Regals Realty Co. v. Commissioner

REGALS REALTY COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Regals Realty Co. v. Commissioner Docket No. 96360. United States Board of Tax Appeals 43 B.T.A. 194; 1940 BTA LEXIS 835; December 31, 1940, Promulgated *835 Decision of petitioner, recorded almost simultaneously with the receipt of property on an "exchange", to sell the property and liquidate, held to show property received was not "to be held * * * for investment" by petitioner as required by the taxpostponing provisions of section 112(b)(1), Revenue Act of 1936, and the value of the property received is therefore to be included in petitioner's gross income. Richard P. Jackson, Esq., and Leland T. Atherton, Esq., for the petitioner. Z. N. Diamond, Esq., for the respondent. OPPER *194 This proceeding was brought for a redetermination of deficiencies in petitioner's income and excess profits taxes for the year 1936 in the amounts of $64,076.74 and $26,923.49, respectively. At the hearing respondent claimed an increased deficiency and a motion was granted to amend the pleadings to conform to the proof. The case involves the tax consequences of transactions in Florida real estate. The questions are (1) whether one of the transactions was within the limited recognition provisions of section 112(b) and (c) of the Revenue Act of 1936; (2) whether the amount of a mortgage on the property*836 should be treated as "other property" within the meaning of that term as used in section 112(c)(1); and (3) what was the proper cost basis to petitioner of the property it transferred. By the petition the constitutionality of section 14 of the *195 Revenue Act of 1936 is challenged. On briefs petitioner does not discuss or urge this issue and we shall consider it as now abandoned. FINDINGS OF FACT. Petitioner, a corporation organized under the laws of Florida on April 15, 1933, has its chief place of business at No. 20 West Forty-third Street, New York, New York. Its certificate of incorporation provides that its authorized capital stock is to be 50 shares of no par value; that the number of its directors shall be three; and that the amount of capital with which it will begin business is $500. On March 15, 1933, in New York City the trustee in bankruptcy of the Cigar Store Realty Holdings, Inc., a subsidiary of the United Cigar Stores, offered for sale certain property, including property located on the southeast corner of Flagler Street and Miami Avenue, Miami, Florida, (known as 2-10 East Flagler Street and the Biscayne Hotel property (hereinafter sometimes referred*837 to as 2-10). The property was improved by a three-story brick and steel building and was surrounded by the Burdine Department Store (hereinafter referred to as Burdine). 2-10 was offered for sale by the trustee in bankruptcy, subject to liens, encumbrances, and leases thereon. At the date of the sale there was a delinquent mortgage on the property held by the Metropolitan Life Insurance Co. in the principal amount of $178,250, bearing interest at 7 percent per annum. Unpaid taxes were also outstanding. The United Cigar Store lease had four years yet to run. At the trustees' sale Leonard Marx, bidding in the name of petitioner, bought the property on a competitive bid of $750. The sale was confirmed by the referee in bankruptcy on March 22, 1933. Initially, petitioner was referred to as the "Regalf Realty Company", but the change to the present name was effected before the delivery of the deed. Pursuant to the sale and confirmation, a deed dated March 24, 1933, transferring the property from the trustee in bankruptcy to petitioner was delivered to petitioner on April 19, 1933. Petitioner was organized only a short time before the deed was delivered. The closing statement*838 for the sale was executed by the purchaser as follows: Regals Realty Company, By Leonard Marx, Vice President. The deed was recorded on June 8, 1933, in Dade County, Florida, in Deed Book 1526 at page 510. Marx had been in Miami in 1931 to look around and familiarize himself with the town. He did not, however, become interested in 2-10 until 1932. Marx looked over the leases on the properties that were advertised in the Inited Cigar Stores sale and discussed them. *196 He went over the occupancy records, the rentals, and street maps. He did not examine the appraisal reports of the appraisers in bankruptcy because he was not interested in them and he did not ascertain the assessed value of the property for tax purposes. He ascertained the rentals from the leases on the property and knew they were not sufficient to make it a paying property. At the time of the trustees' sale, in addition to Marx, Milton M. Silverman and Eugene S. Mindlin were interested in the transaction. Silverman was employed by the Marx Realty & Improvement Co. in New York, which was controlled by Marx at all times. At the time of the transaction Silverman had not seen the property and*839 did not know the figure at which it ahd been appraised in the bankruptcy proceeding. He did not know what liens were on it, the leases or the rents or whether the lessees would agree to higher rental. He knew that Marx' customary practice was to organize corporations to take and hold properties to be acquired and was satisfied to have the property held and owned by a corporation. On April 15, 1933, Marx transferred a subscription of stock in petitioner to each of the following: Relmar Holding Co. (Marx' interest) Milton M. Silverman & Sons, Inc. (Silverman's interest) Eugene