Swanson v. Commissioner

JOSEPH E. SWANSON, JAMES OTIS, EDWARD M. WILLOUGHBY, JOHN H. HARDIN, AND THURSTON B. SWANSON, AS TRUSTEES OF THE FULLERTON PARKWAY LAND TRUST, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Swanson v. Commissioner Docket Nos. 32571, United States Board of Tax Appeals 29 B.T.A. 1123; 1934 BTA LEXIS 1421; February 16, 1934, Promulgated *1421 1. Held, that the Fullerton Parkway Land Trust was, in 1925 and 1926, an association taxable as a corporation. 2. Held, further, that such association is not entitled to claimed increase in deduction for depreciation including obsolescence upon its building for the years 1925 and 1926, since it does not appear that there was any diminution in the earnings and in the value of such building resulting from the increased building activities in the section in which such building was located. Arnold R. Baar, Esq., for the petitioners. E. A. Tonjes, Esq., for the respondent. MCMAHON *1123 These proceedings, duly consolidated for hearing, are for the redetermination of asserted deficiencies in income tax as follows: Docket No. 32571, $4,944.56 for the year 1925; Docket No. 41308, $4,185.44 for the year 1926. It is alleged that the respondent erred in the determination of the asserted deficiencies (1) in treating the Fullerton Parkway Land Trust as an association taxable as a corporation under the provisions of section 2(a)(2) of the Revenue Act of 1926, whereas the income of the trust, being currently distributable, should be taxed*1422 to the beneficiaries of the trust under section 219(b)(2) of the Revenue Act of 1926; and (2) in computing the amount deductible for depreciation and obsolescence of the building held by the petitioners in trust by using the rate of 4 percent, whereas a rate of approximately 6 percent should have been used in computing such depreciation and obsolescence deduction. *1124 FINDINGS OF FACT. The petitioners are the present trustees of the Fullerton Parkway Land Trust, created under a trust agreement dated May 2, 1916, entered into by and between Joseph E. Swanson, Ralph C. Otis, William G. Hibbard, John H. Hardin, and Thurston B. Swanson, all of Chicago, Illinois, for the benefit of themselves. The agreement, among other things, provides that the contracting parties will acquire title to certain described real estate in the County of Cook and State of Illinois, and the buildings and improvements situated thereon; and that title shall be held by the contracting parties and by their successors in trust, as joint tenants, but not as tenants in common. This trust agreement (petitioner's Exhibit No. 1) is lengthy and therefore we forego setting forth the remainder of it in*1423 our findings of fact, but incorporate it herein by reference as if fully set forth. The substance of pertinent provisions thereof will be stated or commented upon in our opinion. Joseph E. Swanson has been since 1909 a member of a partnership of two engaged int the real estate business under the firm name of Willoughby & Co., hereinafter referred to as the company. Such company in the conduct of its real estate business acted as agent and manager ofreal estate. Ralph C. Otis and his son, James Otis, occupied offices with the company. Ralph E. Otis was not a member of the company. Thurston B. Swanson and Joseph E. Swanson are brothers, and together were interested in and owned certain other real estate. Otis, Hibbard, and Hardin were not connected with or employed by the company, and the relationship between them and Joseph E. Swanson and his brother was that of friends, James Otis succeeded his father, who had been in ill health for a number of years, as trustee about 1926, and Edward M. Willoughby, the other partner of the company, succeeded William G. Hibbard as trustee upon the death of the latter. In about 1915 the original trustees met at a home gathering and Hibbard*1424 and Hardin during a discussion of real estate matters stated they would like a real estate investment if Joseph E. Swanson knew of any they could participate in. Thereafter, through another broker, Joseph E. Swanson was afforded an opportunity to purchase the property described in the trust agreement and known as No. 2350 Lincoln Park West and No. 305 Fullerton Parkway, in the city of Chicago, Illinois, for the price of about $62,000. Joseph E. Swanson was favorably impressed and entered into communication with Ralph Otis, Hibbard, and Hardin, which resulted in the purchase of the property. Jeseph E. Swanson originally took title to the property, but shortly after its purchase title was transferred to the five trustees. *1125 The property when purchased was vacant. Within about six months, or as soon as plans could be prepared and arrangements made for the financing, the construction of a four-story brick apartment building was commenced. The trustees selected an architect and contractor and arranged for the construction of the building. The building was completed in 1916. This property is still held in trust under the agreement of May 2, 1916. No