Mather & Co. v. Commissioner

Mather & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent Mather & Co. v. Commissioner Docket No. 9317 United States Tax Court 7 T.C. 1440; 1946 U.S. Tax Ct. LEXIS 3; December 31, 1946, Promulgated *3 Decision will be entered under Rule 50. In determining, for purposes of applying the nonrecognition provisions, whether interests of petitioner's transferors in stock and securities received were substantially in proportion to their interests in the property transferred, under section 203 (b) (4), Revenue Act of 1926, as amended, held assumed liabilities of transferors are to be considered as additional stock and securities received by them; held, further, on the facts, the interests were substantially proportionate, and, no gain or loss being recognizable, petitioner's basis is that of its transferors, under Internal Revenue Code, section 113(a) (8). Frederick*4 H. Spotts, Esq., and William E. Koken, Esq., for the petitioner. Robert H. Kinderman, Esq., for the respondent. Opper, Judge. OPPER *1440 Respondent determined deficiencies in income and excess profits taxes for the calendar years 1942 and 1943, as follows: Year Income tax Excess profits tax [1942] $ 17,600.17 $ 182,171.36 [1943] 3,182.82 59,153.01 *1441 The principal question presented is whether petitioner is entitled to deduct from income for 1942 the amount of $ 270,000, plus $ 1,025 expenses, or any part thereof, and for 1943 the amount of $ 82,500, plus $ 128.50 expenses, or any part thereof, claimed by it to represent losses incurred in the respective years on the sales of real estate located in Philadelphia, Pennsylvania, the sales having been made in 1942 and 1943. Some of the facts have been stipulated. FINDINGS OF FACT. The stipulated facts are hereby found accordingly. Petitioner, a Pennsylvania corporation, was incorporated on December 1, 1926, and commenced business on January 1, 1927. Its principal place of business is at 226 Walnut Street, Philadelphia, Pennsylvania, which is in the insurance district of that city. Its tax *5 returns for the years involved were filed with the collector for the first district of Pennsylvania at Philadelphia. As stated in its certificate of incorporation, its purpose was: * * * to act as Agents for the adjustment of insurance losses, to state General and/or Particular Averages, to act as insurance brokers and to act as Agents and/or Attorneys-in-fact and/or managers and/or settling agents for any firm, Corporation or association engaged in the business of insurance and/or re-insurance, and to conduct all such business as is necessary and incidental thereto. It is the successor to a company founded in 1887 by Charles Mather which went through various partnership phases, the final partnership, preceding petitioner's incorporation, having been formed in 1925. The partners and their respective interests in the partnership property and earnings were as follows: Charles Mather 35 per cent Victor Mather 25 per cent Gilbert Mather 20 per cent Josephine Mather 20 per cent Under the date of October 29, 1926, the partners entered into a written agreement whereby they agreed to incorporate the business and form petitioner with an authorized captial stock of $ 510,000 consisting*6 of 5,000 shares of 6 per cent cumulative preferred stock with a par value of $ 100 per share and 1,000 shares of common stock with a par value of $ 10 per share and an agreed value at the time of transfer of $ 50 per share. Only the common stock had voting rights. Pursuant to the agreement all of the assets and good will of the partnership, except the assets and good will of the New York office, *1442 were transferred to petitioner, and accounts payable were assumed as a liability by petitioner, all as follows: Cash $ 162,963.18 Notes receivable 79,612.45 Accounts receivable 1,054,403.15 Bank stock 3,000.00 Current assets 1,299,978.78 Real estate 150,000.00 Furniture and fixtures 35,000.00 Total 1,484,978.78 Partnership indebtedness (accounts payable) 1,299,978.78 The value of the good will of the partnership was $ 40,000. In the exchange the partners received the following number of shares of petitioner's preferred and common stock, the common stock being "issued in consideration of the purchase of the good will of the going business" of the partnership: Preferred shares Common Charles Mather [250] Victor Mather [250] Gilbert Mather [250] Josephine Mather [50] Total 1,850 [800] *7 The remaining 200 shares of authorized common stock were unissued. In addition and pursuant to the agreement of October 26, 1926, Charles Mather subscribed for the remaining 3,150 shares of preferred stock. These shares were issued to him in exchange for his promissory note in the amount of $ 50,000 and the conveyance of the premises 1325-27 Arch Street and the premises 2039 Chestnut Street, both in Philadelphia, to the corporation. Both were owned individually by the transferor at the time of the transfers late in December 1926, which transfers were made effective as of January 1, 1927. The following tabulation shows the values of the properties transferred to petitioner, the amount of indebtedness, the total value of stock and indebtedness received by or attributable to each transferor, and the gain