Stimson v. Commissioner

C. W. STIMSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Stimson v. Commissioner Docket No. 28847. United States Board of Tax Appeals 22 B.T.A. 26; 1931 BTA LEXIS 2188; February 2, 1931, Promulgated *2188 1. Income derived from the operation of a certain building held to be separate income of petitioner. 2. Loss, measured by the difference between the cost of stock and the amount of liquidating dividends received, allowed as a deduction. 3. Loss alleged to have been sustained on the sale of a tract of land disallowed in the absence of proof of the value of the property at the time of its acquisition by gift. Harry Ballinger, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. ARUNDELL *26 The petition filed herein for the redetermination of a deficiency of $1,684.16 in income tax for 1924, assigns four errors on the part of the respondent, to wit: (a) Determining that income derived from the operation of a certain building was separate income; (b) disallowing a loss of $14,500 sustained on the sale of real property; (c) disallowing a loss of $715 sustained in a stock transaction; and (d) refusing to allow as business expenses items amounting to $1,435.58. FINDINGS OF FACT. The petitioner was married in 1903 and since then has resided with his wife in Seattle, Wash. Petitioner's grandfather, E. D. Stimson, died*2189 in 1898, leaving a will providing for the equal distribution of his estate among his heirs living at the time his youngest child became of age. On the distribution of the estate in 1913, petitioner and his father, W. H. Stimson, applied their shares in the estate, each of the appraised value of $180,000, to the acquisition from the estate of an improved piece of property in Los Angeles, Calif., known as the "Douglas Block," valued at $500,000. In connection with the acquisition of the property, on October 1, 1913, petitioner and his father gave Ezra T. Stimson, petitioner's uncle and another heir of the decedent, a note for $140,000, maturing in five years and secured by a mortgage on the property. The building on the property was partially destroyed by fire in 1915. The proceeds from the insurance on the property were insufficient to make repairs and the owners of the building lost all of their tenants. On April 23, 1918, after unsuccessful attempts had been made to dispose of the property, the mortgagors satisfied the mortgage by *27 deeding the property to the mortgagee. The deed was executed with the understanding that petitioner's father would manage the building*2190 for the account of the mortgagee, and if his efforts were successful "they could have the property back again." The next day the mortgagee executed a satisfaction of the mortgage. The entry made in petitioner's books on December 30, 1918, for the transaction contains a notation reading: "Gave E.T. trust deed which cancels this mortgage & note. We have 2 years from date of trust deed to redeem if we so desire." Prior to the time petitioner and his father deeded the property to Ezra T. Stimson the building was operated at a loss of $36,301.10, of which petitioner in 1919 paid one-half. The petitioner and his father subsequently redeemed the property, and on February 27, 1920, they (their wives joining) gave Ezra T. Stimson a note for $140,000 maturing in five years, secured by a mortgage on the property. The mortgage note was subsequently paid and on January 31, 1924, the mortgagee executed a satisfaction of the mortgage. In 1924 petitioner contributed $17,500 towards the liquidation of the mortgage. None of the money so spent was derived from the operation of the Douglas Block. During the periods petitioner and his father held title to the property they operated it as*2191 copartners under the firm name of Willard H. Stimson & Son. The contention is being made by petitioner that the interest he had in the Douglas Block in the taxable year arose from a purchase of the property in 1920 from Ezra T. Stimson and that community funds derived from his management of the affairs of the Ballard Lumber Company were used in paying his portion of the purchase price. At the time of his marriage petitioner's property consisted almost entirely of stock of the Ballard Lumber Company of a value of about $32,000, and a small house given him as a wedding gift. Petitioner's father owned a 50 per cent stock interest in the corporation and the balance of the stock not owned by petitioner was owned by F. F. Fisher and Frank Doty in equal amounts. From 1902, when the Ballard Lumber Company was organized, until the dissolution in 1912, the corporation paid to its stockholders cash dividends amounting to about $730,000. Petitioner managed the affairs of the Ballard Lumber Company during the period of its existence, and as compensation for his services received a salary of $150 per month. Doty was superintendent of the corporation's logging camp and Fisher had charge*2192 of its office. W. H. Stimson, who resided in Los Angeles, paid no attention to the affairs of the corporation except when he happened to be in *28 Seattle, the corporation's place of business. Not oftener than twice a year nor less frequently than every two years the petitioner and his father would correspond with each other concerning matters relating to the business of the corporation. Petitioner estimated his worth on January 1, 1924, to be $908,553.32. On the dissolution of the Ballard Lumber Company in 1912 there were distributed to its stockholders certain upland property located in Ballard, a