Marlborough House, Inc. v. Commissioner

MARLBOROUGH HOUSE, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. BONDHOLDERS COMMITTEE, MARLBOROUGH INVESTMENT CO., FIRST MORTGAGE BONDS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Marlborough House, Inc. v. Commissioner Docket Nos. 90452, 90486, 90487. United States Board of Tax Appeals 40 B.T.A. 882; 1939 BTA LEXIS 786; November 9, 1939, Promulgated *786 X corporation erected an apartment building in 1927 and issued its bonds in the amount of $500,000, secured by a mortgage on this property. In 1932 X defaulted on these bonds and a bondholders' protective committee was formed under a deposit agreement which gave it broad powers. This committee instructed the trustee under the mortgage to foreclose, and at the foreclosure sale the committee bid in, with the bonds deposited with it plus cash, the property for $340,425. Thereafter the committee held and operated the property for several months and later transferred it to a new corporation, which issued all its stock to the depositing bondholders of X. Held, these acts constituted a reorganization and the basis for depreciation of the property in the hands of the committee and the new corporation is the same as the basis in the hands of X, following Commissioner v. Kitselman, 89 Fed.(2d) 458, and Commissioner v. Newberry Lumber & Chemical Co., 94 Fed.(2d) 447; held, further, that the bondholders' committee was not a liquidating trust but was an association taxable as a corporation as to the income received by it while it held and operated*787 the property, and that since it failed to file any return of such income it was liable for an additional tax of 25 percent; held, further, that under the facts the building acquired by petitioners had an economic and useful life of 30 years from July 1, 1933, and the rate of depreciation should be fixed accordingly. Wm. Z. Kerr, Esq., and Harold L. Scott, C.P.A., for the petitioners. Edward C. Adams, Esq., for the respondent. KERN *882 These proceedings, consolidated for hearing, involve deficiencies in income tax liability. In Docket No. 90486, wherein Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds is petitioner, the deficiency is in the sum of $1,498.02, representing income determined by respondent to have been received by this petitioner during the period July 1 to November 20, 1933, inclusive, plus an additional tax of 25 percent for failure to file a return of such income. In Docket No. 90487, wherein Marlborough House, Inc., is petitioner, the deficiency determined by respondent is in the sum of $245.33 and involves the income tax liability of that petitioner for the period of November 1 to December 31, 1933, inclusive. *788 The same party is petitioner in Docket No. 90452, which involves a deficiency determined by respondent for the year 1934 *883 in the sum of $441.76 and for the year 1935 in the sum of $1,120.35. In the two proceedings in which Marlborough House, Inc., is petitioner those parts of the deficiencies are in issue which result from respondent's determination that the basis for depreciation of the property owned by petitioner is the price bid and paid for it at a foreclosure sale in 1933, and that the estimated remaining life of the property was 45 years. Petitioner claimed a greater basis and a shorter life for the property in calculating depreciation. In the proceeding in which the bondholders' committee is petitioner the deficiency results from respondent's determination that petitioner is not a liquidating trust, but is an association taxable as a corporation and, therefore, should be taxed at corporation rates on the income received by it from July 1 to November 20, 1933, and, furthermore, that having filed no return of such income it was liable for an additional tax of 25 percent as penalty. The same issue of basis and rate of depreciation is present in this proceeding. *789 Other issues presented by the pleadings in these proceedings were either not supported by any evidence at the hearing herein, and may therefore be considered as having been abandoned, or were expressly waived and conceded. FINDINGS OF FACT. Under date of May 20, 1927, the Marlborough Investment Co., a corporation, issued its bonds in the aggregate principal sum of $500,000, and to secure them executed a mortgage or deed of trust on certain real and personal property located in Seattle, Washington, being an apartment building known as the Marlborough House, together with the personal property situated therein, all of which it then owned. Default in the payment of these bonds occurred May 10, 1932, at which time the amount of outstanding bonds was $453,900. Shortly after the default a bondholders' committee was organized, consisting of William D. Perkins, W. O. Bulette, and Harvey Lantz, and a written "Deposit Agreement" was executed by the above three persons constituting the committee, in which the National Bank of Commerce of Seattle was designated as depository. The deposit agreement as a whole is incorporated herein by reference. One especially pertinent provision is*790 as follows: Section 2. Without derogation from the general powers hereby conferred upon the committee, the committee shall have power and authority to enforce, protect, discharge, collect, sue for, extend or adjust all rights at law or in equity attaching to said bonds and coupons thereto attached; to transfer any bond or coupon hereunder into its own name or the name or names of its nominees; to declare due and/or to request the trustee under said indenture to declare due the principal of any and all bonds, whether or not the same be deposited hereunder, and to