Nippert v. Commissioner

ALFRED K. NIPPERT, MAUD GAMBLE NIPPERT, AND OLIVIA P. GAMBLE, EXECUTORS AND TRUSTEES OF THE ESTATE OF JAMES N. GAMBLE, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Nippert v. Commissioner Docket No. 55595. United States Board of Tax Appeals 32 B.T.A. 892; 1935 BTA LEXIS 874; July 9, 1935, Promulgated *874 Over a period of years the decedent paid $373,714.59 for stock and bonds of, and in advances and loans to a corporation. In 1928 he sold all his interest in and claims against the corporation for $80,000. Held, that the stock was worthless prior to 1928; held, further, that decedent's loss is the difference between the total cost of the bonds and advances, and the selling price. Laurence Graves, Esq., and Ike Lanier, Esq., for the petitioners. L. H. Rushbrook, Esq., and Harold Allen, Esq., for the respondent. TURNER *892 This proceeding involves a deficiency in income tax for the year 1928, amounting to $48,219.17. The principal item in issue is the loss sustained by the petitioner's decedent from the sale, in 1928, of common stock and first mortgage bonds of the Cincinnati & Westwood Railroad Co., and the assignment of all his claims against the same company. The respondent has allowed a loss of $20,000, while the petitioners allege that this loss should be allowed in the sum of $315,136.81. In their brief the petitioners now argue that the actual loss was $293,714.59. This figure is arrived at by the elimination of*875 accrued interest and amounts due as rent. By an amended answer the respondent affirmatively alleges that if a loss resulted from this sale in 1928, it was a capital net loss which should be deducted from gross income and the 15 percent limitation for contributions applied to the resulting figure. FINDINGS OF FACT. The Cincinnati & Westwood Railroad Co., hereinafter referred to as the Company, was organized in 1874. It operated a narrow gauge steam railroad of approximately 5 1/2 miles in length, the eastern terminus of which was the Baltimore & Ohio Railroad station at Queen City Avenue in Cincinnati, Ohio. From this station the railroad ran in a northwesterly direction to a community known as Westwood, which has since become a part of the city of Cincinnati. In or about 1891 the decedent purchased the entire issue of the 25-year 6 percent first mortgage bonds of the company, at a cost to him of $100,000. The proceeds of this bond issue were used in making the railroad a standard guage road, in rebuilding and strengthening its treatles, in laying new rails, and in purchasing new equipment. No interest was ever paid on these bonds, and the company defaulted as to the principal*876 upon maturity in 1916. *893 Prior to March 1, 1913, the decedent acquired approximately 90 percent of the capital stock of the company, at a total cost to him of $19,180.87. Part or all of this stock was acquired as early as 1891. On November 16, 1898, the decedent was awarded a judgment against the Company for $61,420.31, plus interest amounting to $11,422.22. This judgment was for loans and advances to the Company by the decedent. Subsequent to 1898 the decedent revived this judgment from time to time, and it was finally revived by the Common Pleas Court of Hamilton County, Ohio, by its order entered July 3, 1928. Between 1898 and March 1, 1913, the Company became indebted to the decedent for additional advances, or loans, in the sum of $64,964.57, and for unpaid rentals amounting to $10,000. Subsequent to March 1, 1913, and up to and including 1928, the decedent continued to make advances or loans to the Company. At the date of the sale here involved these additional advances amounted to $128,148.84, and the unpaid rentals for the same period amounted to $3,583.33. Of the $128,148.84, the sum of $2,475.06 was advanced in 1928. In 1912 an engineer, Bion*877 J. Arnold, employed by the Cincinnati Interurban Rapid Transit Commission, submitted an exhaustive report covering the interurban and traffic situation in Cincinnati. In his report, Arnold submitted a comprehensive plan for better transit facilities in Cincinnati, the estimated cost of which was approximately $13,000,000. Since the cost of the project under this comprehensive or major plan might have made its financing impracticable at that time, Arnold submitted five alternative plans, with estimated costs of from $6,500,000 to $12,700,000, any one of which if carried out would have contemplated and formed the basis for the subsequent execution of the major plan in full. The Company's railroad property was an integral of Arnold's comprehensive plan, being included in the $13,000,000 total and in two of the alternative plans at an estimated cost of $494,128. Arnold's report proposed the purchase of the Company's property and estimated the purchase price at $150,000, which was included in the estimated cost of $494,128 hereinabove mentioned. The report stated that the Company's railroad would take care of through Westwood suburban business and provide an entrance for any new lines*878 from the Middle West, particularly the Indianapolis and Cincinnati Traction Co., which it was