Heldt v. Commissioner

HENRY HELDT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Heldt v. Commissioner Docket No. 29095. United States Board of Tax Appeals 16 B.T.A. 1035; 1929 BTA LEXIS 2468; June 12, 1929, Promulgated *2468 A transaction by which the owner of a mortgage upon property takes such property and discharges the mortgage obligation constitutes an exchange of property for other property and gives rise to taxable gain or deductible loss, measured by the difference between the cost of the mortgage and the market value of the property. F. W. McReynolds, Esq., for the petitioner. W. F. Gibbs, Esq., for the respondent. PHILLIPS *1035 Petitioner seeks a redetermination of a deficiency of $186.67 in income tax for 1924, asserting not only that there is no such deficiency but that there has been an overpayment of $1,063.35. FINDINGS OF FACT. Petitioner sold a farm on March 1, 1920, described as the southwest quarter of section 34, township 15, range 9 east of the sixth principal *1036 meridian, and the southeast quarter of the northwest quarter of section 34, township 15, range 9 east of the sixth principal meridian, Saunders County, Nebraska, consisting of 200 acres, to Joseph F. Kaspar and Thomas V. Simanek, for a consideration of $60,000. Petitioner received $20,000 cash and a purchase money mortgage for $40,000, due in 10 years and secured by*2469 a first mortgage on the land sold for the balance of the purchase price. Petitioner purchased this farm in 1914 for the sum of $34,000. Subsequent improvements costing $2,562.50 were placed on the farm by petitioner prior to the sale. Depreciation subsequently sustained amounted to $1,200. The net cost of the farm to petitioner at the date of the sale was $35,362.50. Petitioner filed a return for 1920 and included therein a profit from the sale of the said farm of $24,637.50. A total tax of $3,963.28 was paid with the return. Subsequently petitioner filed a claim for refund for $3,829.71 in which it was contended that the mortgage note for $40,000 had no fair market value when received and that no profit was realized by him from the said farm sale. The Commissioner allowed the petitioner's contention and refunded or credited the entire tax paid on the said sale, amounting to $3,813.81. On March 1, 1921, the purchasers of the petitioner's farm, namely, Joseph F. Kaspar and Thomas V. Simanek, sold the same to John F. Karloff for $73,000, who assumed the mortgage note for $40,000 hereinbefore mentioned. Finding himself unable to carry the heavy indebtedness which he had*2470 assumed, the said John Karloff, by agreement with the petitioner, deeded the farm back to the latter, in consideration of the cancellation of the $40,000 mortgage note and accrued interest and $1,000 cash. The fair market value of the farm when repossessed by the petitioner on March 1, 1924, was $185 per acre or $37,000. The Commissioner computed a profit on the repossession of this farm amounting to $20,637.50, based on the difference between the fair market value of the farm, on the date of repossession, of $37,000, and the petitioner's reduced cost of $16,362.50 ($35,362.50 less net cash received of $19,000). Petitioner paid a tax of $1,063.35 on the repossession as originally computed by the Commissioner and a deficiency of $186.67 is now asserted. OPINION. PHILLIPS: In 1920 the petitioner owned a farm which had cost him, with improvements and after deducting depreciation, $35,362.50. He sold it in that year for $60,000, receiving $20,000 in cash and the balance in a mortgage, which the parties are agreed had no fair market value. In those circumstances no tax could properly be imposed until there was a realization upon the mortgage. No tax *1037 was paid on*2471 this sale, or, precisely stated, the tax which was paid was subsequently refunded. It seems evident that at this point the petitioner owned a mortgage which, for the purpose of computing taxable gain or loss on its sale or other disposition, had cost him $15,362.50. Any greater sum which he realized from such mortgage would be income. In 1924 petitioner exchanged this mortgage and $1,000 in cash for the property, which then had a value of $37,000. The Commissioner determined that petitioner realized a gain of $20,637.50 from this transaction, being the difference between $37,000 and the sum of $15,362.50 and $1,000. We are of the opinion that the action of the Commissioner was proper. Petitioner contends that this was merely a purchase of property, which can never give rise to a gain. While it was a purchase of real estate, it was likewise a sale or other disposition of the mortgage. One asset was exchanged for another. Such a transaction gives rise to a gain or loss. Petitioner relies upon our decisions in , and *2472 , as controlling. In each of those cases the face value of the mortgage was returned as income when received. For tax purposes those mortgages had a cost equal to their principal amount, and no gain would be realized until a sum greater than their face amount was realized upon them. In the case of Manomet Cranberry Co., the real property was sold under foreclosure and purchased by the owner of the mortgage. We held that the value of the property was unimportant; that as there had been a purchase, the purchase price controlled and not the value of the property. It appeared, however, that after making allowance for costs and taxes paid by the purchaser, the purchase price was in excess of the cost of the mortgage. These were considered part of the price and the petitioner there was charged with taxable gain to the extent that the price realized exceeded the cost of the mortgage. The transaction was treated exactly as it would have been treated had the property been sold to a third party, the proceeds paid to the mortgagee and used by him to purchase other property. The single question presented was whether, when the mortgagee purchased*2473 the property at foreclosure, computation of his gain was to be measured by the price he bid or by the value of the property. We were of the opinion that in such a case the price paid was controlling and that value was immaterial. In the case of , the property received back had depreciated in value and was worth only the cost of the mortgage. It is obvious that no gain resulted. In the case before us, there was no sale of the property; consequently the value of that which was received in exchange for the *1038 mortgage may not be measured by its purchase price, but must be measured by its value. Using this measure and applying against it the basis which must be used as the cost of the mortgage to petitioner, there is a gain in the amount computed by the Commissioner. This property cost petitioner $35,362.50. When he received it back it was worth $37,000. In the meantime he had received cash of $20,000. It is evident that petitioner has realized some $20,000 from these transactions which is subject to tax at some time. No tax having been imposed upon the sale because of the doubtful value of the mortgage, the transaction became*2474 subject to tax when the mortgage was discharged. Reviewed by the Board. Decision will be entered for the respondent.