revoke any such declaration; to dismiss and/or *884 request the trustee under said indenture to dismiss, upon terms satisfactory to the committee, any suit or proceeding instituted by the committee and/or said trustee upon said bonds or under said indenture, and/or against the company to waive any default or defaults by the company under the terms of said bonds or the indenture securing the same; to request the trustee under said indenture to make such waivers; to apply for or secure the removal of any trustee and/or the substitution of other trustees under said indenture; to appoint additional depositaries under*791 this agreement, and to remove any depositaries and appoint successors thereto; to purchase or settle at such prices as they deem proper any claims against the company; to pay or cause to be paid taxes and/or assessments on the property described in the mortgaged lease; to effect or continue insurance thereon; to borrow or advance money or give guarantees for the purpose of carrying out any plan adopted by the committee for the purpose of protecting the mortgaged property and/or the interests of the depositors, including the payment of taxes and/or assessments on the mortgaged property, costs of operation of the mortgaged property, or for the purchase of claims against the company, or for the exercise of any power hereby granted to the committee, or for the purpose of making, in the discretion of the committee, advances to the depositors upon deposited bonds and/or coupons or upon certificates of deposit, or for such periods and upon such terms and conditions as the committee may decide; to pledge the deposited bonds and/or coupons as security for loans which the committee may deem necessary or proper for the protection of the mortgaged property and/or the interests of the depositors; *792 to subordinate the lien of the indenture securing the deposited bonds to a new lien upon the mortgaged property for the purpose of borrowing and/or securing funds to protect the mortgaged property and the interests of the depositors; to pledge or sell any deposited bonds or coupons or the avails thereof, or any other property at any time coming into the possession or control of the committee for the payment of any money so borrowed or agreed to be paid or advanced by the committee or for the performance of any other obligation incurred by the committee hereunder, or for the payment of any expenses incurred by the committee hereunder, or for the securing of any guaranty given by the committee; to exchange the deposited bonds and/or coupons, in whole or in part, for other securities or property; to sell, redeem, surrender, pledge or in any manner charge the deposited bonds and/or coupons as part of any plan adopted by the committee for the protection of the mortgaged property and/or the interest of the depositors; to institute, defend or become parties to, compound, forbear, settle or conduct any legal proceedings at law or in equity; to file or prove with any receiver, court or referee*793 or committee, all or any part of the bonds and/or coupons deposited hereunder; to apply for receivers or the removal of receivers and for the termination of any receivership; to enter into arrangements for decrees or to facilitate or hasten the course of any litigation; to accept and waive notices of every character in legal proceedings or otherwise; to make requests or demands upon the trustee under the indenture securing said bonds; to consent to the issuance of receivers' certificates having priority over deposited bonds and/or coupons; to purchase any such certificates; to make and/or consent to such modifications in the indenture securing the bonds as the committee deems necessary and proper; to take such action as the committee deems necessary and proper to promote or to secure or prevent a sale of the mortgaged property upon foreclosure or otherwise; to prevent, to delay or to adjourn any such sale at its discretion; to bid or refrain from bidding at any such sale; to procure the organization of a new corporation or corporations, or to *885 adopt or use any existing or future corporations; to take, hold, subscribe, pay for or otherwise give value for the securities and*794 obligations of such corporation or corporations; to receive any new securities to be created and to vote upon the stock of any corporation now or in the future organized as part of any plan adopted by the committee for the protection of the depositors; to employ counsel, accountants, agents and assistants, and to pay the expenses thereof as part of the expenses of the committee, and to incur and discharge any and all expenses which the committee deems necessary and proper in functioning hereunder; to cause a new corporation to be formed to take over and/or acquire the mortgaged property, and to surrender and/or exchange the deposited bonds and/or coupons, in whole or in part, for all or part of the stock of such corporation upon such basis of exchange as the committee may determine. Bonds were deposited under the agreement to the extent of more than 97 percent of the whole. The holders of $441,100 of par value bonds came in under the deposit agreement, deposited their bonds thereunder, and authorized the bondholders' committee to act for them. The holders of $12,800 par value of bonds failed to deposit. Under date of August 15, 1932, the bondholders' committee in writing requested*795 the National Bank of Commerce of Seattle, the trustee under the trust deed and mortgage, to commence foreclosure proceedings because of the existing defaults in payments, and it did so on August 26, 1932. While the foreclosure proceedings were