engineroom took in water which required stoppage of the machinery. The major rupture to the hull was a single approximately 16-inch transverse rupture of bottom plating, directly under the main generator, opened to a maximum width of about 3 inches. In addition there were several other smaller hull fractures. The vessel's bow was grounded and subsequently the Belvedere was towed by a U.S. Coast Guard vessel out of the main waterway and into a nearby creek, where the Belvedere partially sank. On August 25, 1957, the Belvedere was refloated and temporarily repaired and towed to a shipyard in Charleston, S.C., where it was placed in drydock on August 27, 1957. Temporary repairs were made to the hull and, after a survey of damages was completed, the Belvedere was removed from drydock on about August 29, 1957, to an open wharf in the Charleston Shipyard, Inc. Five bids for repairs to the Belvedere were submitted and were opened on September 5, 1957. *170 Charleston Shipyard, Inc., Charleston, S.C., was the lowest bidder at $ 100,500. Other bids ranged up to $ 120,000. Subsequently, due to a dispute between surveyors as to the required repairs, an arbitrator determined that additional repairs to restore the vessel to its condition prior to August 11, 1957, would be required in the amount of $ 38,876. None of the new items was included in the repairs specifications of the surveyors which had been used as the basis for the original repair bids. At a meeting held on September 6, 1957, by the petitioner's board of directors, the status of the Belvedere was discussed. The minutes of the meeting state, in part, as follows: After consulting with our surveyor, George L. McInnes, as to the condition of the "Belvedere" and the likelihood of ever being able to put her back into service in as good condition as she was prior to sinking, he stated that he considered that, even if repaired, the boat would not be one that he would recommend for the service that she had previously been in, and that under the circumstances, we forego making repairs, put her up for sale on an "as is-where is basis", assert our claim to the full extent practicable*171 against the insurers, and invest the proceeds in a new vessel which, if possible, would be operated in the same service as the "Belvedere". *471 In a letter dated September 6, 1957, C. G. Willis, Jr., petitioner's president, advised Marsh & McLennan, Inc. (insurance brokers), of the five bids for repairs and then stated "It is our intention to sell the 'Belvedere' as is, where is. Therefore, we would like very much to have settlement with Hull underwriters on this repair cost." On September 9, 1957, the Belvedere was offered for sale through Hughes Bros., Inc., marine equipment brokers in New York, N.Y. On May 8, 1958, the Belvedere was sold for petitioner by Hughes Bros., Inc., for $ 100,000. Petitioner received a net price of $ 95,000 after commission charges of $ 5,000 were deducted. In a letter dated January 22, 1962, the then owners of the Belvedere, Richard A. Williams & Co., Barbados, West Indies, stated in response to an inquiry from petitioner that "we consider the present value of the vessel to be $ 175,000.00." The value of the Belvedere on August 11, 1957, as determined by appraisers on March 21, 1958, was $ 390,000. The Belvedere, on August 11, 1957, was insured*172 for $ 400,000. On October 29, 1957, the insurance underwriters paid to petitioner the amount of $ 100,000 in partial settlement of petitioner's damage. The remainder of petitioner's claim of $ 38,870 was paid to petitioner on July 10, 1961. On June 12, 1958, the petitioner entered into a contract with Dravo Corp. to purchase, after construction, a welded steel dry-cargo barge (hereinafter called the Peter Willis) without propulsion machinery. The cost to petitioner of the Peter Willis was $ 270,000. The Peter Willis was delivered to petitioner at Wilmington, Del., and was placed by petitioner into Intercoastal Waterway traffic service on January 3, 1959. The Peter Willis had an overall length of 256 feet, a beam of 43 feet, and a cargo capacity of about 2,500 tons, though the normal cargo would be from 1,900 tons to 2,200 tons. All of the cargo was carried below deck. The gross tonnage of the Peter Willis was 2,029 tons. The barge Peter Willis did not require a master or crew in its operation, being towed or pushed by tugboats. The Peter Willis did not have a loading device on board. The Peter Willis covers the same ports and carries the same kind of cargo as the Belvedere*173 did prior to August 11, 1957. Of the original cost basis ($ 378,000) of the Belvedere to the petitioner, 70 percent of the total amount (or $ 264,600) was subject to the allowance of amortization for emergency facilities under section 124(a) of the Internal Revenue Code of 1939 and section 168 of the Internal Revenue Code of 1954, while the remaining 30 percent of the cost basis was subject to the allowance for depreciation under section 23(1) of the Internal Revenue Code of 1939 and section 167 of the *472 Internal Revenue Code of 1954. The adjusted basis for the Belvedere as of December 31, 1957, was as follows: Cost Cost recoverable by recoverable by Total depreciation amortization Cost -- 1953 $ 113,400.00 $ 264,600 $ 378,000.00 Depreciation to Dec. 31, 1957 25,313.10 Amortization to Dec. 31, 1957 244,020 269,333.10 Remaining basis Dec. 31, 1957 88,086.90 20,580 108,666.90 Petitioner in its 1958 corporation income tax return did not report any gain on the Belvedere represented by the insurance proceeds and the receipts from the sale of the vessel. Respondent determined that petitioner realized a gain of $ 86,333.10 in 1958 from the sale of*174 the Belvedere and that this entire amount was taxable as ordinary income under section 1238 of the Internal Revenue Code of 1954. Respondent made the following explanation: (a) It has been determined that you omitted from income, gain in the amount of $ 