S. Mindlin. No shares of petitioner's stock were in fact issued until March 27, 1934. It had no bank account prior to that date. Funds were advanced to it by Joseph E. Marx Co. On April 17, 1933, these assignee subscribers held the first meeting of petitioner and adopted minutes reciting the presence of the assignee subscribers and concluding: That the undersigned, being all the incorporators named in the certificate of incorporation of Regals Realty Co., and all the subscribers to the capital stock thereof, do hereby waive all notice of the first meeting of the incorporators and subscribers*840 to the capital stock of the said corporation, and do hereby agree and consent that the 17th day of April, 1933, at 10 o'clock in the forenoon, be and the same is hereby fixed as the time, and the New York office of the corporation at No. 347 Madison Avenue, in the Borough of Manhattan, City of New York, as the place for holding the same; that all sucu business may be transacted thereat as may lawfully come before such meeting. Dated 17th day of April, 1933. [Signed] LEONARD MARX, MILTON M. SILVERMAN, E. S. MINDLIN. Under date of April 21, 1933, a letter requesting the transfer of fire and tornado insurance policies to petitioner, with the proper endorsements and the forwarding thereof to the Metropolitan Life Insurance Co. was signed "Regals Realty Co., Inc., E. S. Mindlin." *197 Mindlin was then petitioner's secretary. Pursuant thereto the insurance policies on the property were transferred to the name of petitioner. The owner endorsement on the mortgagee clause was in the name of petitioner. On October 14, 1933, a contract of employment was entered into with an architect named Bruce, for the remodeling of part of the property. The agreement was executed: *841 Owner Regals Realty Co., Inc. Leonard Marx President. On October 18, 1933, a contract for alterations on the property was entered into with Henry Hunt, Inc., and was executed in the name of petitioner. The alterations and repairs were completed in January 1934. On October 23, 1933, a contract was entered into with the Keyes Co. of miami for the management of the property and was: Agreed to by: Regals Realty Co. by Leonard Marx. The Keyes Co. immediately following its appointment to manage the property, made efforts to secure new tenants. On October 31, 1933, it transmitted to petitioner two leases drawn between petitioner and certain proposed lessees. By letter dated November 6, 1933, petitioner acknowledged receipt of the leases and stated: As soon as we have anything closed in New York for any of the stores, we will wire you immediately. Unless and until you hear from us, you can go ahead with any deal which you have in mind. Very truly yours, REGALS REALTY CO. INC. At the time of the acquisition of the property in April 1933 by petitioner the property was not on a paying basis and Marx and his associates knew that fact. The lease to United was*842 at a rental not sufficient to pay even the interest on the mortgage. In order to forestall any thought in the minds of the officers of the Metropolitan Life Insurance Co. that petitioner was endeavoring to "milk the property," it gave its rent collector in Miami instructions to pay all income directly to the insurance company. The corner store was leased to the United Cigar Stores Co. on a low percentage lease. One of Marx's chief efforts in the period following the acquisition of the property was directed to securing a modification of the United lease. The modification or cancellation of the United lease was regarded as necessary for putting the property on a paying basis. Marx did not know at the time the property was *198 acquired whether it would be possible to secure a modification but felt that this could be done because he had obtained a modification of a United Cigar Store lease on property in Auburn, New York, in 1932. The United lease was junior to the Metropolitan mortgage and in July 1933 petitioner regarded foreclosure as a necessity because of the United lease. At that time it regarded the situation with respect to the property as so uncertain that it*843 was inadvisable to discuss permanent leases with the tenants. On the same date, petitioner instructed its Miami attorney to delay the progress of the foreclosure action as best he could. Similar instructions were given in August 1933. Meanwhile, following the acquisition of title, Marx went to see a representative of the Metropolitan Life Insurance Co. in April 1933, with a plan to make extensive alterations in the property and to pay up arrears in taxes. He was advised that the interest due on the mortgage would have to be paid immediately; that the taxes would have to be taken care of; and that the company would not reduce its interest rate or change the mortgage. Marx was of the opinion that "to attempt to comply with their requirements would mean an investment on our part of over $40,000, in a building which will not even at projected higher rents yield sufficient money to pay the interest called for under the mortgage." Marx had further negotiations with the mortgagee in which petitioner offered to pay the delinquencies in interest and taxes. In October 1933 petitioner was successful in securing a modification of the United lease. At that time foreclosure proceedings*844 were already in process and Marx used the fact that the United lease would be wiped out if the property went to sale as an additional inducement to secure the consent of United to the modification. Pursuant to the