other property, *1425 except supplies necessary for the operation of this property, was purchased or acquired by the trustees. Ralph Otis, Hardin, and Hibbard each contributed $25,000, and Joseph E. Swanson and his brother, Thurston B. Swanson, contributed in equal amounts another $25,000, aggregating $100,000, toward the purchase of the land and the construction of the building. For that purpose also, Ralph Otis and Joseph E. Swanson negotiated a mortgage loan in behalf of the trust in the amount of $200,000. In addition $70,000 was borrowed from a bank. Pursuant to the trust agreement, 3,000 shares of the par value of $300,000 were issued to the original beneficiaries, respectively, who were the same as the original trustees. John H. Hardin still holds the 750 shares issued to him originally. The remaining shares issued to the other beneficiaries were transferred as follows: Date Original beneficiary Transferee Number of shares Jan. 2, 1920 Jos. E. Swanson Esther L. Swanson, his wife [375] Do Ralph C. Otis Central Trust Co. of Illinois [750] as Trustee for Ralph C. Otis under agreement dated Oct. 30, 1919 Nov. 8, 1919 Wm. G. Hibbard Susan F. Hibbard, his wife [500] Nov. 23, 1920 Estate of Wm. G. Hibbard Susan F. Hibbard [250] Jan. 6, 1920 Thurston B. Swanson Joseph E. Swanson [375] Do Joseph E. Swanson Esther L. Swanson [375] *1426 The books of account set up the value of this land and building as $500,000, which does not represent the original cost thereof. At the time the real estate was purchased and the building thereon constructed, the original trustees and beneficiaries were consulted in regard to the terms of the mortgage loan as to principal and rates The property was turned over to the company as manager thereof and such company has had complete management of it ever since. It negotiated the original leases and all renewals. The company employed janitors and elevator boys, made arrangements for the cleaning and decorating, collected the rentals, purchased, through its own purchasing agent, all the coal and other supplies for the building, and did all things necessary pertaining to the management of the property. The company kept separate books of account covering the operation of the building as it did for other properties managed by it. It sent annual financial statements covering its operation and *1126 management of the property to the trustees and beneficiaries, and it pursued the practice of distributing the income, less operating and maintenance expenses and taxes, to the beneficiaries*1427 four times a year, so that during the entire period of operation no income from the property was accumulated. In 1925 and 1926 the entire income up to that time had been distributed. The affairs of the property were handled by the company in the regular routine of its office by its employees. Joseph E. Swanson participated therein as a partner of the dompany to the same extent as he did in other matters handled by the company, except, however, being directly interested in the enterprise as beneficiary and trustee, he was usually consulted as to rentals and other matters pertaining to the operation and management of the property. Edward M. Willoughby, after he became trustee, was not active in the management of the property except as he may have participated therein as partner of the managing company. The trustees had no officers or directors or governing body managing the affairs of the property. They never adopted any bylaws or other code of laws except the trust agreement. They never adopted any resolutions governing the amount of rental to be charged. They had no minute book or book of any kind in which to record actions of the trustees or of the beneficiaries. They kept*1428 no books of account. At no time since the execution of the trust agreement have the trustees assembled in formal meeting. The trustees, as trustees, other than Joseph E. Swanson, were not consulted as to the rentals to be charged, help to be employed, supplies to be purchased, repairs to be made, or other matters relating to the management and operation of the property, except that such matters were discussed with Ralph Otis, who was frequently in the office of the company, since he officed with it. Ralph Otis, however, was not a trustee after 1926 or 1927, his son, James, having succeeded him. Matters relating to the property were discussed by the trustees as they met from time to time as friends or as they came into the office of the company for a chat with Joseph E. Swanson. The holders of the beneficial interest never assembled in meeting and never expressed any decision relating to the property held in trust by vote. Other than the financial statements, no communications were sent to the beneficiaries, except the checks of distribution, which were also sent by the company, No matter or question relating to the property held in trust was submitted to the beneficiaries for*1429 their consideration or decision. The property is located at the southwest corner of Fullerton Parkway and Lincoln