pending, a written stipulation was entered into between certain of the defendants in the action and the trustee bank, as plaintiff, under date of July 1, 1933, by which the parties consented to the entry of a decree of foreclosure, and by the further terms of which the record owners of the property, i.e., State Developers, Inc., a corporation, and Russell L. Cooley and Lillian A. Cooley, his wife, each executed and delivered a quitclaim deed to all the property in question in consideration of the payment of the sum of $10,025 cash. In these deeds the name of the grantee was left blank. The stipulation specifically authorized the plaintiff and/or its attorneys to insert the name of the grantee in the deeds. On September 28, 1938, the attorneys for the plaintiff, acting under the written authority conferred in the stipulation, filled in the name of Russell C. Perkins, trustee for the bondholders' committee, as grantee in each of the deeds*796 and on the same day Perkins, as trustee, executed and delivered a quitclaim deed covering all the property to Marlborough House, Inc., a corporation, which was organized by the bondholders on or about November 10, 1933, to take over and manage the property acquired by the bondholders at the foreclosure sale. By the stipulation, the defendants further agreed to turn over to the plaintiff or its nominees, on July 1, 1933, the possession of the *886 real and personal property involved. The bondholders' committee put up the money for the purchase of the property from the record owners and was made the nominee of the plaintiff, to whom the possession of the property was turned over. The committee appointed Russell C. Perkins its agent to collect the rents and pay the expenses of the general management of the building and to take physical possession of the building for the committee. Perkins, on the first day of July 1933, took physical possession of the property, and thereafter, until November 20, 1933, managed the property, collected the rents, and paid the expenses for the committee. After the passing of title to this property from State Developers, Inc., and Russell*797 L. Cooley and wife by the quitclaim deeds dated July 1, 1933, the foreclosure action was prosecuted to judgment and sale. The judgment and decree of foreclosure was entered in accordance with the stipulation and on the same date as the stipulation. The sheriff's foreclosure sale was held on the 30th day of September 1933, and the bondholders' committee was the successful bidder and purchaser. The sale was thereafter duly confirmed by the Superior Court having jurisdiction of the matter and thereafter the sheriff's certificate of purchase covering the property was made out to the bondholders' committee and was duly assigned by the committee on the back page thereof to Marlborough House, Inc. After the year of redemption had gone by and the property had not been redeemed the sheriff's deed to the property was issued directly to Marlborough House, Inc., assignee of the bondholders' committee. The bid price at the sheriff's sale submitted by the bondholders' committee was $340,425. This bid was accepted and the property was sold to the bondholders' committee. The purchase price was paid mainly by a surrender of the deposited bonds, the remainder by cash. The total amount of the*798 bonds deposited with the sheriff to apply upon the purchase price of the real and personal property was $441,100. The holders of the nondeposited bonds were paid in cash their proportion of the purchase price after deducting their pro rata cost and expense of the foreclosure, which resulted in a payment to them of 73.58 percent of the face value of their bonds. The reason the committee arrived at the bid price of $340,425 was twofold: First, the amount of the bid was governed to some extent by the amount of cash available for payment to the nondepositing bondholders, and, second, in the event of redemption of the property, the bondholders wished to assure themselves and adequate and fair return on their investment. Neither the fair market value of the bonds deposited with the committee plus the cash used by it in partial payment of the bid price nor the fair market value of the property sold was in excess of $340,425 at the date of the foreclosure sale or on July 1, 1933. *887 Subsequent to the passing of the title from the record owners by the quitchaim deeds dated July 1, 1933, the bondholders' committee made no attempt to sell the property, since, because of the severe*799 financial depression, there was no market for a sale. Marlborough House, Inc., after it was organized and took possession of the property, issued all of its stock to the bondholders of the Marlborough Investment Co. who had deposited their bonds with the committee. The steps taken by the bondholders' committee after the institution of the foreclosure suit and until the final vesting of title in Marlborough House, Inc., were pursuant to a plan of reorganization formulated by the committee for the benefit of the bondholders pursuant to the power granted to it by the deposit agreement. The basis for depreciation on the property in the bonds of the bondholders' committee and Marlborough House, Inc., was the same as in the hands of the Marlborough Investment Co., less the depreciation already taken by the latter. Bondholders Committee, the petitioner in Docket No. 90486, did not file an income tax return for any period. Marlborough House, Inc., the petitioner in Docket Nos. 90487 and 90452, at the time of filing its first return, included figures of gross income and deductions for the period between July 1 and December 31, 1933, which period covers