Warrick v. Commissioner

DUPUY G. WARRICK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Warrick v. Commissioner Docket No. 98689. United States Board of Tax Appeals 44 B.T.A. 1068; 1941 BTA LEXIS 1241; July 18, 1941, Promulgated *1241 1. Where an individual moves out of one residence into another, using his equity in the first as part of the purchase price for the second, and then continues to use the latter as a residence for a four-year period until, through a professional fee transaction, a larger and better home is acquired, it is held that his predominant motive in purchasing the second piece of property was to acquire a residence and not to enter into a transaction for profit. A loss sustained in disposing of such property is not a proper deduction under the provisions of section 23(e)(2) of the Revenue Act of 1932. 2. The endorsement of a $5,000 note and its surrender by the payee to the maker is held, under the evidence, to constitute a gift and not additional compensation for services rendered. John E. Park, Esq., and A. F. Hillix, Esq., for the petitioner. Benjamin L. Bird, Esq., for the respondent. MELLOTT *1068 The respondent determined deficiencies in the income tax of petitioner in the amounts of $839.98 for the year 1933 and $1,830.71 for the year 1935. The issues are: 1. Did the respondent err in disallowing a deduction of $6,500, *1242 claimed by petitioner as a loss resulting from the sale in 1933 of improved real estate? 2. Did the respondent err in including $5,000 in the petitioner's income for 1935, this being the value of a note made by petitioner in 1933 and surrendered to him in 1935 without payment? FINDINGS OF FACT. Petitioner is a resident of Kansas City, Missouri. His income tax returns for the years 1933 and 1935 were filed with the collector of internal revenue for the sixth district of Missouri. Prior to 1929, petitioner resided in a house located at 6140 Rockhill Road, Kansas City, Missouri. The house was of the bungalow type, had seven rooms, and was situated on a lot measuring 50 feet by 150 feet. Petitioner acquired this property in 1926. As a result of overbuilding, there was a depression in residential real estate values in Kansas City during the years 1926 to 1929. In the latter year a real estate man told petitioner that there were many desirable real estate properties selling for less than their real value because of this overbuilt condition, and that when conditions became good, such houses could be turned over quickly for a substantial *1069 profit. He showed*1243 petitioner a house and lot located at 121 West 69th Terrace and told him that if this house were attractively furnished and exhibited, it would sell very rapidly. In June 1929 petitioner purchased the 121 West 69th Terrace property. At that time there was a first mortgage of $8,250 on it which petitioner did not assume. The house was a brick and stucco English-type house with a slate roof. It had seven rooms and a sun porch and was in excellent condition. The living room was 1 1/2 stories and had large steel casement windows. There were two connecting steps between the living room and the hall and dining room. The house had been built in 1926 but had never been occupied. It was larger than the Rockhill Road house, but the grounds were not appreciably larger. The probable useful life of the improvements on the property at the time petitioner purchased it in 1929 was 40 years. After purchasing the above property, petitioner and his family moved into it. Immediately upon acquisition it was listed for sale with several real estate dealers in Kansas City, Missouri, at a price of $17,500. It was shown to several prospective buyers, but it was never*1244 sold. Petitioner continued to live in it until June 1933, at which time he acquired and moved into residential property located at 5820 State Line Road, Kansas City, Missouri. The house on this property was of brick construction, had about 12 rooms, and was situated on a plot of ground containing approximately 2 1/2 acres. Subsequent efforts to rent the West 69th Terrace house were unsuccessful. In June 1933 petitioner decided that he would not be able to sell the West 69th Terrace property at a profit, and deeded it to the holder of the first mortgage in order to save the latter the expense of foreclosure. He did not receive any consideration for making the deed. As a result of the transaction petitioner sustained a loss in the amount of $6,500, representing the difference between the amount of the first mortgage ($8,250) and the aggregate amount of his equity in the Rockhill Road property, which he applied as part of the purchase price of the West 69th Terrace property, plus the amount paid by him on a second mortgage, plus cash of $1,000 and the cost of certain improvements made by him. In his income tax return for 1933, petitioner deducted $6,500 as a loss incurred in*1245 a transaction entered into for profit. This deduction was disallowed by the respondent. At all times material herein petitioner was a partner in the law firm of