Lapsley v. Commissioner

JAMES B. LAPSLEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CARY W. JONES AND MRS. BERTHA M. JONES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Lapsley v. Commissioner Docket Nos. 102201, 102202. United States Board of Tax Appeals 44 B.T.A. 1105; 1941 BTA LEXIS 1234; July 24, 1941, Promulgated *1234 1. Two partners acquired the interest of a third. In order to effectuate a transfer of the real estate from the partnership of three to the partnership of two the property was deeded to a "straw man." Four days later it was deeded to the two partners for a recited consideration of $100. Held, that the two were at all times the equitable owners of the real estate, the "straw man" being a mere accommodation holder of, and conduit for, the title. Their basis is therefore the actual cost of the realty rather than $100. 2. The real estate referred to in the preceding paragraph was subject to a mortgage which none of the partners had ever assumed or agreed to pay. During the taxable year it was deeded to the mortgagee without consideration, petitioners thereby sustaining a loss. Held, that the loss is an ordinary loss, deductible in full and not a capital loss subject to the limitation contained in section 117 of the Revenue Act of 1936. A. F. Hillix, Esq., for the petitioner. G. W. Reardon, Esq., for the respondent. MELLOTT *1105 These proceedings, duly consolidated, involve deficiencies in income tax for the calendar year 1936*1235 in the respective amounts (Lapsley) of $139.80 and (Jones) $760.74. Since the controversy in Docket No. 102202 arises solely in connection with the income of Cary W. Jones, he will sometimes be referred to as the petitioner and elsewhere he and Lapsley will be referred to as petitioners. The issues as framed by the original pleadings involved the addition of $8,849.87 to the net income of each of the petitioners. This amount is one-half of a loss reported by the partnership of Jones and Lapsley (1/2 of $20,071.90) or $10,035.95, less $1,186.08. The latter amount is composed of one-half of the loss sustained by the partnership during the taxable year in connection with the rent of a building (1/2 of $372.17) and one-half of $2,000, which last mentioned amount was allowed by the Commissioner as a capital loss. Each petition alleges that the Commissioner erred in holding that the loss is a capital loss and in limiting the deduction to $2,000, $1,000 for each partner. During the hearing respondent asked leave to file amended answers, asserting claims for increased deficiencies. Leave was granted and amended answers were filed, in which respondent alleges that he erred in allowing*1236 the petitioners any capital loss. He asks that the Board redetermine the deficiencies to be $216.84 in Docket No. 102201 (Lapsley) *1106 and $879.72 in Docket No. 102202 (Jones). Replies were duly filed and the issues raised in the amended pleadings have been briefed. FINDINGS OF FACT. Petitioners are residents of Kansas City, Missouri, and duly filed returns of income for the year 1936 with the collector of internal revenue at Kansas City, Missouri. They also caused to be filed with the same collector a partnership return of income, verified by each of them, for the period January 1 to April 1, 1936. On or about the 11th day of April 1936, petitioners conveyed by quitclaim deed to the Business Men's Assurance Co. of America, a corporation, for a recited consideration of $1 and other valuable considerations, real estate located at 12th and Troost in Kansas City, Missouri, described as lots 11 and 12 and the east 12 1/2 feet of lot 10, block 2, Dundee Place, in Kansas City, Missouri. No consideration actually passed except as stated in the following clause contained in the deed: This deed is an absolute conveyance of title in effect as well as in form, and is not*1237 intended as a mortgage, conveyance in trust or security in any form. The consideration for this deed is the full release and discharge of the grantors and makers of the note secured by the deed of trust hereinafter mentioned, and all personal liability on account of said obligations hereinafter mentioned and a full release of all debts, notes, obligations, costs and charges heretofore or now subsisting on account and by the terms of a certain deed of trust dated the 15th day of May, 1931, and now held by the grantee herein, and recorded in Book B-3028, at page 180, in the Recorder's Office of Jackson County, Missouri; this conveyance completely satisfying said obligations and terminating said deed of