suburb of Seattle, Wash., and the unexpired terms of leases covering adjacent tidelands leased from the State of Washington. The leases and land had a value at that time of $98,000. W. H. Stimson directed that the portion of the property he was entitled to receive in the liquidation of the affairs of the corporation be transferred to petitioner as a gift. Included in the property given to petitioner were a lease to Block 4 in the tideland and an adjoining piece of land in the upland tract known as Reserve No. 3. The lease and land had a combined value at the time of their*2193 acquisition by petitioner, and on March 1, 1913, of $15,000. The tract covered by the lease was filled in in 1914, 1915, or 1916, and thereafter the city of Seattle regraded the streets and made an assessment against the property for a portion of the expense of grading the streets, laying curbs, etc. The land known as Reserve No. 3 was sold on or about April 10, 1924, for $500. Prior to such sale the lease covering Block No. 4 was canceled for nonpayment of rent. In 1919 the petitioner paid the sum of $2,000 for stock of the Auto Owners Investment Company, a corporation organized by petitioner and six other men to engage in the business of buying and selling notes given in connection with the sale of automobiles. Thereafter the corporation started to wind up its affairs, and during 1922, 1923, and 1924 the petitioner received as liquidating dividends on his stock sums amounting to $1,290. In 1924 petitioner was advised by the manager of the corporation that the liquidation of the corporation had been completed. A further and final liquidating dividend of $26.99 was received in October, 1925. Petitioner never took any active interest in the affairs of the corporation. *2194 During 1924 petitioner was a man of large means and was engaged in a number of different business enterprises. In addition to operating the Douglas Block in Los Angeles, he owned property in Seattle, had extensive timber holdings in Oregon, and was manager of the Stimson Lumber Company, a corporation having its principal office in Seattle. In the conduct of his various business enterprises he expended $1,123.60 in the maintenance of an automobile; $7.61 for telephone and telegraph charges; $113.75 for traveling expenses and hotel bills; $130 for counsel fees, most of which was incurred in settling his tax liability to the State of Oregon; $100 for entertainment; and contributed $120 to the Chamber of Commerce of Seattle *29 for advertising that city. He also paid dues of $132 to the Rainier Club, which he never patronized except as a place to take persons residing outside of Seattle. OPINION. ARUNDELL: The income in controversy under the first issue is that derived from the operation of the Douglas Block. The petitioner's contention against taxing him on such income as earnings on his separate property is that the title he held to the property in 1924 was not acquired*2195 by devise of his grandfather, but by a community purchase made under an option given by Ezra T. Stimson in 1918 when the property was deeded to his uncle in satisfaction of the mortgage. The facts of record do not support the contention that the property was acquired by purchase rather than devise. On the distribution in October, 1913, of the estate of his grandfather, petitioner and his father desired to acquire title to the Douglas Block and since the appraised value of their shares in the estate was less than such value of the Douglas Block, they gave Ezra T. Stimson, petitioner's uncle and heir of the decedent, a mortgage on the property for the difference. They were unable to operate the building at a profit, and in 1918 the mortgagors deeded the property to the mortgagee with the understanding that petitioner's father should continue to manage the building and in case his efforts were successful they "could have the property back again." That petitioner understood the arrangement to mean that he and his father had been given a right to redeem the property, rather than an option to purchase, is evidenced by the manner in which he recorded the transaction on his books at the*2196 close of 1918. Other testimony of petitioner is to the effect that the right given by the mortgagee was one of redemption. No attempt was made to prove the contents of the alleged option to purchase. Neither was anything offered to show that a purchase agreement was entered into in 1920 when title was reacquired. So far as the record discloses the only papers executed at that time affecting the change of ownership were a deed executed by Ezra T. Stimson and a mortgage back in the same sum as the one previously satisfied of record. The transaction has none of the appearance of one conducted at arm's length between a buyer and a seller. It was simply one to place the petitioner and his father in the same position they were prior to the time the property was deeded to Ezra T. Stimson. Such being our conclusion from the facts, we are unable to agree with the contention being made by petitioner that his position in 1924 as respects the property was no different than it would have been had he never had an interest therein. *30 Having reached the conclusion we have that the reacquisition of the Douglas Block in 1920 was not a new purchase, it may not be necessary to consider*2197 petitioner's further arguments. However, if we are wrong on the first proposition advanced, we do not believe that the record supports petitioner's view that the Douglas Block was acquired