Park West, both of which are boulevards. It is *1127 one of the outstanding corners with respect to location, being on the corner of two boulevards; also, Lincoln Park is to the north and to the east of the property. In 1916 the section in which this property is located contained mostly residential houses. The building constructed on the property contained 16 apartments of 4, 8, 10, and 12 rooms. respectively. In 1916 the building was considered one of te finest buildings on the north side on an attractive location, and the apartments were considered to be in the best class of high-priced apartments, The apartments were rented unfurnished, originally under leases for terms of 3 to 5 years. Most renewals, however, were not made for more than one year. The building had two elevators, which were not operated continuously but only during certain hours of the day and evening. This building was about the last one of its type erected in that neighborhood. Some others were erected, but were not as good as this building. Within ten years after 1916 a change*1430 occurred in the size and character of buildings erected in that section. In 1925 no singlefamily houses were erected, nor any new three or four-story apartment buildings, with the exception of two or three three-story buildings which were erected on the side streets. In about 1921 the Webster Hotel, a first-class transient hotel of 16 to 18 stories in height, was built on Webster and Lincoln Park West, two bblocks from the Fullerton Parkway Land Trust Building. A year later, the Belleview Stratford, a residential apartment hotel, 16 to 18 stories in height, with furnished two to six-room apartments, was erected a block or two to the south of the building involved herein. For about a mile to the north of this property about 60 percent of the boulevard frontage has been improved with more modern and larger buildings. There were other buildings similar to that of the Webster, hotel and Belleview Stratford erected in that section. Three of them were erected in the next block on Fullerton Parkway toward the west, and on Lake View Avenue to the north of the Fullerton Parkway Land Trust Property, two were built before 1925 and one after that. The newer buildings constructed in that*1431 section had complete elevator service. They were more elaborate and therefore involved greater expense in construction. The year 1925 was a year of considerable building activity, which activity continued up to within the last few years. Nothing but the better, higher-priced buildings were erected. There has been no building activity since 1929. In 1916 an eight-room apartment in the building brought a monthly rental of $200, which represents the lowest rental received for such an apartment. The rent increased to $300 a month in 1926. The highest rent received was $550 a month for the best apartment *1128 in the building. The rentals of the apartments varied according to size and location. The rent for a 10-room apartment in the new buildings was $700, whereas a 10-room apartment in the Fullerton Parkway Land Trust Building rented for $400 a month. The total annual rentals during 1920 and 1921 amounted to $65,000, and from 1921 to 1926 the total annual rentals increased gradually to about $82,000 to $84,000. This was the highest total annual rentals received and ran about the same until 1929. After 1929 the total annual rentals received fell off considerably*1432 and are only about half of that amount at the present time. However, that condition prevails in general, except that the newer and more modern buildings are preferred to the older buildings by tenants. Renting conditions were somewhat better in 1932 than in 1931, and if conditions continue to improve the trustees should be able to erect a new building on the property about 1935. In 1924, 1925, and 1926 the building had no vacant apartments and such condition continued until 1929. Since 1929 numerous vacancies have occurred. Both John Hardin and Ralph C. Otis have been and still are tenants of the building. Due to building activities and the erection of the tall buildings in the section in which the Fullerton Parkway Land Trust property is situated, land values increased considerably from 1916 to 1925. In 1925 the land herein involved had a value of $400,000. As values increased, taxes increased correspondingly. In 1925 the trustees began to realize that within ten years they would have to change the improvements on the property. The trustees have no immediate plans for the removal of the present building. It appears that they cannot continue for more than five years. *1433 Although there is no possibility of getting a construction loan under present conditions, the trustees still anticipate the removal of the building within a few years. No discussions were had between Joseph E. Swanson and his partner about plans for erecting a new building. There has been no determination by the trustees with respect to the removal of the old building and the erection of a newer and larger building. The