understood was anxiously awaiting for entrance to Cincinnati from that direction. On January 14, 1914, the decedent executed an "option contract" granting a 60-day option to Charles L. Henry of Indianapolis, who was president of the traction company operating out of Indianapolis *894 and within 40 miles of Cincinnati. The option gave Henry the right and privilege to purchase from Gamble all the latter's right, title, interest, claims, and holdings in, to, and against the Company for the sum of $175,000 cash. Gamble's holdings, according to the option, consisted of not less than 3,600 shares of Company stock, $100,000 of 6 percent first mortgage bonds, together with all unpaid interest coupons, the judgment and all other liens, and bills and accounts payable held then or thereafter acquired against the Company by the decedent. This right and privilege to purchase was extended from time to time, by agreement of the parties, the last extension being entered into July 12, 1920, and provided for a purchase price of $180,000, plus the sum of any and all moneys advanced by Gamble to*879 the Company from March 4, 1917, until the exercise of the option, which expired on March 14, 1922. The option extension of July 12, 1920, provided for payments by Henry of $5,000 on or before September 14, 1920, $7,000 on or before March 14, 1921, and $9,000 on or before September 14, 1921. These payments, which were duly made by Henry to Gamble, were to be deducted from the total advances made by decedent to the Company if Henry exercised his option. Between March 14, 1917, and March 3, 1922, the decedent's advances to the Company totaled $85,288.92. Henry offered $3,000 to secure a further extension of his option in March 1922, but Gamble asked $5,000 and no extension was given. Subsequent to Arnold's report, the city of Cincinnati floated a bond issue and expended over $6,000,000 in construction work upon a rapid transit system for the city. The project being incomplete, a second survey was made by John A. Beeler, director of an engineering concern of New York City, and a report was submitted in September 1927. This report estimated that an additional $10,600,000 would have to be expended to complete the system. Work on the Arnold plan was abandoned after the Beeler report. *880 The Company discontinued the handling of freight in June 1924. Passenger service had been discontinued prior to that time. On July 13, 1928, the decedent, who was then 92 years of age, sold his stock and bonds and assigned all his claims against the Company, including the judgment and open accounts, for the sum of $80,000. In his income tax return for 1928, he claimed a loss of $318,743.43 on this transaction. He reported contributions of $480,806.04, and claimed a deduction of $2,153.21 in respect to such contributions. OPINION. TURNER: The petitioners take the position that the decedent had a net cash investment, including bonds, stock, judgment, and advances, in the Cincinnati & Westwood Railroad Co. in the amount *895 of $373,714.59, which he sold in 1928 for $80,000, thereby sustaining a loss of $293,714.59. This loss they claim as an allowable deduction for that year under the provisions of section 23(e) 1 of the Revenue Act of 1928. *881 The respondent has determined that the decedent's stock and all claims against the Company, exclusive of the bonds, were worthless prior to 1928 and that neither the cost of the stock nor any part of the judgment or advances is deductible for that year either as a loss under section 23(e), supra, or as bad debts under subsection (j) 2 of the same section. He has therefore applied the $80,000 received against the cost of the bonds and found a deductible loss of only $20,000. The petitioners have alleged that the respondent erred in refusing to allow as a deduction all of the amount claimed as a loss in respect to the stock, judgment, and advances. On the record we agree with the respondent that the stock was worthless prior to the year of the sale. Numerous events in the history of the Company convince us that the stock had been worthless for a*882 number of years. We note particularly in this connection the fact that the Company was heavily indebted to the decedent. We also note that freight service was discontinued in 1924 and that passenger service had previously been discontinued. It is thus apparent that the road, if it had any value, was valuable to the extent that it might be utilized as part of a more comprehensive transportation unit. It is also apparent that the decedent's hope of recovering the money he had spent was dependent upon his ability to sell, and as early as 1914 he gave Henry an option to purchase his interest for an amount which allowed nothing for the stock, if the priority of debts over stock be considered. On that basis the result would have indicated a total loss of his stock investment had Henry exercised the option. It is true that the stock was still outstanding and was included in the transaction in 1928. It seems reasonable to assume, however, that had the stock been owned by some one other than the decedent, he would have taken steps many