Hort v. Commissioner

WALTER M. HORT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Hort v. Commissioner Docket No. 89033. United States Board of Tax Appeals 39 B.T.A. 922; 1939 BTA LEXIS 954; May 19, 1939, Promulgated *954 1. YEAR OF LOSS. - Where the offer of a taxpayer to sell real estate was accepted in 1933, and, thereafter in that year, deeds were delivered to the purchaser, possession was taken by the purchaser, and the purchaser put up collateral for payment of the purchase price, the seller sustained loss from the disposition of the property in 1933 rather than in a later year. 2. CANCELLATION OF LEASE. - An amount received by the taxpayer from a lessee for the cancellation of a lease was taxable in its entirety as ordinary income and no loss was sustained, either in the amount of the difference between future rentals under the lease and future rentals for the same term obtainable from other tenants, or in any other amount. Edwin Hort, Esq., for the petitioner. F. S. Gettle, Esq., for the respondent. MURDOCK *922 The Commissioner determined a deficiency of $59,012.62 in income taxes of the petitioner for the calendar year 1933. The first issue is whether certain capital losses were sustained in 1933 or whether they were not sustained until 1934. The second issue is whether the petitioner realized ordinary taxable income of $140,000 from the cancellation*955 of a lease in the taxable year, whether it was capital gain, or whether he sustained a loss from that transaction. FINDINGS OF FACT. The petitioner is an individual, who filed his income tax return for the calendar year 1933 with the collector of internal revenue for the second district of New York. He acquired two parcels of improved real estate in 1928 by bequest from his father. He made an offer on March 27, 1933, to sell the properties to a corporation. The purchaser was to take the properties subject to existing encumbrances and was to pay, in addition, $5,000 for one of the properties and $7,500 for the other. Of the purchase price, $1,500 was to be paid upon delivery of the deeds. The balance was to be paid in five annual payments thereafter. The offer specified that the stock of the corporation should be placed with the seller as collateral for the payments. The offer was subject to acceptance by the corporation on or before December 31, 1933. The corporation accepted the offer on December 28, 1933. The petitioner, on the latter date, executed and delivered warranty deeds for the property to the corporation. The corporation entered *923 into possession*956 of the premises on that same day and delivered its stock to the petitioner. The deeds were recorded on January 11, 1934. The initial payment of $1,500 was not made at the time of the delivery of the deeds. The petitioner orally consented to an extension of the time for that payment and the payment was made within the extension on January 26, 1934. The petitioner continued to hold the stock of the corporation until January 1936, at which time notes of the corporation were substituted as collateral and the stock was returned to the corporation. The corporation made additional payments on the purchase price at various times but not in strict accordance with the terms of the agreement. A small balance of the purchases price still remained unpaid at the time of the hearing of this case on November 30, 1938. The petitioner did not receive any rentals from the properties which accrued after December 28, 1933. He was never a stockholder of the corporation. The capital loss of $167,535.25, which the petitioner sustained from the sale of the above mentioned properties was sustained in the calendar year 1933. The petitioner also acquired by bequest from his father a property at*957 76-78 Madison Avenue, in New York City. The property was improved with a 10-floor modern fireproof commercial and office building. A trust company was occupying a part of the property as lessee at the time the father acquired the property. That lease was to expire on February 1, 1932. The father entered into an agreement with the trust company on August 31, 1927, whereby he leased the main floor and basement of the building to the trust company for a term of 15 years beginning on February 1, 1932, at an annual rental of $25,000. The fair market value of the entire property at the time of the father's death on March 7, 1928, was $650,000. The trust company continued to occupy the main floor and basement until June 1933, at which time it discontinued that branch office. A change in the neighborhood where the property was located began to be noticed in 1933. Manufacturers, who had given the neighborhood a definite business character, were moving away and there was a consequent depreciation in the value of the building as business property. The trust company, although it made every effort to sublease the first floor and basement between June and December 1933, for a rental of*958 about $15,000, was unable to find any tenant willing to give more than from four to eight or nine thousand dollars. The trust company then negotiated with the petitioner for cancellation of the lease. They entered into an agreement on December 1, 1933, whereby the lease was canceled upon the payment to the petitioner on that same day of $140,000. The petitioner lost the property through foreclosure in 1935. *924 The petitioner reported in his income tax return for 1933 a loss of $21,494.75 as a result of the cancellation of the lease, but did not claim the amount as a deduction from income because other capital losses claimed exceeded his income. The $140,000 received from the trust company was ordinary income received and realized by the petitioner in the calendar year 1933. All facts contained in the stipulation filed by the parties are incorporated herein by this reference, whether or not referred to above. OPINION. MURDOCK: The parties are in agreement that the petitioner sustained a capital loss of $167,535.25 from the sale of the two properties to the corporation. The petitioner contends that the loss was sustained in the calendar year 1933, whereas*959 the respondent contends that it was not sustained until 1934. The court said in Commissioner v. Union Pacific Railroad Co., 86 Fed.:2d) 637: A closed transaction for tax purposes results from a contract of sale which is absolute and unconditional on the part of the seller to deliver to the buyer a deed upon payment of the consideration and by which the purchaser secures immediate possession