agreement of modification petitioner on April 1, 1934, paid United Cigar Stores $4,000 for the right of canceling the lease as of that date. While the foreclosure proceedings were pending petitioner entered into the contracts with Bruce and Hunt for alterations and repairs, and they performed thereunder. Petitioner filed no Federal income tax return for 1933. The Relmar Holding Co. (Marx) reported in its return for 1933 an amount purporting to be its portion of income from the operation of 2-10, under an alleged beneficial ownership. In order to avert the foreclosure and to complete the alterations, approximately $50,000 in cash was needed, which was more capital than Marx and his associates were willing to put into the property. To attract new capital a prospectus was prepared by the Marx Realty & Improvement Co. and issued in January 1934, in which it *199 is stated that: "The Regals Realty Co., the present owners, purchased the property from the Trustee*845 in Bankruptcy of the Cigar Stores Realty Holdings, Inc." The prospectus described the alterations in progress, presented an analysis of the rental value, gave a list of prospective tenants and estimated the prospective rental at $39,180. Expenses were estimated at $12,718.55, with an estimated net profit "as if free and clear" of "$26,462.45" [sic] per year. The "financial set-up" was stated as follows: The present amount of the first mortgage is $178,250. Arrears in taxes and interest and the cost of completing the alterations together with a small amount of working capital total approximately $50,000, as follows: Tax arrears $18,500 Due mortgagee net 21,000 Balance for completion of alterations and working capital 10,500 TOTAL $50,000 The corporation has been organized with 50 shares of no par value common stock to be sold at $1,500 a share. 16 2/3 shares will be paid to Joseph E. Marx Company, Inc. and their associates for their ownership of the property, balance of 33 1/3 shares are to be subscribed for in cash. An 8 year extension of the mortgage can be secured with 7% interest and amortization of $3,600 semi-annually, but the syndicate*846 will not proceed unless Metropolitan gives a mortgage at 6%. Mr. John Nicholas has subscribed to 6 2/3 shares and the Joseph E. Marx Company, Inc. and their associates have agreed to subscribe to the unsubscrobed shares not to exceed 10 2/3 shares. The prospectus concludes with a summary in which it is stated: "This property is in our opinion the outstanding real estate investment for development in the United States." In January of 1934 Marx caused an advertisement to be inserted in a Miami newspaper with reference to 2-10 as follows: Owner Offers The Proposition Is Opportunity For Both a Sound An Investor To Investment and Make An Investment Has Good Speculative Of $30,000. Possibilities. PRINCIPALS ONLY BOX M-184, MIAMI HERALD Marx' efforts to secure the required fund succeeded some time between January and April 1934. On March 27, 1934, petitioner wrote a letter to the Metropolitan Life Insurance Co., purporting to confirm a conversation of March *200 26, 1934, in which petitioner offered to cure the default in the mortgage in accordance with a proposal outlimed in the letter, which was in substance as follows: (a) Petitioner would*847 immediately pay the default, including the costs of the foreclosure suit. (b) Petitioner would complete within 60 days alterations then in progress upon the property. (c) Metropolitan Life Insurance Co. would extend the mortgage for a period of five years from maturity, said maturity being October 1936. (d) Metropolitan Life Insurance Co. would agree for the period of extension to reduce its interest rate from 7 to 6 percent, petitioner agreeing that the mortgage should continue at the 7 percent rate until its maturity on October 1, 1936. There was to be no amortization on the mortgage until its maturity, and thereafter it would be amortized at the rate of $5,500 annually. (e) As a token of petitioner's sincerity a certified check for $10,000, conditioned upon the acceptance of the proposal, was enclosed. This was duly accepted. On March 27, 1934, the books of petitioner record the issuance of shares of its capital stock upon the following basis: 8 1/2 shares to Relmar Holding Company [Leonard Marx] 4 1/3 shares of which were purportedly issued for cash and 4 1/6 shares were purportedly issued "in exchange for our interest in the Relmar Holding Company's interest*848 in the original equity in the property in Miami, Florida, 2-10 E. Flagler Street." 4 1/4 shares to Eugene S. Mindlin, of which 2 1/6 shares were purportedly issued for cash and 2 1/12 shares were purportedly issued "in exchange for his interest in the original equity in the property in Miami, Florida." 