years prior to 1928 to have the corporation liquidated and its property brought directly under his control. *883 Any equity that the stockholders had in the corporation's assets was, in *896 our opinion, entirely extinguished long prior to 1928. ; ; certiorari denied, ; . Cf. ; ; ; . With reference to the judgment and advances, the claim of the petitioners is much more convincing. Throughout the period of his connection with the Company the decedent undoubtedly believed that it had assets with a large potential value. It is perhaps true that there were times when the value of the Company's railroad contracted sharply, but it is equally true that at other times they promised the recoupment of a substantial part of his advances and investment. For example, during 1920 and 1921 the decedent received $21,000 on an option to buy his interests at a total figure of*884 approximately $265,000. A sale at such a figure would have resulted in the recoupment of decedent's investment in bonds and approximately $165,000 of his loans and advances. While Henry would not pay $5,000 to renew his option in 1922, the decedent still had the city of Cincinnati as a prospective purchaser. The potential value of the Company's property remained until the city abandoned its project on account of the Beeler report. Even then the property had a substantial cash value, since the decedent actually received $80,000 in cash for all of his interests in the Company. This sale completely closed the transaction for the decedent and established the amount of his loss, and prior to this sale we do not believe it could have been said that there was no possibility of recouping at least a part of the advances. Accordingly we find nothing in this record to indicate that decedent was accumulating bad debts to deduct them in a year subsequent to the year of their worthlessness, as was true in . We believe that a deduction for any year prior to 1928 would properly have been denied decedent because of the substantial value*885 of the Company's property. See ; ; ; affd., . We are of the opinion, therefore, that the advances made by decedent to the Company were not worthless prior to the year of the sale. ; affd., ; , petition to review dismissed, . The respondent has urged that the bar of the statute of limitations was available to the Company, both as to the judgment and as to *897 most of the advances, Pages Annotated Ohio General Code, secs. 11218-22, which fact, he contends, establishes the worthlessness of the judgment and all advances made more than six years prior to 1928. Under the Ohio code a judgment becomes dormant if execution be not sued out within five years from the date of judgment, or if five years intervenes between the date of last execution issued thereon and that of suing out another execution, sec. *886 11663, Ohio code. It further appears, sec. 11648 of said code, that an action to revive a judgment can only be brought within 21 years after it becomes dormant. There is nothing in the record to show that the judgment ever became dormant. On the contrary, the record is that the judgment was revived from time to time. Two such revivors would bring this judgment within the 21-year period of the statute of limitations. A court of competent jurisdiction has considered the question and ordered the judgment to stand revived. On the record before us we can not say that the judgment has become outlawed by the statute of limitations. While the Ohio statute of limitations might have been available to the Company as a defense against decedent's efforts to collect his advances, such local statutes are not decisive of what deductions may be taken under a Federal tax statute. . The Board has considered this question in several cases and has held that the availability of the statute of limitations as a defense is not in itself a sufficient ascertainment of the worthlessness of a debt to justify its charge-off, *887 ; ; ; affd., ; ; affd., ; ; . In view of these decisions we hold against respondent on his contention respecting the prior worthlessness of decedent's judgment and advances. The remaining issue presents the question as to whether or not a capital net loss should be deducted from gross income in applying the 15 percent limitation in computing the deduction for contributions. We have considered this question in , wherein we held that the base for the computation of the 15 percent limitation on such a deduction is gross income less all permissible deductions except contributions themselves. This issue is accordingly determined in favor of the respondent. Reviewed by the Board. Decision will be entered under Rule 50. Footnotes 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * (e) Losses by individuals. - In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise - (1) if incurred in trade or business; or (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or (3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft. ↩ 2. SEC. 23 (j) Bad debts.↩ - Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recovorable only in part, the Commissioner may allow such debt to be charged off in part.