or loss of each. Good will is valued at $ 40,000, common stock at $ 50 per share, and preferred stock at $ 100 per share. *1443 A Value received Value of B C properties transferred Indebtedness Preferred stock Charles Mather (individual): Real estate $ 465,000.00 Note 50,000.00 $ 515,000.00 $ 200,000.00 $ 315,000.00 Charles Mather (partnership), 35% interest 533,742.57 454,992.57 64,800.00 Victor Mather (partnership), 25% interest 381,244.70 324,994.70 46,200.00 Gilbert Mather (partnership), 20% interest 304,995.76 259,995.76 37,000.00 Josephine Mather (partnership), 20% interest 304,995.75 259,995.75 37,000.00 Total 2,039,978.78 1,499,978.78 500,000.00 *8 Value received E F G D Total Percentage indebtedness Gain of column F Common and (loss) to column A stock stock Charles Mather (individual): Real estate $ 465,000.00 Note 50,000.00 $ 515,000.00 Charles Mather (partnership), 35% interest $ 12,500.00 532,292.57 ($ 1,450.00) -0.2716665% Victor Mather (partnership), 25% interest 12,500.00 383,694.70 2,450.00 +0.6426318% Gilbert Mather (partnership), 20% interest 12,500.00 309,495.76 4,500.00 +1.47543% Josephine Mather (partnership), 20% interest 2,500.00 299,495.75 (5,500.00) -1.8033038% Total 40,000.00 2,039,978.78 The difference between the greatest gainer and the greater loser is less than 3.28 per cent. As of December 31, 1926, the premises 1325-27 Arch Street had a fair market value of $ 350,000, of which $ 290,000 was the value of the land and $ 60,000 the value of the buildings; the property was encumbered by a mortgage of $ 150,000. As of the same date the Chestnut Street property had a fair market value of $ 115,000, of which $ 85,000 was the value of the land and $ 30,000 the value of the buildings. This property*9 was encumbered by a mortgage of $ 50,000. Each was transferred to petitioner subject to the respective mortgage. Charles Mather acquired the Chestnut Street property in 1884 at a cost to him of $ 20,000. He acquired the premises 1327 Arch Street on January 3, 1910, at a cost of $ 66,047.67. He acquired the premises at 1325 Arch Street, partly by inheritance, through the death of his wife, intestate, on May 12, 1908, and partly by a deed to him dated May 5, 1926, by other heirs at law. Petitioner's witness, a real estate broker since 1881 and an appraiser since 1903, was of the opinion that the 1325 Arch Street property was of a value in May 1908 of $ 81,718. He valued the land at $ 3,500 a front foot, or a total of $ 75,250. The building, of 46,200 cubic feet, was valued at 14 cents per cubic foot, or a total of $ 6,468. The building at 1327 Arch Street was valued at the same figure. In his individual income tax return for the calendar year 1926 Charles Mather reported a gain of $ 99,300 upon the transfer of the Arch Street property and a gain of $ 25,400 upon the transfer of the Chestnut Street property, computed as follows: *1444 1325-27 Arch 2039 Chestnut St. St. Value March 1, 1913 $ 275,000 $ 95,000 Depreciation 24,300 5,400 Cost basis 250,700 89,600 Value when conveyed to petitioner 350,000 115,000 Cost basis as above 250,700 89,600 Taxable gain 99,300 25,400 *10 The return showed an income tax liability of $ 15,587.50 on the total gain of $ 124,700 reported in his return. Neither Charles Mather nor any of the other partners of Mather & Co. reported in their income tax returns any gain or loss on the exchange of partnership assets, under and subject to all partnership liabilities, to the petitioner for petitioner's preferred and common stock. Petitioner's balance sheet, as appearing in schedule K of its corporation income tax return for the calendar year 1927, was as follows: ASSETS Cash $ 160,989.68 Notes receivable 129,612.45 Accounts receivable 1,054,403.15 Deferred charges (organization expense and state tax) 1,973.50 Land 431,000.00 Buildings 184,000.00 Furniture and fixtures 35,000.00 Good will 10,000.00 Treasury stock 2,000.00 50 shares of bank stock (Alleg. Trust Co.) 3,000.00 Total 2,011,978.78 LIABILITIES Accounts payable $ 1,299,978.78 Mortgages on realty 200,000.00 Donated working capital 2,000.00 Preferred stock (5,000 shares at $ 100) 500,000.00 Common stock (1,000 shares at $ 10) 10,000.00 Total 2,011,978.78 The accounts receivable of $ 1,054,403.15 represented premiums due petitioner*11 from its customers for insurance placed for them in various companies; and the accounts payable of $ 1,299,978.78 represented premiums due various insurance companies from petitioner for insurance placed with them. The items of "Land" and of "Buildings" in the above balance sheet are made up as follows: *1445 Land Buildings 222-4-6 Walnut Street $ 56,000 $ 94,000 1325-27 Arch Street 290,000 60,000 2039 Chestnut Street 85,000 30,000 Total 431,000 184,000 On December 31, 1942, petitioner sold the Arch Street property for the sum of $ 20,000 and incurred expenses in connection therewith of $ 1,025. It claimed a loss as a result of the sale on its 1942 income tax return in the amount of $ 270,000, computed as follows: Cost $ 350,000 Depreciation, allowed or allowable, being the full value of the improvements (buildings were torn down in 1934) 60,000 290,000 Gross sale price 20,000 Claimed loss 270,000 Respondent disallowed the claimed loss and also disallowed as a