4 1/4 shares to Milton M. Silverman and Sons, Inc. [Milton M. Silverman], 2 1/6 shares of which were purportedly issued for cash and 2 1/12 were "exchanged for his interest in the original equity." The entries accordingly reflected the issuance of 17 shares to Marx, Mindlin, and Silverman. The remaining 33 shares were issued for cash. John Nicholas, who had subscribed to 6 2/3 shares of petitioner's stock by January 1934, became the owner of about 30 percent of such stock. Marx, Mindlin, Silverman, and Nicholas owned a majority of petitioner's stock and were at all times in control of petitioner. Petitioner paid the back interest on the mortgage and the back taxes from the cash it received from the issuance of stock in March 1934. Thereafter, and after the cancellation of the United Cigar Stores' lease, petitioner proceeded with alterations and rented stores to the A. *849 S. Beck Shoe Corporation and Robin Redbreast Hosiery Co. *201 On July 11, 1934, petitioner transmitted to Mindlin its check for $1,353.78, "which represents your original investment in the old Regals Realty Company and your profit on this transaction." The letter was accompanied by a statement showing receipts and disbursements of petitioner for 1933. The statement shows receipt by petitioner on May 15, 1933, of the sum of $229.66 identified as "M. N. Silverman & Sons, Inc., Investment 24 1/2 percent." It likewise shows receipt by petitioner on May 19, 1933, of the sum of $239.03 as an investment by Eugene S. Mindlin representing 25 1/2 percent. In September 1935 petitioner paid a dividend of $100 per share and on April 1, 1936, another dividend of $100 per share, it being the policy of the company to pay out as dividends all available cash. On October 9, 1934, in reply to a letter of inquiry, petitioner wrote to the Crow-Dodd Newman Co. of Miami, Florida, that "while the Biscayne Hotel property [2-10] is not being offered for sale, it may be that the members of the owning corporation would consider an offer of sufficient size." On March 8, 1935, Crow-Dodd Newman*850 Co. made further inquiry as to a price for 2-10 and Marx, on behalf of petitioner, replied under date of March 12, 1935, that he did not know what the shareholders would be willing to consider an adequate price for the property but that he had recently turned down an offer of $350,000. He stated further: "While I do not think that the property is on the market, I certainly would not be the one to hold back any offer which might be submitted to us." On March 19, 1935, Marx refused offer submitted. H. H. Trice & Co., by letter dated January 3, 1936, offered to buy 2-10 and petitioner replied by letter dated January 7, 1936, "that this property is not for sale." By letter dated March 21, 1936, Holopeter & Post, Inc., offered to purchase 2-10 and petitioner advised by letter dated April 1, that "this property is not now on the market" and offered to lease them stores in the property. On April 2, 1935, Marx sent to the stockholders a report for the period ending December 31, 1934, stating in part: The property is now operating on a paying basis. Funds on hand are adequate to meet the requirements of the business and it is my hope that the Directors will see fit in the near*851 future to put the stock on a dividend basis. Efforts have been made and are being made to market the property, but as yet we have been unable to secure an offer at a satisfactory price. On about August 31, 1935, petitioner paid off the $178,250 mortgage held by the Metropolitan Life Insurance Co. with the proceeds of a loan of $180,000 made to petitioner by the Equitable Life Assurance Society. In connection with the loan, petitioner executed its mortgage note to the Equitable under which it promised and agreed to pay the amount of $180,000 with interest at 5 1/2 percent for *202 the first year and 5 percent thereafter for the term of the loan, and to pay the sum of $5,400 a year, semiannually, on the principal. The note was secured by a mortgage on the property. In connection with the loan, Equitable required petitioner to furnish an abstract of title. The abstract of title thus furnished showed that petitioner acquired full fee simple title to the property by the deed from the trustee in bankruptcy in April 1933 and contained no reference to any other means or manner of acquiring title. In the early part of 1936 representatives of the Burdine Department Store*852 negotiated with Marx for the purchase of 2-10 on the basis of paying $600,000 for the property free and clear of all mortgages. Although a definite offer of this amount was not made, Marx felt that if he had indicated such figure would be accepted he could have obtained this offer. Marx called a meeting of petitioner's stockholders. He explained to them that if the offer of $600,000 in cash were accepted and the property sold they would get a large amount of taxable income and after payment of Federal income taxes they would be left a sum less than $200,000. They examined the offer in the light of the question of individual and corporate income tax liability and the possibilities of reinvestment and decided to reject the offer. Some time later a suggestion was made by a representative of Burdine that if petitioner were willing to accept, as part payment for 2-10, property at 26 East Flagler Street recently purchased by Burdine, petitioner would only have to pay taxes on the cash received. Marx asked his bookkeeper about the validity of the suggestion and requested him to look up the tax law involved. He found section 112(b)(1) and Marx and the bookkeeper thought that the suggestion*853 would fit into that section. Marx thereupon called an official meeting of petitioner's stockholders to be held in New York City on July 2, 1936. At the meeting the stockholders considered the new offer made by Burdine, which was 26 East Flagler and $120,000 cash, and the net proceeds available to them after giving effect to section 112(b)(1). The discussion included the question of the effect of an expressed assumption by Burdine of the Equitable mortgage, although Burdine had not offered to assume the mortgage. Marx informed them that 26 East Flagler was leased to S. H. Kress until 1938 for $12,000 a year and that he thought it could be leased again for at