only discussion of the matter was had by Ralph Otis and Swanson a few days ago. During the life of the trust there has been no negotiation for the sale of the property. The respondent, as shown by the statement attached to the deficiency notice herein, adjusted the claimed deduction for depreciation in 1925 as follows: Depreciation deducted at 3% on valuation of $372,000 $11,160.00 Depreciation deducted at 4% on valuation of $271,668.93 10,866.76 Disallowed 293.24 *1129 The parties stipulated that the amount of $271,668.93, used by respondent in the above computation, is the proper basis for the computation of depreciation and obsolescence. As to the year 1926, the statement attached to the deficiency notice shows adjustment*1434 of allowance for depreciation as follows: Depreciation allowed $10,866.76 Depreciation claimed 7,440.00 Additional depreciation 3,426.76 OPINION. MCMAHON: The first question to be determined is whether the Fullerton Parkway Land Trust is a trust or an association taxable as a corporation within the meaning of section 2(a)(2) of the Revenue Act of 1926, which is as follows: SEC. 2. (a) When used in this Act - * * * (2) The term "corporation" includes associations, joint stock companies, and insurance companies. In Trust No. 5833, Security-First Natl. Bank v. Welch, 50 Fed.(2d) 613; affd., 54 Fed.(2d) 323; certiorari denied, 286 U.S. 544, it appears that a real estate operator in association with other persons undertook to acquire a tract of some 90 acres of land to improve the same by laying out streets, etc., and to subdivide the tract into city lots and sell them to the public at a substantial profit. The District Court, in its opinion, after setting forth certain provisions of the declaration of trust under which the project was launched, states: * * * It is true that the trust in many respects was*1435 self-executing, and to some extent was an escrow and security device. It was, however, also a functioning, operating business carried on for profit by the joint action of the trustee, beneficiaries, and sales agents. * * * * * * It seems to me that to classify this trust as a mere liquidating trust such as those encountered in the administration of estates of deceased persons or in financially embarrassed businesses or projects would be an unreasonable classification. * * * To the same effect see Commissioner v.Atherton, 50 Fed.(2d) 740, affirming C. H. Atherton et al., Trustees,19 B.T.A. 1172. See also discussion and cases cited in Monrovia Oil Co.,28 B.T.A. 335, and in Ittleson v. Anderson,2 Fed.Supp. 716; affd., 67 Fed.(2d) 323. To the effect that the nature of the activities of the entity probably constitutes the best test, see Tyson v. Commissioner, 54 Fed.(2d) 29 (C.C.A., 7th Cir.); Fisk v. United States, 60 Fed.(2d) 665; *1436 Sloan v. Commissioner, 63 Fed.(2d) 666 (both (C.C.A., 9th Cir.); *1130 Dunbar v. Commissioner, 65 Fed.(2d) 447 (C.C.A., 1st Cir.), and cases cited in them. The petitioners contend that all the characteristic forms and modes of procedure of a corporation are lacking in the instant proceeding; but, in this respect, the trust agreement provides that the trustees shall have exclusive management and control of the real estate described therein and of any buildings or improvements thereon; that the trustees shall have certain enumerated powers, including the right to hire suitable offices for the transaction of the business of the trust and to employ agents, servants, and attorneys at law, either from among their own number or otherwise; that neither trustees nor any beneficiary shall be personally liable and all persons dealing with the trustees shall look only to the property of the trust; that the interest of the beneficiaries shall be evidenced by receipts issued by the trustees, which receipts shall be construed to be personal property and shall not be held to be an interest in or evidence of an interest in real estate; that the beneficial*1437 interests shall be represented by 3,000 shares of the par value of $100 each, aggregating $300,000; that such shares may be transferred in the manner provided in the trust agreement; that upon resignation of a trustee or trustees such vacancies shall be filled by the remaining trustees or trustee, if there be only one; that the trustees may delegate their powers for a period not exceeding one year at any one time to any other trustee or to other trustees; that the trust agreement may be amended by an agreement in writing by the beneficiaries holding three fourths or more in value of the receipts, which amendment or amendments shall be binding upon the beneficiaries and trustees; that the trust shall be terminated at the expiration of 20 years after the death of the last survivor of named children of Ralph C. Otis, Joseph E. Swanson, and Thurston B. Swanson or by the trustees in their discretion at any time before the expiration of the 20 years by selling all the property held by them as such and distributing the net proceeds of such sale. In the instant proceeding the