trust and promissory note secured thereby and the effect thereof in all respects. The petitioners were associates of R. Bryson Jones. The three of them and others, had been stockholders in the Kansas City Ground Investment Co. for a number of years prior to 1931. This corporation acquired the title to the above described property on or about November 11, 1909. While the title to the property stood in the name of the corporation, $60,000 was borrowed from the Business Men's Assurance*1238 Co. of America. Petitioners and R. Bryson Jones and some of the other stockholders signed the notes. The property was subsequently sold (apparently under a contract) to a man by the name of Curry. Some time during 1929 or 1930 petitioners ascertained that payments were in arrears and that the Business Men's Assurance Co. was threatening to institute foreclosure and to hold the signers of the notes for the amounts therein stated. At that time petitioners and R. Bryson Yones were the only responsible signers of the notes then alive. *1107 On May 5, 1931, the Kansas City Ground Investment Co. deeded the property to Clyde W. Bracy and Mabel Bracy, husband and wife. Bracy was a bookkeeper in the office of Herbert V. Jones & Co. On April 1, 1931, Bracy and his wife signed six notes in the aggregate amount of $40,000, payable to the Business Men's Assurance Co. of America, one in the principal amount of $25,000 and five in the amount of $3,000 each. On May 15, 1931, Bracy and his wife executed a deed of trust on the above described property to the Business Men's Assurance Co. to secure the payment of six promissory notes. One of the five notes in the amount of $3,000*1239 was due on April 1, 1932, and the others at annual intervals thereafter until April 1, 1936. The $25,000 note was due and payable on April 1, 1936. Petitioners and R. Bryson Jones endorsed the five $3,000 notes and thereby became personally liable for their payment. They did not endorse the $25,000 note or assume any obligation for its payment. Each of the petitioners and R. Bryson Jones put up $7,500 in 1931, most of the aggregate of said amount, or $22,500, being paid to the Business Men's Assurance Co. to be released from liability under the $60,000 in notes which they had signed in connection with the loan to the corporation. They established a partnership composed of the three of them to hold and operate the property, the property consisting of a building bringing in rents of approximately $300 a month. After the deed of trust executed by the Bracys was filed for record in the office of the recorder of deeds on May 20, 1931, petitioners and R. Bryson Jones caused to be filed in the same office on April 6, 1932, a warranty deed to the property signed by Bracy and his wife, in which the three of them were named as grantees. The deed recited that it was subject to any*1240 and all encumbrances of record. About the time of the execution and delivery of the notes and deed of trust petitioners and R. Bryson Jones designated Herbert V. Jones & Co. as the agent of the partnership to collect the rents. The agent was instructed to make the necessary repairs upon the building, to pay the taxes and insurance, to pay the interest as it accrued upon the notes to the mortgagee, and to apply any remaining balance to the retirement of the five $3,000 notes. The five $3,000 notes were paid by the three partners, either out of the rents or out of other funds. The partnership operated at a loss during each of the years. Some time in the latter part of 1934 R. Bryson Jones felt that there was no future for the property and expressed the desire to have it deeded over to the mortgagee. Petitioners felt that they could work something out of it so they collectively gave R. Bryson Jones $100 for his share in the partnership, each putting up $50. *1108 In order to effectuate a transfer of the property from the partnership composed of the three individuals to a partnership composed of petitioners, the three, together with the wives of those who were married, *1241 joined in the execution of a warranty deed on December 15, 1934, conveying the property to Carll V. Kretsinger. This deed was recorded on January 4, 1935, in the office of the recorder of deeds. Kretsinger paid nothing for the property or the deed. On December 19, 1934, Kretsinger and his wife executed a warranty deed to petitioners herein. This deed was recorded on the 28th day of January 1935. It recited a consideration of $100. Kretsinger was a mere "straw man", accommodation holder of, and conduit for, the title to