Borders, Borders & Warrick. The partnership was entitled to participate in any compensation received by him for legal services. *1070 During the year 1933 petitioner was employed by Frank Parrish to defend him in a mail fraud criminal proceeding in Chicago, Illinois. Parrish had employed lawyers other than petitioner to defend him in the mail fraud suit, and they had received substantial fees in this connection. When the suit was set for trial these lawyers demanded additional compensation. Parrish could not comply with their demands and they withdrew from the case. Petitioner continued his connection and the defense of the suit devolved upon him. Thetrial of the case lasted six weeks and was concluded on April 30, 1935. Parrish was acquitted. At the time petitioner was employed by Parrish, his (Parrish's) wife owned the house and lot located at 5820 State Line Road in Kansas City. The house had been occupied by the Parrish family as a residence from 1929 to 1932. When purchased, the property was deeded*1246 to Mrs. Parrish who paid for it with her husband's money. In return for petitioner's services in the mail fraud suit, Parrish agreed to give him or his firm a note for $15,000, plus the difference between the value of the property located at 5820 State Line Road and $5,000. Parrish executed and delivered to petitioner his note dated January 1, 1933, for $15,000, payable two years after date, and his wife deeded the State Line Road property to petitioner. Petitioner executed and delivered to Mrs. Parrish his personal note for $5,000, dated January 31, 1933, payable January 31, 1938. The $15,000 note was worthless in 1933. Parrish stated that he would pay it if, as, and when he could. Neither the note nor any interest thereon has ever been paid, and the note is carried on the books of the partnership at a value of $1. The members of the law firm agreed that the value of the State Line Road property was $15,000 as of the date of conveyance to petitioner. Petitioner borrowed $10,000 in cash on his personal note and turned that sum into the partnership. The only compensation Parrish ever paid petitioner for defending him in the mail fraud suit was the value of the State Line*1247 Road property over and above $5,000. Parrish went abroad in February 1933, and from then until December of that year his whereabouts were unknown. During his absence petitioner extended many kindnesses and courtesies to Mrs. Parrish of a personal nature which were in no way related to his or her business matters. These acts of friendship did not include any legal or professional services of any kind, and petitioner never intended to make any charge for them. In June of 1935 Mrs. Parrish returned the $5,000 note to petitioner. At the time of the delivery of the note to petitioner it was *1071 endorsed by her. Petitioner was financially able to pay the note, which was not then due, and prior to its delivery had paid all interest due thereon. In returning the note to petitioner Mrs. Parrish intended to make a gift of the note to him and was motivated solely by a desire to express her gratitude for the many courtesies which he had extended to her. Respondent determined that the note represented compensation paid to petitioner for legal services and added $5,000 to the income reported by petitioner in his income tax return for 1935. OPINION. MELLOTT: Petitioner*1248 contends that he acquired the residence at West 69th Terrace in a transaction entered into for profit and that the loss sustained upon the disposal of the residence in 1933 is deductible under the provisions of section 23(e)(2) of the Revenue Act of 1932. Both parties agree that whether or not a loss is incurred in a transaction entered into for profit must be determined by the facts in each proceeding. Petitioner cites and relies upon a number of cases in which this Board has allowed as deductions losses incurred in connection with the sale of residential property where the predominant purpose in purchasing such property was to realize a profit on a subsequent sale, and where the use of the property for residential purposes was merely incidental. ; ; ; ; and . Respondent relies upon cases in which the predominant purpose in acquiring residential property was either not resale at a profit or where the use of the property for residential purposes*1249 from the time of its acquisition caused the transaction to lose the characteristics of a transaction entered into for profit, even though a profit-making motive might have existed at the inception of the transaction. ; affd., ; ; ; ; and . At the hearing petitioner testified that his intention at the time he bought or traded for the West 69th Terrace home was to occupy it as a residence for the purpose of exhibiting it after it was furnished, that he intended to live in it until he could sell it at a profit, that he was not interested in this type of house as a permanent residence for his family, and that his primary interest was in larger grounds. Despite petitioner's testimony, we are not convinced that his