and exercises all the rights of ownership. The delivery of a deed may be postponed and payment of part of the purchase price may be deferred by installment payments; but for taxing purposes it is enough if the vendor obtains under the contract the unqualified right to recover the consideration. The evidence in the present case shows that the sale actually took place in 1933. The corporation accepted the petitioner's offer, deeds conveying title were delivered, the capital stock of the corporation was delivered to the petitioner as security for the payment of the purchase price, and the corporation took possession of the properties on December 28, 1933. The petitioner was then committed absolutely to the transaction, and he sustained the loss at that time. The respondent contends*960 that the evidence fails to show delivery of the stock to the petitioner during the year 1933. The petitioner did not state specifically the exact time at which he received the stock. The contract provided that the stock was to be delivered at the time of the delivery of the deeds. The deeds were delivered on December 28, 1933. The petitioner testified that he received the stock, and he further testified that the only modification of the contract was the extension of the time for payment of the first installment of the purchase price. The finding has therefore been made that he received the stock on December 28, 1933. But the result would be no different if he had not received the stock on that date. The payment of the first installment of the purchase price was not a condition *925 precedent to the sale. The petitioner expressly provided when he extended the time for payment that it was not to affect the sale on December 28, 1933. He unqualifiedly parted with his property in that year and received in exchange a right to receive the purchase price. The Commissioner erred in disallowing this item as a loss for 1933. Cf. *961 ; ; ; ; affd., 100 Fed.:2d) 625; ; affd., 90 Fed.:2d) 876; ; ; Davidson & Case lumber Co. v. Motter, 14 Fed.:2d) 137. The remaining question is to determine the income tax consequences of the payment to the petitioner of $140,000 by the trust company in cancellation of the lease on the petitioner's property. The petitioner contends that he sustained a loss on the cancellation of the lease. He claims his loss is the difference between the total rent payable under the lease for the unexpired term and the probable total rental which might be obtained for that period from other tenants. There are several reasons why the petitioner is not entitled to deduct that amount or any other as a loss in computing his income tax liability for the calendar year 1933. The alleged loss as described by*962 the petitioner represents only the amount of earnings which he expected to obtain from the use of his property but which he probably will never receive. A mere reduction in the amount of income to be expected does not give rise to a deductible loss. ; ; . Failure to prove the present value of the future payments under the lease at the close of 1933 and the then value for rental purposes of the first floor and basement for a similar period independent of the lease is of no consequence. Comparison of those two figures would show the then value of the lease or the probable loss of future earnings which the petitioner could expect as a result of the cancellation of the lease, but such a comparison would not show any figure important in the computation of any loss for income tax purposes. The petitioner has failed to prove any figures from which a loss could be computed. A loss from the disposition of property is computed for income tax purposes by deducting the amount realized from the adjusted basis. The amount realized from the cancellation*963 of the lease was $140,000. Basis is always cost or some substitute therefor authorized by the revenue act. Where, as here, property was acquired by bequest in 1928, the basis would be the fair market value *926 of the property in 1928. The evidence does not show any separate basis for the lease in question in the hands of this petitioner or that the lease had any value in itself at the time that the property was acquired by this petitioner. Certainly there is no reason to believe that the lease had a value at that time which, after adjustment for exhaustion up to the close of 1933, would exceed $140,000, the amount realized. The land and building had a basis for gain or loss in his hands. But he did not dispose of that property, and he sustained no loss in regard to it. Even if there was a shrinkage in the value of that property, he would still not be entitled to any loss on that account. Thus, even if on some theory the petitioner might be entitled to a loss, nevertheless, he has failed to prove that in fact any loss was sustained. This lease cost the petitioner nothing and we must assume, in accordance with the Commissioner's determination, that it had no basis*964 in his hands for gain or loss. The payment of $140,000 which he received was income. Cf. Langwell Real Estate Corporation, 47 Fed.:2d) 841, reversing . The final argument of the petitioner is that if the $140,000 was income, it was capital gain rather than ordinary income. Capital gain is defined in section 101:c):1) of the Revenue Act of 1932 as a gain from the sale or exchange of capital assets. A sale or exchange involves a transfer of property in goods. Williston on Sales :2d Ed.), vol. 1, ch. 1. Here the lease was extinguished, not sold or exchanged. The lessee did not acquire any valuable asset but merely obtained a release from his liabilities under the lease. The Supreme Court has held recently in , that exchange within the normally accepted meaning of the words@ and the gain derived from the redemption of bonds is not a capital gain. Likewise, it has been held that the settlement of a note for less than its face value is not a sale or exchange and does not give rise to a capital loss. Hale v. Helvering, 85 Fed.:2d) 819. *965 Similar holdings have been made in regard to the voluntary surrender of a life insurance and annuity contract and in regard to liquidated damages for failure to perform a contract for the purchase of stock. ; ; . Cf. . Neither business men nor lawyers refer to the cancellation or forfeiture of a lease for a consideration as a sale or exchange. The $140,000 received by the petitioner is not capital gain but is taxable to the petitioner as ordinary income. Decision will be entered under Rule 50.