86,333.10 realized on the sale of the motor vessel, Belvedere, an emergency facility, during the year 1958, which is taxable as ordinary income under Section 1238, Internal Revenue Code of 1954, because the amount of cost amortized exceeded normal depreciation to the extent of $ 157,701.90 as shown below. Further it has also been determined that Section 1033(a) of the Internal Revenue Code of 1954, relating to involuntary conversions does not apply with respect to the acquisition of a barge following damage to the motor vessel, Belvedere, because it was not acquired in replacement of the converted property and was not similar or related in service or use to the converted property. Adjusted basis, if normal depreciation were used $ 266,368.80 Less: Adjusted basis per books, following amortization per Section 168, Internal Revenue Code of 1954 108,666.90 Amortization in excess of normal depreciation 157,701.90 Sale price 100,000.00 Less: Commission 5% 5,000.00 Net proceeds of sale 95,000.00 Adjusted basis prior to casualty $ 108,666.90 Less: Extent of casualty measured by amount of insurance proceeds received 100,000.00 Basis at time of sale 8,666.90 Gain 86,333.10 *175 *473 OPINION Section 1033(a) of the Internal Revenue Code of 19541 provides for nonrecognition of gain where property that has been "compulsorily or involuntarily converted" into money or unrelated property and the taxpayer, within a certain period, acquires replacement property that is "similar or related in service or use to the property so converted." *176 It appears that petitioner's realized gain on the sale of the Belvedere was $ 86,333.10. The original cost basis of the Belvedere in 1953 was $ 378,000. Petitioner was entitled to amortize 70 percent of this total (or $ 264,600) under section 124(a) of the Internal Revenue Code of 1939 and section 168 of the Internal Revenue Code of 1954, which sections allow a rapid amortization (based on a period of 60 months) for certain emergency facilities. However, section 1238 of the Internal Revenue Code of 1954 provides that "Gain from the sale or exchange of property, to the extent that the adjusted basis of such property is less than its adjusted basis determined without regard to section 168 (relating to amortization deduction of emergency facilities), shall be considered as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231." Respondent's notice of deficiency indicates that, at the time here relevant, the adjusted basis of the Belvedere would have been $ 266,368.80 if normal depreciation were used, and that the adjusted basis with the use of rapid amortization, as shown by petitioner's books, was $ 108,666.90. None of*177 these amounts is disputed by petitioner. Since the actual adjusted basis of the Belvedere is $ 157,701.90 ($ 266,368.80 minus $ 108,666.90) less than its adjusted basis without regard to the rapid amortization provisions, it would appear that the entire gain of *474 $ 86,333.10 realized on the sale of the Belvedere would be taxable as ordinary income unless, of course, the nonrecognition provisions of section 1033(a) apply. To qualify under section 1033(a) the taxpayer must establish an involuntary conversion of his property. Included in the parenthetical portion of the statute are such conversions of property that result from "its destruction in whole or in part." There was an involuntary conversion here in that there was an "in part" destruction of the property. In the year 1957 petitioner had been paid $ 100,000 in partial settlement for this involuntary conversion. The ship was fully insured so the 1957 involuntary conversion (destruction in part) was a conversion of part of the property into money. It resulted in no gain because petitioner's basis, even with the fast writeoff, was $ 108,666.90. Thus, at the close of 1957 petitioner owned an unrepaired ship with*178 the basis reduced to $ 8,666.90 ($ 108,666.90 less $ 100,000 insurance paid in 1957) and a claim against the insurer in an undetermined amount. 2 In 1958 it sold the unrepaired ship for $ 100,000. Respondent's determination treats the 1958 sale of the damaged ship as a voluntary sale for a net of $ 95,000 ($ 100,000 less $ 5,000 sale expense) and computes the gain as $ 86,333.10, using a basis of $ 8,666.90. Petitioner does not dispute the figures but argues the 1958 sale of the damaged ship was also an involuntary conversion within the meaning of section 1033 and that the insurance recovery and sale proceeds should be treated as one sum received from an involuntary conversion and all invested in property, a barge, that was similar or related in service and use to the property it replaced. It is obvious that the issue of whether the proceeds from the insurance paid in 1957 and sale made in 1958 were invested in "other property similar or related in service *179 or use" will not be reached unless it first be held the sale of the damaged ship in 1958 was an involuntary conversion within the meaning of section 1033. We are convinced it was not. The wording of the statute makes it plain that it does not include conversions or sales of property where the owner had a choice of keeping the property or converting or selling it. In S. E. Ponticos, Inc., 40 T.C. 60, this Court said that the "basic purpose of section 1033(a)(3)(A) undoubtedly is to allow the taxpayer to replace his property or continue his investment without realizing gain where he is compelled to give up such property because of circumstances beyond his control." Petitioner argues the damage was so extensive that it was justified in selling the vessel in its damaged condition rather than attempt to repair it. There is testimony here that indicates petitioner made a sound business judgment when it decided to sell instead of repair after it settled with the insurance company. That very argument *475 defeats its contention that the sale was involuntary. It cannot be said that the sale of the unrepaired ship