least that much; that it was a higher traffic spot than 2-10; and that he thought the proposal excellent. The stockholders decided to accept the new Burdine offer. The property at 26 East Flagler was 50 feet from 2-10 and used for retail merchandising. It was worth $300,000 at the time of the exchange. Burdine was at one time willing to assume the Equitable mortgage as part of the consideration for the transfer to it of 2-10. *203 The property was transferred subject to the Equitable mortgage. It was understood*854 and expected that Burdine would make the future payments on the mortgage. At the time Burdine acquired 2-10 interest was due on the Equitable mortgage from February 1 to July 20, 1936, the date of settlement, in the amount of $4,950. This amount was paid by Burdine and a credit therefor was given it at settlement against the purchase price of the property. Petitioner never made any payments on the mortgage indebtedness after the transfer to Burdine and was never davised of any default. It never made any inquiry after the transfer to ascertain the status of the mortgage indebtedness. So far as it is aware, the mortgage indebtedness is still outstanding and a deficiency judgment thereon is still a possibility. Liquidation of petitioner has been completed. The new property at 26 East Flagler Street was acquired by petitioner by deed from the Burdine Realty Corporation dated July 29, 1936. Affixed to the deed were Federal documentary stamps in the amount of $300. 2-10 was acquired by Burdine by deed from petitioner dated July 20, 1936. Affixed to this deed were Federal documentary stamps in the amount of $420. Petitioner also received the $120,000 cash. The Marx Realty*855 & Improvement Co. was paid a $15,000 commission on the transaction. Other than the transactions above noted, petitioner did not at any time negotiate purchases or sales of any property, nor did it purchase or sell any other property, or act as broker. On August 10, 1936, at 3 p.m., a special meeting of petitioner's directors was held in New York City. It was voted that petitioner be put into liquidation promptly by distributing as quickly as possible all the available cash and that petitioner should sell its remaining asset, namely, 26 East Flagler, the proceeds of such sale to be distributed to petitioner's stockholders, and that a cash "liquidating" dividend of $2,000 per share, payable August 15, 1936, be paid to stockholders of record on August 10, 1936. This action of petitioner's directors was approved by its stockholders at a special meeting held in New York City at 4 p.m. on the same date. The phrasing of the minutes adopted for the stockholders' meeting was prepared and furnished by the attorney for petitioner and the stockholders for the purpose of avoiding tax on the profit of the sale of the 2-10 property which would have resulted from its distribution as an*856 ordinary dividend. During 1936 the following offers to buy 26 East Flagler Street were received: (a) On September 14, Miller-Weil, Inc., wrote to Marx offering to buy 26 East Flagler and Marx, on behalf of the Marx Realty & Improvement Co., which was the manager of the property, replied by letter stating that "this property is not for sale." *204 (b) On August 11, Mayer Spiesberger telegraphed Marx, asking for the lowest cash price for which the property would be sold, and petitioner telegraphed a reply on the same date stating: "No price has been put on building as yet." (c) On August 19, Spiesberger wrote Marx inquiring the best price for a 21-year net lease on the property. Petitioner replied by letter dated August 24, stating that they did not believe they would do anything with the property until they had an opportunity to examine it during the coming winter; that they were not quoting any price on a 21-year lease because of the large security which would be required and their desire not to have other people speculate with their property. The letter concluded: "We have not as yet put any selling price on the property." (d) In 1936 Michael Sientz, who was in*857 charge of the United Cigar Stores real estate for the territory covering Maine to Florida, discussed the property at 26 East Flagler Street with Marx, inquiring whether it was for sale or lease. Marx declined to discuss it until he had a chance to go to Miami and look the property over. Marx went to Miami in the winter of 1936-1937 and on his return told Sientz that they were going to hold the property. During 1937, 26 East Flagler was leased to the Woolworth Co. through Siedenbach for a term of 32 years and one month at a net rental of $30,000 per year, commencing March 1938. Woolworth, in turn, leased the property to the Lerner Stores, who are now in possession. After the lease to Woolworth had been made in 1937, Siedenbach discussed the purchase of the property with Marx several times and each time was told that the property was not for sale but he persisted in asking. During 1938 and 1939, the 26 East Realty Corporation considered and rejected several offers for the purchase of the property. At a meeting of petitioner's directors held February 10, 1937, its president reported that in accordance with the plan of liquidation of the company, he had been endeavoring*858 to sell the remaining piece of Florida real estate owned by the company at 26 East Flagler Street, but that he had been unsuccessful in finding a purchaser and decided that apparently the time was not propitious for the sale of the property. He suggested that the property be