organization had succession and the death of a beneficiary or a trustee did not interfere with or terminate the*1438 existence of the association; while it had no corporate name, the trust so-called could be sued and could sue in the name of the trustees; it could acquire and hold property and do other acts in the name of the trustees; it had no common seal, but this is not an indispensable requirement; it did not have bylaws, but bylaws are not an essential requisite to corporate existence. They are rules for internal government and if the agreement or charter is deemed sufficient for that purpose, bylaws are superfluous. *1131 Fletcher Cyclopedia Corporations, vol. 2, sec. 10, p. 14, and sec. 5, p. 5, and cases cited. In Sears, Roebuck & Co., etc., Fund v. Commissioner, 45 Fed.(2d) 506, the court held that a practical semblance to corporate forms and methods was sufficient. To the effect that a quasi-corporate form or organization is not a controlling factor or indispensable element of an "association", see Twin Bell Oil Syndicate,26 B.T.A. 172; Investment Trust of Mutual Investment Co.,27 B.T.A. 1322. See discussion in the latter case at page 1330. The petitioners argue that the trustees were not subject to the control of*1439 the beneficiaries. Control by the beneficiaries is not a determinative factor. Ittleson v. Anderson, infra. Furthermore, this lack of control in the instant proceeding is largely theoretical, as the beneficiaries and the trustees were the same until 1920, in which year Joseph E. Swanson transferred his shares to his wife, and Ralph E. Otis transferred his shares to the Central Trust Co. as trustee for himself. In 1919 or 1920 Hibbard died and thereafter the partner of Swanson became trustee. Ralph E. Otis was later succeeded by his son as trustee. The association enjoyed benefits similar to those of corporate existence. The beneficiaries in the trust agreement provided that the trustees could delegate their powers to a trustee. It seems that at the very outset the group relied and has continued to rely upon the business acumen and ability of Joseph E. Swanson; that under the agreement they could and did permit him or his firm under his direction to manage and operate the enterprise. The agreement gave the beneficiaries the sole right to amend the agreement and had they desired to do so they could have curtailed the powers of the trustees by amending the agreement. *1440 The petitioners further argue that the trust was not engaged in business and that it was not formed for the purpose of carrying on any business. It certainly was not organized for the purpose merely of preserving or of settling, liquidating, and winding up the affairs of an estate or business. It was doing more than acting as a passive holder of property or a conduit to carry over profits to persons entitled to them. Ittleson v. Anderson, supra.Cf. Commissioner v. Morriss Realty Co. Trust No. 2, 68 Fed.(2d) 648, affirming Morriss Realty Co. Trust No. 2,23 B.T.A. 1076. In J. W. Pritchett et al., Trustees,17 B.T.A. 1056, 1064, 1071, the Board held that the owning and renting of one apartment home or an apartment hotel constitutes the carrying on of a business for profit. There is but one property involved in the instant proceedings. Tyson v. Commissioner, supra, cited by the petitioners, is distinguishable. The court held that, for income tax purposes for the *1132 years in question, the Zenith Real Estate Trust was a trust and not an association, based primarily upon testimony of*1441 witnesses, from which the court concluded that "the investment was one which provided with reasonable certainty for a sure and fixed income without either care or supervision." The facts as disclosed by that testimony are similar to the facts in Lansdowne Realty Trust v. Commissioner, 50 Fed.(2d) 156, cited by the petitioners. The doctrine enunciated by the court in Tyson v. Commissioner, 54 Fed.(2d) 29, supra, was applied by the same court in Tyson v. Commissioner, 68 Fed.(2d) 584. The difference in activity required to take care of a property covered by a long term lease and that required to take care of a property with 16 apartments, which apartments were originally leased for a term of from three to five years and thereafter renewed for a term of one year, is considerable. Joseph E. Swanson testified that after the erection of the modern buildings the better tenants moved. In fact it is argued on brief in support of the second issue involved herein that the testimony was very definite to the effect that during the taxable years, and prior thereto, it was becoming increasingly difficult to rent the apartments. *1442 However, it appears that the total rental during 1920 and 1921 amounted to $65,000 and increased gradually until from 1926 to 1929 the total rentals were about $82,000 to $84,000, and that there were no vacancies during 1924, 1925, and 1926. Despite the alleged difficulty in renting the apartments, the total rentals increased substantially. It may be said in reference to the situation present