deduction the expenses of $ 1,025. On December 30, 1943, petitioner sold the Chestnut Street property for the sum of $ 2,500 and incurred expenses in connection with the*12 sale of $ 128.50. It claimed a loss on its 1943 income tax return of $ 82,500, computed as follows: Cost $ 115,000 Depreciation allowed and allowable, being the full value of the improvements (buildings were torn down in 1936) 30,000 Adjusted basis 85,000 Gross sale price 2,500 Claimed loss 82,500 Respondent disallowed the claimed loss and also disallowed as a deduction the expenses of $ 128.50. Petitioner was liable on the mortgages on both pieces of property. Shortly prior to the sale of the Arch Street property petitioner paid off the balance due on the mortgage in the amount of $ 79,538.50; shortly prior to the sale of the Chestnut Street property, petitioner paid off the balance due on the mortgage in the amount of $ 30,000. Throughout the entire period that the Arch and Chestnut Streets properties were owned by petitioner, they were rented. Depreciation upon the buildings was claimed and allowed until their demolition. The Arch Street buildings were demolished in 1934, and a deduction of $ 51,600 was claimed and allowed therefor; the Chestnut Street buildings were demolished in 1936 and a deduction of $ 26,540.35 was *1446 claimed and allowed therefor. *13 These amounts represented the 1926 values of the buildings, less depreciation claimed to year of demolition. The basis of petitioner's transferor for the properties in question is as follows: Land Buildings 1325 Arch Street $ 75,250.00 $ 6,468 1327 Arch Street 59,579.67 6,468 2039 Chestnut Street 15,000.00 5,000 OPINION. Neither respondent's attempt to deprive petitioner of a loss deduction because the property in question had already become worthless nor his contention that it should be limited by the capital loss provisions is persuasive. There was here no abandonment of the property at any time and no cluster of events prior to the tax years before us which demonstrated worthlessness as in Alice V. Gordon, 46 B. T. A. 1201; affd. (C. C. A., 4th Cir.), 134 Fed. (2d) 685. It took the sales to close the transactions. Cf. Commissioner v. Green (C. C. A., 3d Cir.), 126 Fed. (2d) 70. Nor can it be said that the property is to be treated as a capital asset because it was not used in the trade or business of the taxpayer. It was the vehicle of the receipt of income throughout*14 petitioner's ownership of it, and under such circumstances it is not in conflict with respondent's regulations to conclude that it was used in the taxpayer's trade or business. Leland Hazard, 7 T. C. 372. The result is that petitioner was entitled to deduct as an ordinary loss the difference between what it received and its basis. Determination of petitioner's basis for the properties in issue presents the most complex question. It turns on whether the provisions of section 113 (a) (8) require that petitioner assume the basis of its transferors because the transaction by which petitioner received the property in 1926 from the predecessor partnership was one in which gain or loss was not recognized. Section 113 (a) (8) calls for the application to the transferee of the basis of the transferor: * * * if the property was acquired after December 31, 1920, by a corporation -- (A) by the issuance of its stock or securities in connection with a transaction described in section 112 (b) (5). Section 112 (b) (5) prohibits the recognition of gain or loss: * * * if property is transferred to a corporation by one or more persons solely in exchange for stock or*15 securities in such corporation and immediately after the exchange such person or persons are in control of the corporation. * * * *1447 While the corresponding section of the Revenue Act of 1926 which was in effect when the transfer took place was numbered 203 (b) (4), it seems evident that the reference in 113 (a) (8) must be to the quoted section as a means of identification of the character of the transaction without reference to what section number was used to designate the corresponding provision of an earlier act. When the code refers to "section 112 (b) (5)" without other designation, we take it as implicit that the section intended is one also included in the code itself. Petitioner concedes that the control requirement of section 203 (b) (4) of the 1926 Act 1 has been met. It denies the applicability of the section, however, because of a failure to conform to the additional requirement that "in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange." *16 We have set forth in our findings, and need not reiterate here, our ultimate conclusion of fact as to the respective values of the property exchanged and the consideration received by the individual participants. Petitioner and respondent are in accord that it is to the relative values which we must look in applying the section in question. United Carbon Co. v. Commissioner (C. C. A., 4th Cir.), 90 Fed. (2d) 43; Bodell v. Commissioner (C. C. A., 1st Cir.), 154 Fed. (2d) 407. The difference between them hinges upon the application of subsection (f) (1), added by section 213 of the Revenue Act of 1939, and the retroactive amendment to the 1926 Act, which deal with assumptions of