the period of existence of*800 the bondholders' committee and the first period of existence within the year 1933 of the corporation. The committee was an association taxable as a corporation. The Marlborough Apartment Building is a modern 12-story apartment building of concrete, steel, and brick with two elevators, and was constructed in 1927. It contains approximately 81 apartments and 254 rooms. It is well constructed and probably is the best of its type as of the date of construction. As of July 1, 1933, it had an economic and useful life of 30 years. OPINION. KERN: The first issue to be determined in these proceedings has to do with the basis for depreciation of the property held by petitioners. The answer depends upon whether the acquisition by the bondholders of a corporation of the latter's property as a result of a foreclosure action, and the subsequent acquisition of the same property by another corporation organized for that purpose by the bondholders, constitute a reorganization within the meaning of the statute, so that the basis for depreciation of the property in the hands of the bondholders and later in the hands of the second corporation would be the same as the basis for depreciation*801 in the hands of the first corporation against which the foreclosure action was brought. *888 It is the contention of petitioners that there was such a reorganization. Respondent contends that there was no reorganization and that the basis for depreciation in the hands of the petitioners must be the amount bid for the property at the foreclosure sale. The rule applied by us until recently in similar cases was that the basis for depreciation in the hands of foreclosing bondholders and corporations organized by them for the purpose of acquiring the property foreclosed was either the fair market value of the property at the time it was sold on foreclosure, or the fair market value of the bonds used by the bondholders in payment of the price bid at the foreclosure sale. Suncrest Lumber Co.,25 B.T.A. 375; Newberry Lumber & Chemical Co.,33 B.T.A. 150. But in the case of Commissioner v. Kitselman, 89 Fed.(2d) 458 (certiorari denied, 302 U.S. 709), the Circuit Court of Appeals for the Seventh Circuit, in reversing our decision reported in *802 33 B.T.A. 494, held under similar circumstances that there was a reorganization as defined in section 112(i) of the 1928 Act. To the same effect is Commissioner v. Newberry Lumber & Chemical Co., 94 Fed.(2d) 447 (reversing 33 B.T.A. 150), decided by the Circuit Court of Appeals for the Sixth Circuit. In that case the precise question presented by the instant proceedings was considered and it was held that the basis for depreciation in the hands of the corporation organized by the bondholders to take over the assets upon foreclosure would be the same as that of the mortgagor corporation. In the cases of Lucien H. Tyng,36 B.T.A. 21 (affirmed on this issue, 106 Fed.(2d) 55), and Frederick L. Leckie,37 B.T.A. 252, we indicated our intention to now apply the rule laid down in Commissioner v. Kitselman, supra, and Commissioner v. Newberry Lumber & Chemical Co., supra. In one respect the instant proceedings differ from the Kitselman case and the Newberry Lumber & Chemical Co. case. The record here does not contain any evidence specifically*803 relating to a plan of reorganization. There is testimony as to the different steps taken by which the second corporation acquired title after the foreclosure proceedings and the bondholders of the first corporation became the stockholders of the second. There is also testimony to the effect that, since no market existed for the sale of the property, no attempt at liquidation was made by the bondholders upon foreclosure. The deposit agreement, which was put in evidence and under which the committee was created, grants broad powers to the committee such as are usual in corporate reorganizations, and makes several references to a "plan" to be adopted by the committee for the purpose of protecting the interests of the depositors. In other words, the record discloses a reason for a reorganization rather than a liquidation, *889 and also discloses the taking of steps usual in the most common type of reorganization. Cf. I.T. 2071, III-2, C.B. 34. As we said in William H. Redfield,34 B.T.A. 967, 973: "It is not necessary, however, that such a plan of reorganization be evidenced by a formal written document, such as a contract or corporate minutes. *804 It is sufficient if the circumstances indicate that the various steps taken were pursuant to a definite plan of reorganization." We can not doubt that under the circumstances present in these proceedings there was a plan of reorganization formulated by the committee and pursuant to which the steps were taken as disclosed by the record. Holding as we do that there was here a reorganization within the meaning of sections 112(a)(3) and 112(i), Act of 1932, it follows that the basis for depreciation in the hands of petitioners will be the same as that in the hands of the predecessor corporation, the Marlborough Investment Co., less the depreciation already taken by such predecessor. Sec. 113(a)(6), Act of 1932. The next issue has to do with the income received by the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds, petitioner in Docket No. 90486, while it was in possession of the property from July 1 to November 20, 1933. The double question is raised of who should have returned this income and the rate at which it should have been taxed. This income was reported in the return of the new corporate petitioner, but the committee made no return of any kind. *805 It is plain that this procedure was erroneous (see Chicago, Rock Island & Pacific Railway Co. v. Commissioner, 47 Fed.