sold to a new company "in the process of formation" for 100 shares of the capital stock of that corporation. Upon motion duly made and seconded it was unanimously resolved that petitioner sell 26 East Flagler by warranty deed to the 26 East Flagler Street Corporation for 100 shares of its capital stock. *205 During 1937, 26 East Flagler was transferred to the 26 East Realty Corporation for stock of the latter, which stock was subsequently distributed in liquidation to petitioner's stockholders, and is still held by them or by members of their families to whom they sold it. At the last above mentioned meeting, petitioner's president presented the profit and loss statement and balance sheet of the company for the year ended December 31, 1936, and these were duly approved by petitioner's directors. On March 5, 1937, pursuant to authorization by petitioner's board of directors, the following statements*859 of assets and liabilities and of profit and loss were sent out to petitioners' stockholders: REGALS REALTY CO. STATEMENT OF ASSETS, LIABILITIES AND CAPITAL December 31, 1936 ASSETS: Land $120,000.00 Building 180,000.00 $300,000.00 Cash in Bank 7,030.32 TOTAL ASSETS $307,030.32 LIABILITIES: Notes Payable to Stockholders (distributed as a dividend) 10,000.00 Federal Taxes for 1936 15,982.64 25,982.64 Deferred Profit on Sale of Real Estate 237,148.11 Reserve for Depreciation 1,500.00 CAPITAL: Capital Stock $60,000.00 Less Liquidating Dividend Cancelling 25% of Stock 15,000.00 (represented by 50 shares no-par value) 45,000.00 Surplus - Jan. 1, 1936 1,453.65 Profit for Year 111,928.56 TOTAL SURPLUS 113,382.21 Less: Ordinary Dividend $5,000.00 Balance of Liquidating Dividend 95,000.00 100,000.00 NET SURPLUS 13,382.21 Provision for Federal Taxes - 1936 15,982.64 2,600.43 $307,030.32 REGALS REALTY CO. PROFIT AND LOSS STATEMENT FOR THE YEAR ENDING December 31, 1936 Rental Income $29,383.86 Miscellaneous Income 561.14 TOTAL OPERATING INCOME $29,945.00 Operating Expenses 18,286.51 OPERATING PROFIT $11,658.49 Depreciation and Amortization of Lease and Mortgage Expense 4,729.93 OPERATING PROFIT AFTER CHARGES $6,928.56 Profit on Sale of Real Estate $342,148.11 Deferred Profit on Real Estate 237,148.11 APPLIED PROFIT ON REAL ESTATE 105,000.00 TOTAL INCOME BEFORE FEDERAL INCOME TAX $111,928.56 Federal Tax Liability Thereon 15,982.64 NET PROFIT AFTER FEDERAL TAXES $95,945.92 (Equivalent to $1,919 per share) DIVIDENDS PAID: Ordinary Dividends, $100. per share $5,000. Liquidating Dividends, $2200. per share 110,000. TOTAL DIVIDENDS PAID $115,000. (of which $105,000. was in cash and $10,000. in the Corporation's notes) *860 *206 Petitioner did not acquire 26 East Flagler to be held by it for productive use or for investment. The cost basis to petitioner of 2-10 is made up of the following items and expenditures: [1933] April 20 United Cigars Store Co. - on closing $435.41 28 L. Marx - Bid payment 187.50 28 L. Marx -Traveling Expenses 403.55 Oct. 17 Burdine, Terry & Fleming - re: Foreclosure 100.00 18 George Bruce: Architect 60.00 9 L. Marx 417.49 Dec. 29 George Bruce: Architect 40.00 [1934] Feb. 3 Leonard Marx 320.19 [1933] Oct. 28 Henry Hunt, Inc. (Construction) $100.95 Nov. 4 Henry Hunt, Inc. (Construction) 163.07 25 Henry Hunt, Inc. (Construction) 837.06 Dec. 2 Henry Hunt, Inc. (Construction) 1,400.00 [1934] Jan. 24 George Bruce (Architect) $50.00 2,551.08 Check Tax & Bank Charge 2.12 $2,553.20 Jan. 22 Price & Zaring - Legal - conferences, etc 160.00 22 Henry Hunt, Inc. on a/c - Construction 700.00 23 Henry Hunt, Inc. final 175.00 $5,552.34 $5,552.34 [1934] April 6 Mortgage interest in arrears 20,174.66 Attorney's fees 2,000.00 Taxes 13,585.87 Taxes 5,094.85 Abstract of Title 56.00 40,911.38 Amount of Metropolitan Life Insurance Company mortgage 178,250.00 $219,161.38 Cost of Improvements 10,204.87 Capital and deferred expenses 10,810.14 $240,176.39 Less Depreciation Allowable from Mar. 1934 7,324.50 $232,851.89 232,851.89 $238,404.23 *861 *207 OPINION. OPPER: The first question is whether the "exchange" of petitioner's real property for other property of a "like kind" was such as to result in postponement of the gain, not received "in cash or other property", within the terms of the Revenue Act of 1936, sections 112(b)(1) 1 and 112(c)(1). 2 On this issue the single question is the applicability of these provisions, since in their absence the entire *208 gain realized was unquestionably taxable in the year the transaction took place. *862 Without pausing to consider whether the original property was held for productive use or investment, whether the transaction was an exchange, and whether the property acquired was of like kind, it is sufficient for our present purposes to examine the remaining requirement which must be met. All of the aspects just described are insufficient to invoke the provisions of 112(b)(1) unless the property received is also "to be held either for productive use in trade or business or for investment." Unless petitioner has sustained its burden of proving the existence of that prerequisite, it can not be said to have brought itself within the situations there described. The evidence shows that an offer of the same vendee to buy the property for an entirely cash consideration had been rejected a short time previously, after an examination of the extent to which the profit would be subject to Federal corporation and individual income tax; and that the substituted proposal for exchange was not considered favorably until the provisions of 112(b)(1) had