with community funds, nor that community funds were used to liquidate the mortgage. The basis for petitioner's argument that community funds were used in the acquisition of the Douglas Block is a rule of law laid down by the courts in the State of Washington that where the investment of separate property in a business is small, and abnormal profits earned on the investment by able management of the community are intermingled with income which might be attributable to the original investment, the source of the investment will be ignored and all of the investment will be considered as community property. ; ; ; ; , and ; *2198 . None of the cases called to our attention by petitioner's counsel seem to go as far as we are asked to go in this case and on facts so meager. It is true that the Ballard Lumber Company made large earnings during the period it was managed by the petitioner. But such evidence falls far short of establishing that the earnings were so clearly the result of his management as to have us accredit all of the earnings to his efforts above a bare legal interest on the money invested. We have not been furnished with any details as to how the Ballard Lumber Company was able to pay such large dividends on its stock. For ought the record shows, the excessive earnings may have been brought about by an increase in the value of timber holdings of the corporation due to causes over which the petitioner had no control whatever. Assuming petitioner's statement of the law to be correct, the facts presented in this proceeding are, in our opinion, entirely inadequate as a basis for applying the principle petitioner urges. Our conclusion being that the income received by the petitioner from his investment of stock in the Ballard Lumber Company must be treated as separate*2199 property, there remains for decision the question of whether its character was lost by the investment of all or part of the fund in real property in California. ; , the decedent resided in Illinois from the time of his marriage until his death. During his married life the decedent sent from Illinois funds which were used to purchase real property in California. In passing upon the question of whether the realty so purchased was separate or community property, the court remarked: * * * it *31 is well settled that separate personal property, enjoyed under the law of the domicile by one of the spouses at the time it was acquired, is not lost by its investment in real property in another jurisdiction where a different law is in force. The cases of ; ; and ; , are to the same effect. The same doctrine prevails in the State of Washington. *2200 ; ; ; . If the law as laid down in the foregoing cases may be said to have been modified by section 164 of the Civil Code of California, as amended in 1917 and 1923, nevertheless, on authority of , the income in question would be taxable to petitioner. We find no error in the respondent's determination in this particular. On the dissolution in 1912 of the Ballard Lumber Company the petitioner acquired by gift from his father the fee to a piece of land in Ballard, a suburb of Seattle, and the unexpired term of a lease covering certain adjoining tideland. The land and lease had a combined value at that time and on March 1, 1913, of $15,000. The land was sold in 1924 for $500. We are here asked to allow as a loss sustained in the sale of the land the sum of $14,500 representing the difference between the aggregate value of the lease and land at the time of their acquisition and selling price of the land. Beyond the fact that the lease was canceled prior to the sale of*2201 the land on or about April 10, 1924, the record fails to disclose when the petitioner's interest in the leased property terminated. It may have expired prior to 1924. Even had the lease expired in 1924, evidence of its separate value on the date of acquisition would have been necessary, as a lease is property subject to exhaustion and only the unexhausted value could have been taken as a deduction at the time it terminated. There was ample proof at the hearing of the combined value of the assets, but no effort was made to prove a separate value for each property. Without the value of the land sold there is lacking a basis for computing the loss sustained, if any, and for this reason alone we are compelled to sustain the respondent. The respondent's position as to the loss suffered on the stock investment is that it was sustained after 1924. The evidence here is to the contrary. During 1922, 1923, and 1924 there were paid to petitioner as liquidating dividends on his stock of the corporation sums amounting to $1,290. In the taxable year, after the corporation had been liquidating its affairs for at least two years, petitioner was advised by the corporation's manager that its*2202 affairs had been wound up. We think petitioner was fully justified in relying upon *32 such advice and is entitled to deduct as a loss in 1924, the sum of $710, representing the difference between the cost of the stock and the amount of liquidating dividends received thereunder by the close of 1924. From the evidence we are satisfied that all of the claimed deductions, except the item of $132, representing dues paid to the Rainier Club, which we regard as a personal expense, were paid in connection with one or more of the several business enterprises in which petitioner was engaged in 1924. These deductions should be allowed in computing petitioner's taxable income. Decision will be entered under Rule 50.