(2d) 990) and petitioners do not now contend otherwise. The petitioner Bondholders' Committee now contends, however, that it is taxable as a liquidating trust and not as a corporation, and that its failure to file a return was due to reasonable cause. Respondent, on the other hand, contends that the committee was an association doing business in an organized capacity, the net income of which was distributable to its members in proportion to the capital each had invested, and was, therefore, taxable as a corporation (see arts. 1312 and 1314, Regulations 77); and he further contends that an additional tax of 25 per centum is to be properly assessed against the committee because of its failure to file a return pursuant to section 291 of the Revenue Act of 1932. The pertinent cases relied on by petitioner are Broadway-Brompton Buildings Liquidation Trust,34 B.T.A. 1089, and Delese & Shepherd Co.,30 B.T.A. 1171. The pertinent case relied upon by respondent is Bondholders Protective Committee v.United States*806 (U.S. Dist. Ct., So. Dist. Calif., Nov. 16, 1938). Having held as we have that the acts of petitioners constituted a reorganization and that there was a plan of reorganization, we can not consistently adopt the view urged on us by petitioners that the *890 primary object of the committee was the liquidation of the property and not its transfer to a newly organized corporation. A careful reading of the deposit agreement convinces us that the primary object of the committee was to hold, manage, and operate the property after foreclosure and pending the organization of the corporation which would take over the property in consummation of the plan of reorganization worked out by the committee. There is nothing in the record to indicate that liquidation by selling the property on the market was ever contemplated or desired. The mere fact that the committee had an incidental power to sell which could have been exercised in the event the contemplated reorganization was unsuccessful does not persuade us that the activities of the committee constituted a liquidation. Since it was not a liquidating trust but an association meeting the tests laid down in *807 Morrissey v. Commissioner,296 U.S. 344, we hold that the Bondholders Committee, Marlborough Investment Co., First Mortgage Bonds was properly taxalbe as a corporation on the income received by it. Since the committee filed no return, it is liable for the additional tax of 25 per centum computed upon its taxable income, regardless of the reason for its failure to file such a return. Moulton Green, Trustee,24 B.T.A. 1121; Harry D. Kremer,31 B.T.A. 566. The next issue involves the proper rate to be applied in ascertaining the amount of depreciation to be deducted by petitioners for the taxable years. It is the contention of petitioners that the apartment building had an economically useful life of only 30 years after July 1, 1933, instead of 45 years as determined by the respondent, and that respondent, in applying a rate of depreciation determined by estimating a remaining life of 45 years, did not include a reasonable allowance for obsolescence as required by section 23(k) of the Act of 1932 and section 23(l) of the Act of 1934. Two witnesses testified as experts on behalf of petitioners. *808 They were familiar with the history of apartment house values in the city of Seattle and were familiar with the general location and general construction of the apartment house building owned by petitioners. Their testimony was that such an apartment building had a useful life of from 30 to 35 years, and they justified their conclusion by relating case histories of other apartment buildings of similar type and location which had lost their value within such a period by reason of the construction of newer apartment buildings better and more suitably arranged with more modern plumbing and equipment, and also by reason of the shifting of regions thought desirable for apartment buildings. They further testified to the effect that the economic and useful life of an apartment building was not as long as that of an office building because of the former's continuous use throughout the full day. While this evidence was, as *891 respondent points out, rather general in its scope, it nevertheless embraced and definitely referred to the property in question, and since it is uncontradicted and we have no special knowledge on our own part which would justify its rejection, we can not disregard*809 it. Pittsburgh Hotels Co. v. Commissioner, 43 Fed.(2d) 345, and cases there cited. Therefore, we must conclude that the apartment building owned by the petitioners had an economic and useful life of 35 years after it was constructed in 1927. Since under the pleadings the petitioners claim depreciation calculated on a basis of a useful life of the property of 30 years from July 1, 1933, we have made our finding to that effect. The rate of depreciation will be determined accordingly. Petitioners have, apparently, abandoned the issues having to do with accrued interest on bonded indebtedness and accrued taxes. No evidence was adduced to substantiate the assignments of error in regard thereto which were set out in the petitions. The determination of the respondent as to these issues is affirmed. Petitioners concede that the allocation of the basis for depreciation as between real and personal property is correctly made by respondent. They also concede that the rate used as to the personal property is correct. Reviewed by the Board. Decision will be entered under Rule 50.