was a "result" of its partial destruction. *180 The sale was the result of a business decision by the owner that the money equivalent of the unrepaired ship would serve its business interests better. The record shows that after the mishap the ship was repairable. Initial bids for repairs were in the range of $ 100,500 to $ 120,000. Subsequently it was found that additional repairs of $ 38,876 would be needed to restore the vessel to its condition prior to the collision. We do not believe that such damage to the vessel compelled petitioner to sell the vessel in 1958 so that the whole transaction would amount to an involuntary conversion within the meaning of the statute. On the contrary, the record suggests that the decision to sell the Belvedere was actually dictated by other motives. Petitioner owned one other motor vessel in addition to the Belvedere. The rest of petitioner's fleet consisted of seven barges and five tugs. The motor vessels required a crew of about 14 men, while the barges required no crew. Yet the barges were able to transport substantially larger cargoes over the same routes served by the motor vessels. Prior to the mishap, petitioner had made attempts to dispose of the Belvedere. In 1958 the petitioner*181 was compelled to tie up its remaining motor vessel for business reasons, and it appears from the evidence that this motor vessel was not in use at the time of trial. The petitioner certainly had a strong economic incentive, completely unrelated to the damages caused by the collision, to sell the Belvedere. Petitioner's executive officer admitted that it was "common knowledge" the various shipyards that bid on the repairs to the Belvedere could have restored the vessel to usability. It also appears that as late as January 1962 the Belvedere was in the possession of a company in the West Indies and that its owners considered its value to be about $ 175,000. We have considered the testimony of petitioner's witness, a consulting marine engineer, who inspected the Belvedere on August 28, 1957, when the vessel was already in drydock. We do not consider his testimony very helpful. His broad statement that, in his opinion, the vessel would have proved a "constructive total loss," which he defined as "useless for the purpose for which it was built," is simply unsupported by anything in the record. The witness admitted that such a total loss would mean that the entire policy coverage *182 of the vessel would be paid to petitioner, yet it is stipulated that petitioner received no more than $ 138,870 from the insurance underwriters. 3 The witness *476 also testified that even if all repairs were made to the Belvedere, there would be future operational difficulties with the vessel. As to this he was rather vague, testifying that after damage such as was sustained by the Belvedere "there are always little things going out of order caused by distortion perhaps of, say, a propeller shaft structure, things that might be pushed out of place by thousandths of an inch that one cannot see and cannot check, but they can really vitally affect the future operation of a vessel." Such testimony is not persuasive to establish that petitioner was compelled to sell the damaged vessel. *183 Involuntary conversion, within the meaning of section 1033(a), means that the taxpayer's property, through some outside force or agency beyond his control, is no longer useful or available to him for his purposes. 4 On the record before us, we do not believe that the sale of the unrepaired Belvedere amounts to a forcible taking of petitioner's property. We hold the Belvedere was not "compulsorily or involuntarily converted" within the meaning of section 1033(a) and that petitioner is not entitled to the nonrecognition of gain provisions of that section. Decision will be entered under Rule 50. Footnotes 1. All section references will be to the Internal Revenue Code of 1954, as amended, unless otherwise noted. SEC. 1033. INVOLUNTARY CONVERSIONS. (a) General Rule. -- If property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted -- * * * * (3) Conversion into money where disposition occurred after 1950. -- Into money or into property not similar or related in service or use to the converted property, and the disposition of the converted property (as defined in paragraph (2)) occurred after December 31, 1950, the gain (if any) shall be recognized except to the extent hereinafter provided in this paragraph: (A) Nonrecognition of gain. -- If the taxpayer during the period specified in subparagraph (B), for the purpose of replacing the property so converted, purchases other property similar or related in service or use to the property so converted, or purchases stock in the acquisition of control of a corporation owning such other property, at the election of the taxpayer the gain shall be recognized only to the extent that the amount realized upon such conversion (regardless of whether such amount is received in one or more taxable years) exceeds the cost of such other property or such stock. * * *↩ 2. It settled the insurance claim in 1961 for $ 38,870.↩ 3. This same witness represented petitioner in perfecting the claims against the insurance underwriters for settlement. It is stipulated that on August 11, 1957, the Belvedere was insured for $ 400,000. It is also stipulated that "The value of the 'Belvedere' was $ 390,000.00 on August 11, 1957, as determined on March 21, 1958, by Frank S. Martin & Son, Ship and Engineer Surveyors, Consulting Engineers and Appraisers, New York, New York."↩ 4. We do not know the uses to which the Belvedere was put after 1958 by its new owners in Cuba and in the West Indies. It may well be that the vessel was placed in oceangoing trade, as opposed to the Intercoastal Waterway System where petitioner operated Under such a circumstance it would be odd to maintain that the vessel, as a result of its mishap, was no longer useful for transport on the waterway.↩