the property, petitioners at all times remaining the equitable owners thereof. The depreciation upon the property allowed or allowable during the period of petitioners' ownership amounted to $5,028.10. Petitioners each sustained a loss on April 11, 1936, computed as follows: Amount paid by the three partners in 1931 $22,500.00 Amount paid by the three partners in connection with the five $3,000 notes 15,000.00 Total 37,500.00 One-third of above amount paid by each 12,500.00 Plus one-half of $100 paid in 1934 to R. Bryson Jones 50.00 Less one-half of depreciation allowable from 4/1/31 to 4/11/36 Less one-half of depreciation allowable from 4/1/31 to 4/11/36 ($5,028.10) 2,514.05 Loss sustained by each 10,035.95 *1242 OPINION. MELLOTT: Respondent's claim for increased deficiencies can not be allowed. Relying solely upon the recited consideration of $100 in the deed from Kretsinger and his wife to petitioners, respondent contends that this is the measure of the loss sustained by them, and, since it is less than the allowable depreciation upon the property during the period it was held, that they sustained no loss in 1936. He also argues that the loss was sustained by petitioners in December of 1934, when they joined with R. Bryson Jones in the execution of the deed to Kretsinger. Finding has been made that Kretsinger was a mere straw man, accommodation holder of, and conduit for, the title to the property and that petitioners at all times remained the equitable owners of it. Therefore, when petitioners deeded the property to the mortgagee on April 11, 1936, they sustained a loss equal to the total amount of their investment in the property. *1109 Respondent contends that, even if the partnership sustained a loss upon the transfer or conveyance of the real estate to the mortgagee in 1936, still such loss constitutes a capital loss and is limited, under section 117 of the Revenue*1243 Act of 1936, to $2,000, or $1,000 to each of the two partners. He cites ; ; ; and ; argues that the rule applied in those cases is applicable "whether or not there is an existing personal liability on the mortgage"; and concludes his argument with the statement that "The decision of the Board in , which was decided in 1937, as well as the other cases relied upon by the petitioners, have in effect been reversed by the foregoing recent decisions." The Board has not taken the view that the Commonwealth case was in effect reversed or overruled by the cited cases. Our view, expressed in , that an ordinary loss, deductible in full, was sustained by a taxpayer who abandoned real estate subject to mortgages which he had never assumed, was recently affirmed by the Circuit Court of Appeals for the Second Circuit. *1244 . A similar conclusion was reached in , where a quitclaim deed was given, "not to relieve petitioner of a liability, but only to simplify the transfer of title." It was pointed out that as to petitioner the transaction "had no aspect of a sale or exchange", the Commonwealth case being cited. After the Supreme Court handed down its opinions in the Hammel and Electro-Chemical cases respondent filed a motion to vacate. In a Memorandum Sur Decision Under Rule 50 and Denial of Motion to Vacate subsequently published in , it was said: "These opinions of the Supreme Court have been duly considered and are found to be distinguishable and to require no modification of the Board's opinion in the present proceeding." In , the petitioner "had no continuing liability" on a mortgage at the time a quitclaim deed was given to the mortgagee. We followed the Commonwealth case and held that, since there was no sale or exchange of a capital asset, the loss should be allowed as an ordinary loss, not*1245 limited by section 117(d) of the Revenue Act of 1936. 1 It is clear, under our findings, that petitioners were not obligated to make payment of the $25,000 note. They, like the petitioner in *1110 the Commonwealth case, made no sale or exchange of a capital asset (cf. , affirming ), but abandoned the property to the mortgagee (, and ) Paraphrasing the language used in , "The execution of the deed marked the close of a transaction whereby petitioners abandoned their title." Being of the opinion that the cited cases are controlling, we hold that the Commissioner erred in determining the deficiencies. Decision will be entered for the petitioners. Footnotes 1. SEC. 117. CAPITAL GAINS AND LOSSES. * * * (d) LIMITATION ON CAPITAL LOSSES. - Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000 plus the gains from such sales or exchanges. * * * ↩