liability. We do not agree with petitioner that those sections are inapplicable on the ground that they cover only situations which would otherwise be tax-free. The transaction presently in controversy seems to us to fall squarely within the language of the provisions of section (f) (1), 2 since "the taxpayer [petitioner's transferor] *1448 received as part of the consideration property [stock or securities in petitioner, the transferee*17 corporation] which would be permitted by subsection * * * [203 (b) (4) of the 1926 Act] to be received without the recognition of gain if it were the sole consideration * * *." Petitioner, the other party to the exchange, having assumed a liability of these transferors, such assumption shall not be considered as other property or money by the explicit terms of section (f) (1). Moreover, pursuant to section 213 (h), Revenue Act of 1939, amending the 1926 Act, section 203 (b) (4) now includes the following provision: Where the transferee assumes a liability of a transferor * * * then for the purpose only of determining whether the amount of stock or securities received by each of the transferors is in the proportion required by this paragraph, the amount of such liability (if under section 213 of the Revenue Act of 1939 it is not considered as "other property or money") shall be considered as stock or securities received by such transferor. [Emphasis added.] *18 In compliance with what seems to us to be the clear command of the composite result of these provisions, we have included in our computation of the amount received by the transferors not only the value of the stock which they received, but also the amount of the partnership liabilities assumed by petitioner, for the purpose only, as the statute directs, of determining whether the value of the interests received by each of the transferors was substantially equivalent to their respective interests in the property prior to the exchange. As our findings show, the maximum difference in result percentage-wise of the most extreme variations is in the neighborhood of 3 per cent. The statute does not require exact identity as between the new interest and the old, but only a substantial equivalence. Larger proportionate divergences than those shown here were approved in Ared Corporation, 30 B. T. A. 1080, 1087, and no case to which we have been referred rejects the nonrecognition where the variance between the proportionate interests was as small as that resulting from the transaction before us. In fact, we do not understand petitioner to contend otherwise. *19 For the reasons stated, we can not accept the essence of its position that the liabilities assumed are not to be included in the consideration received for the purpose of computing the respective interests. Upon the disappearance of that support, petitioner's case must fail. We *1449 conclude that petitioner's basis is the same as that of the property in the hands of its transferor, Charles Mather. We have found from the evidence as accurately as possible what this basis was. The proof was not entirely satisfactory, but allocation between land and improvements has been made from the record as a whole. Decision will be entered under Rule 50. Footnotes 1. (4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.↩ 2. SEC. 213. [Revenue Act of 1939]. ASSUMPTION OF INDEBTEDNESS. * * * * (f) Assumption of Liability Not Recognized Under Prior Acts. -- (1) Where upon an exchange occurring in a taxable year ending after December 31, 1923, and beginning before January 1, 1939, the taxpayer received as part of the consideration property which would be permitted by subsection (b) (4) or (5) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts, to be received without the recognition of gain if it were the sole consideration, and as part of the consideration another party to the exchange assumed a liability of the taxpayer or acquired from the taxpayer property subject to a liability, such assumption or acquisition shall not be considered as "other property or money" received by the taxpayer within the meaning of subsection (c), (d), or (e) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts, and shall not prevent the exchange from being within the provisions of subsection (b) (4) or (5) of section 112 of the Revenue Act of 1938, or the corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts; except that if, in the determination of the tax liability of such taxpayer for the taxable year in which the exchange occurred, by a decision of the Board of Tax Appeals or of a court which became final before the ninetieth day after the date of enactment of the Revenue Act of 1939, or by a closing agreement, gain was recognized to such taxpayers by reason of such assumption or acquisition of property, then for the purposes of section 112 of the Revenue Act of 1938, and corresponding provisions of the Revenue Act of 1924 or subsequent revenue Acts, such assumption or acquisition (in the amount of the liability considered in computing the gain) shall be considered as money received by the taxpayer upon the exchange. (2) Paragraph (1) shall be effective with respect to the Revenue Act of 1924 and subsequent revenue Acts as of the date of enactment of each such Act.↩