been observed and the arrangement made such that it was thought it would fit that section. An exact compliance with statutory requirements*863 may suffice, even in the presence of an apparent motive to escape taxation. See . But in such circumstances we are commended to the strictest scrutiny to ascertain whether in fact that meticulous observance of the statutory formula undeniably appears. In this case the task of thus scrutinizing the action taken is complicated by the character of the particular requirement to which we are directing our attention. It is necessary for us to find that the property was "to be held" for investment. This in our view imports the existence of an intent or mental condition on the part of the holder, 3 so that for our decision to be favorable to petitioner we must be satisfied that its mental state was such that it intended to hold the property received as an investment. 4 Such a motive would in itself be inconsistent with a finding that the real intention of the taxpayer had been to arrange an outright sale of property for cash, but that for tax purposes it had been compelled to create the appearance *209 of a tax-free exchange. *864 For, if the latter is the case, an intention to sell the substituted property for cash as soon as possible in order to achieve the final result originally desired would be more consistent with the underlying purpose than that the new property was also an investment venture. Even an asserted intention of that kind, if such were present here, which it is not, "means little in view of the evidence that the plan was conceived and executed to avoid the tax on that very ground. The whole transaction seems to us to have been artificial in the sense that, given no tax problem, it would almost certainly have been carried out in another way." . That is not to say, of course, that the taxpayer's*865 intention to hold the property as an investment would have been impossible, particularly if it had recognized that such an intention was a part of the procedure through which it must pass to obtain the tax benefits it sought. But that that is not the fact in the present proceeding seems to us to appear conclusively from the contemporaneous declarations of those responsible for petitioner's actions. The deed conveying the property which petitioner received was dated July 29, 1936. On August 10, 1936, at a special meeting of petitioner's directors, it was decided to liquidate petitioner promptly, and in connection therewith to sell the real estate which had just been received and to distribute the proceeds of that sale to complete the liquidation. On the same day this course of action was approved by petitioner's stockholders. It places an unbearable strain on the credulity to believe that under those circumstances the property acquired was "to be held" for investment. The action thus taken is the nearest one in point of time to the exchange itself. It is for this reason the most significant as to the intention with which the new property was acquired. That the property was not*866 thereafter sold for cash may have been due to numerous reasons, among them the possibility that inquiring purchasers were not considered satisfactory; that the price offered was thought to be insufficient; or that, as petitioner's representative telegraphed to an inquirer on the day following the meeting, "no price has been put on building as yet." Nothing of this kind is as persuasive in determining the motive with which the new property was acquired as the action of petitioner's directors and stockholders upon the consummation of the exchange. Far from sustaining petitioner's burden of proof of compliance with the requirement of section 112(b)(1) that the property received was "to be held either for productive use in trade or business or for investment", the evidence demonstrates affirmatively the reverse. Petitioner contends that an intention to transfer the new property for cash can not reasonably be imputed to it, since the effectuation *210 of such an intention would have the result of eliminating the possibility of any tax reduction. Its argument is that if the new property were thereupon sold for cash, gain on that sale would not be postponed and the total amount*867 realized on the exchange and the sale would be immediately taxable to it. We assume that implicit in this contention is the thought that, petitioner being a corporation and not subject to individual surtax rates, the rates of tax would be the same whether it sold the entire property for cash in one year or received only part cash in one year and the balance in property and sold the exchanged property for cash in the next. This would presumably be true if the normal tax rates on petitioner as a corporation were the limit of our consideration or were the limit of the consideration of petitioner's stockholders and managers. But if we assume that they had in mind the "undistributed surplus tax" provisions of the Revenue Act of 1936 and were aware that the taxable proceeds of any sale would have to be distributed to the shareholders in the year of receipt in order to obtain the benefit of the dividends-paid credit, and if the shareholders, being in the upper tax brackets, 5 preferred to have such a distribution made in successive years rather than all at once, a sufficient motive might have existed for the treatment which we know to have been adopted. Of course such a consideration*868 of possible motives is the purest speculation and we indulge in it only