here, as stated by the court in Sears, Roebuck & Co., etc,. Fund v. Commissioner, supra, that a "study of all the purposes of the plan discloses that its objects have been and can only be gained through the use of much skill, ability, and sound business judgment." Numerous cases decided by the courts and the Board bearing on the first issue presented in these proceedings are cited and discussed on briefs by the parties. While prior decisions enunciate general principles and illustrate the application thereof to the facts presented in each case, it is apparent that each case must be determined upon its own peculiar facts. Therefore, we do not believe that a discussion of all these cases would serve a useful purpose. Upon the authority of the foregoing cases which we have discussed*1443 or cited, we conclude that the Fullerton Parkway Land Trust is an association within the meaning of section 2(a)(2) of the Revenue Act of 1926. The petitioners further contend that, if the Fullerton Parkway Land Trust is subject to tax as an "association", the deduction *1133 allowed by the respondent for depreciation, including obsolescence, should be increased to from 6 to 8 percent of the stipulated basic sum of $271,668.93. It is claimed that due to building activities in the section in which the property involved is located the value of the realty, which was purchased in 1916 for about $62,000, increased to more than $400,000 in 1925; that the increased land value resulted in increased taxes; and that the return from the building became wholly disproportionate to the capital value of the property. Joseph E. Swanson testified that the building of the modern 16 to 20-story apartment buildings and hotel buildings changed the Fullerton Parkway Land Trust Building into a second-class building; that people coming to the neighborhood in search of an apartment preferred the newer and more modern buildings; that they naturally had to reduce the rents to meet the competition*1444 of the more pretentious buildings; that in 1925 and prior thereto the better tenants left to go to these more modern buildings. However, he also testified that there were no vacancies in the buildings during 1924, 1925, and 1926; that the total yearly rentals increased from $65,000 in 1920 and 1921 to about $82,000 to $84,000 in 1926, and continued at about $84,000 until after 1929, when rentals fell off considerably, which condition, however, prevailed generally with respect to all buildings. It appears, therefore, that while the building activities resulted in increased land values and increased taxes, and while greater difficulty in obtaining tenants may have been encountered, such building activities also resulted in increased rentals to the petitioners. Anna J. Cotton,25 B.T.A. 1158, affd., 68 Fed.(2d) 436, on another issue, by the Circuit Court of Appeals of the District of Columbia, wherein no question was raised as to the Board's holding as to obsolescence. In U.S. Cartridge Co. v. United States,284 U.S. 511, 516, the United States Supreme Court defines "obsolescence" as follows: *1445 * * * Obsolescence may arise from changes in the art, shifting of business centers, loss of trade, inadequacy, supersession, prohibitory laws and other things which, apart from physical deterioration, operate to cause plant elements or the plant as a whole to suffer diminution in value. Burnet v. Niagara Brewing Co.,282 U.S. 648, 654; Gambrinus Brewery Co. v. Anderson,282 U.S. 638. [Emphasis supplied.] There is no evidence showing that the building decreased in value. The character of the section wherein this property was located did not change. It remained residential in character. In fact, the erection of the modern apartment buildings and hotels increased its desirability for residential purposes. In the instant proceeding, as in the Cotton case, supra, the rentals increased after the erection of the modern buildings, and in the instant proceeding the rentals continued to increase until after 1929, when rentals decreased in general. *1134 Swanson testified as follows: Q. Well, the question of whether the building could be profitably operated for any length of time, that is purely your opinion, isn't it? *1446 A. The building could not be profitably operated for any length of time, knowing the expenses of this building, it can not be operated on such a valuation with the taxes there, because now it is running at a loss. He also testified in substance that the rate of return, based on cost, without taking into consideration any enhancement of land values, was better in 1926 than in 1920; and that, based on the increased land values, without taking into consideration the cost, the rate of return on the property was not as good in 1926 as in 1920. However, a decrease in the rate of return does not in itself establish obsolescence. The action of the respondent with respect to computation of the allowance for depreciation including obsolescence is therefore approved. Reviewed by the Board. Decision will be entered for the respondent.