predominant purpose in acquiring the West 69th Terrace property *1072 was its resale at a profit. Immediately upon acquiring it he and his family moved in and used it for residential purposes. He had no other residence*1250 since he did not retain the Rockhill Road residence which he had been occupying since 1926, but used his equity in that property as part of the purchase price of the West 69th Terrace home. In furnishing this newly acquired house he appears to have used the furnishings of the Rockhill Road house in so far as they were adaptable. There was but slight difference in the size of the Rockhill Road and West 69th Terrace lots, and during the seven years he occupied the houses located on these lots he apparently made no effort to satisfy his expressed desire to secure a home with larger grounds surrounding it. Most people acquiring residential property believe they have made a good bargain; otherwise they would not buy. They hope or expect to make a profit when and if they sell it, and it is not unusual during their occupancy of such property for them to attempt to make a sale at a profit. But where, as here, an individual moves out of one residence into another, using his equity in the first as part of the purchase price paid for the second, and then continues to use the latter as a residence over a four-year period until, through a professional fee transaction, a larger and better home*1251 on a two and one-half acre tract is acquired, it would take stronger evidence than that submitted by petitioner to convince us that his predominant motive was to enter into a transaction for profit. As we view the transaction, petitioner acquired the West 69th Terrace property as a residence. As a result of its continued use as such, the purchase and sale of this property lost the characteristics of a transaction entered into for profit, even though a profit-making motive may have existed at the time of its acquisition. Respondent did not err in disallowing the deduction of $6.500 as a loss incurred in a transaction entered into for profit. The remaining issue relates to the note for $5,000 which petitioner executed and delivered to Mrs. Parrish on January 31, 1933, and which she returned to him endorsed in blank in June of 1935. Petitioner contends that Mrs. Parrish made a gift of the note, and that respondent erred in including its face value, $5,000, in his income for 1935. Respondent takes the position that the facts belie that Mrs. Parrish made a gift of the note to petitioner in spite of the fact that she testified she intended*1252 to make a gift and that she was motivated solely by a desire to benefit petitioner as an expression of gratitude for numerous courtesies extended to her by him. Respondent urges that the return of the note should be treated as additional compensation to petitioner for the good job which he had done in defending her husband in the mail fraud suit and that the amount *1073 of the note should therefore be included in petitioner's gross income. The evidence on this issue convinces us that the note for $5,000 was not returned to petitioner as additional compensation for services rendered. Mrs. Parrish testified that she gave the note back to petitioner as an expression of gratitude for the many services and kindnesses that she had received from him; that petitioner never performed any legal or professional services for her; that from time to time, and especially during the time when she did not know the whereabouts of her husband, she had talked to petitioner as a friend about certain individual and personal problems; that petitioner had made it very clear at all times that any and all of the little things he had so graciously done for her were strictly acts of friendship; and*1253 that she intended when she returned the note to him to make a gift. Petitioner's testimony was to the same effect. He testified that during the time the note was held by Mrs. Parrish he paid the interest due thereon, and that at the time she delivered the note to him in 1935, she said: "I want you to know that there are a few people in the world who have some sense of gratitude. I have appreciated your friendship over a very difficult period. I have something I want to give you. Here it is." She then handed him the $5,000 note with her endorsement in blank. Petitioner also testified that the law firm which was entitled to participate in his earnings from legal services, when informed of this transaction, agreed that it had no interest in it. Respondent's attempt to connect the delivery of the note to petitioner with his defense of Parrish in the mail fraud suit is based largely upon inference. Petitioner has proved to our satisfaction that when Mrs. Parrish delivered the note to him in 1935 she intended to, and did, make a gift. He was justified in treating it as such. It is our conclusion that respondent erred in adding $5,000 to the income reported by petitioner in his*1254 return for 1935, and this issue is decided in favor of petitioner. Judgment will be entered under Rule 50.