because of petitioner's insistence that there could have been no tax-saving motive for the procedure which we have found petitioner selected. *869 Petitioner contends further that the intention should be gauged by what was actually done rather than by the expression of that intent. We are not persuaded that this is correct. But, assuming we were to do so, the result would be the same. For the action actually taken was to dispose of the property to another corporation controlled by the same interests. It may be true that this transaction was in the nature of a tax-free reorganization. Nevertheless it was a transfer *211 from this petitioner and made it impossible for it to "hold" the property as an investment. We think the provisions of 112(b)(1) were intended to apply only to the same taxpayer. We are not required to disregard the separate corporate entities of petitioner and its successor at the behest of their creators. . Consequently, resort to what was actually done equally leaves this petitioner without foundation for its assertion that the intention was that it would continue to hold the property received as its own investment; and, as we have said, without that factor the provisions of 112(b)(1) are without force. There was, accordingly, no error in respondent's*870 determination that the entire profit on the transaction was taxable to petitioner in the year before us. In the view we have taken of the principal question it becomes unnecessary to consider whether the transferee of petitioner's property assumed the payment of the mortgage thereon or merely accepted conveyance of the property subject to it, and, in either event, whether the amount of the mortgage represented "other property" received within the provisions of section 112(c)(1). A further controversy originally presented appears now to have been eliminated by a concession of petitioner's counsel. The parties were in dispute as to whether the property in question was acquired by petitioner upon its formation, or remained in the beneficial ownership of petitioner's promoters until approximately a year later, when the details of petitioner's organization had been completed. The only materiality of that question under the present disposition of the case is to assist in determining petitioner's basis for gain or loss, and in view of petitioner's present concession, as we understand it, that in any event petitioner's basis and the basis of its transferors would be the same under*871 section 112(b)(5), that issue is no longer of any moment and need not be decided. Capital items expended during the promotion period are proper additions to cost on either theory. These items, as well as others, contributing to petitioner's total cost basis are set forth in detail in our findings of fact. Although some were questioned by respondent and were made the foundation for a request for increased deficiency, evidence which would justify us in concluding that respondent has sustained his burden of proving the absence of such expenditures has not been produced. For this reason the facts as to those items have been found in accordance with petitioner's original claim and the statement in the deficiency notice and respondent's request for increased deficiency is denied. Reviewed by the Board. Decision will be entered under Rule 50. ARUNDELL and LEECH dissent. Footnotes 1. SEC. 112. RECOGNITION OF GAIN OR LOSS. * * * (b) EXCHANGES SOLELY IN KIND. - (1) PROPERTY HELD FOR PRODUCTIVE USE OF INVESTMENT. - No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness of interest) is exchanged solely for property of like kind to be held either for productive use in trade or business of for investment. ↩ 2. (c) GAIN FROM EXCHANGES NOT SOLELY IN KIND. - (1) If an exchange would be within the provisions of subsection (b)(1), (2), (3), or (5) of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property. ↩ 3. See Webster's New International Dictionary, 2d Ed., including among the uses of "to" as "introducing an infinitive as an adjective modifier: (1) indicating intention * * * a house to↩ sell * * *." 4. That this is petitioner's conception, also, appears from its brief: "* * * it is necessary to consider: * * * (b) The intention of the transferor towards * * * the new property which was received * * *" ↩ 5. The following testimony of petitioner's president may throw some light on this situation: "* * * Each stockholder had a different problem. I explained to him that if the property was sold we would get $420,000, and under the provisions of the federal tax law we would have to pay that out of our dividends, and we would get that immediately. "Q. Who would get that immediately? "A. The stockholders, and I think out of the $420,000 we would have to pay corporate and individual taxes, * * *" At another point he testified: "A. * * * So the stockholders suggested - and I did not see anything harmful in it - that the company be reorganized by liquidating Regals, after transferring the property to another corporation, distributing the $105,000 in cash that way, so as to make available to the stockholders the provision I have referred to. "Of course, we recognized at the same time that we would be paying a tax on the new property; in other words, on the total profit and prospective profit. "Q. In other words, you were not saving a tremendous amount? "A. No; but I guess some of the stockholders were in very high brackets, and they thought that all of that $105,000 was going to go places for them, and I said, 'All right.'" ↩