Schieffelin v. Commissioner

ESTATE OF LUCY S. SCHIEFFELIN, TITLE GUARANTEE AND TRUST COMPANY AND BENJAMIN G. BAIN, EXECUTORS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Schieffelin v. Commissioner Docket No. 99961. United States Board of Tax Appeals 44 B.T.A. 137; 1941 BTA LEXIS 1377; April 9, 1941, Promulgated *1377 1. A mortgagee purchased certain mortgaged property at a foreclosure sale. Taxes and water rates against the property had been paid by mortgagee prior to acquisition by foreclosure. Held, that such payments by mortgagee enlarged her mortgage investment and must be recognized in determining the gain or loss resulting from the foreclosure sale. 2. When the mortgagee purchased other mortgaged property at the foreclosure sale, taxes and water rates were outstanding against the property and were paid by mortgagee in the following taxable year. Held, that such amounts constituted an addition to mortgagee's capital investment in the property acquired at the sale. H. F. Matheis, C.P.A., for the petitioners. Allen T. Akin, Esq., for the respondent. VAN FOSSAN *137 The respondent determined a deficiency of $342 in the petitioners' income tax for the year 1935. Of this amount $92.02 is in controversy. The only question now presented is whether real estate taxes and water rates paid by a mortgagee, either before or after acquisition of the property by her at a foreclosure sale, are costs of acquiring the property, or are a part of the*1378 mortgage debt. FINDINGS OF FACT. The facts were stipulated and in so far as they are material to the issue are substantially as follows: The petitioners are the executors of the last will and testament of Lucy S. Schieffelin, who died on May 10, 1936. Their address is 176 Broadway, New York, New York. Prior to June 21, 1935, the decedent held a mortgage on real estate located at 586 Third Avenue, Brooklyn, New York (hereinafter called *138 the Third Avenue property). Her investment in the mortgage was $24,000. The mortgage contained the following provision: That until amount hereby secured is paid the mortgagor will pay all taxes, assessments or water rates, which may be assessed as lien on premises, and in default thereof, the mortgagee may pay the same, and the party of the first part will repay same with interest and same shall be a lien on said premises and secured by this mortgage. The mortgage was foreclosed on June 21, 1935, under regularly instituted proceedings and the decedent purchased the real estate at the sale for $25,000. The costs and expenses in connection with the foreclosure aggregated $602.47, all of which were paid prior to the acquisition*1379 of the property. Taxes, assessments, and water rates, with interest and penalty thereon in the amount of $109.65, were paid by the decedent prior to her acquisition of the property. The fair market value of the property at the time of the foreclosure was $23,000. The respondent determined that the decedent realized a gain from the foreclosure computed as follows: Bid in price $25,000.00 Less: foreclosure costs 602.47 Balance 24,397.53 Principal amount of mortgage acquired 12/31/31 24,000.00 Gain - All accrued interest on mortgage 397.53 The petitioners concede that the sum of $287.88, a part of such gain, is properly includible as taxable income. Prior to October 18, 1935, the decedent held a mortgage on real estate located at 3727 Oceanic Avenue, Brooklyn, New York (hereinafter called the Oceanic Avenue property). Her investment in the mortgage was $6,500. The mortgage agreement contained the following provision: AND the mortgagor covenants with the mortgagee as follows: * * * 6. That the mortgagor will pay all taxes, assessments or water rates, and in default thereof, the mortgagee may pay the same. On October 18, 1935, the decedent*1380 purchased the property for $8,000, pursuant to regular foreclosure proceedings. The costs and expenses in connection with the foreclosure totaled $653.45, all of which were paid prior to the decedent's acquisition of the property. Taxes and water rates aggregating $1,090.50 were paid by the petitioner on April 18, 1936. Of the amount so paid the sum of $51.34 was allowed as an expense deduction in 1936. The fair market value of the property at the time of the foreclosure was $7,000. *139 The respondent determined that the decedent realized a gain from the foreclosure computed as follows: Bid in price $8,000.00 Less: foreclosure costs 653.45 Balance 7,346.55 Principal amount of mortgage acquired 8/6/31 6,500.00 Gain - All accrued interest on mortgage $846.55 The Commissioner made certain adjustments in the petitioner's net income, including the item of delinquent taxes on the Third Avenue and Oceanic Avenue properties. As to them he took the following action: Your contention, that in the case of 3727 Oceanic Avenue, there were unpaid delinquent real estate taxes of $1039.06, and on 586 Third Avenue, the delinquent taxes amounted to $109.65, *1381 and that, therefore, in computing the amount of the "excess," the taxes accrued to the date of foreclosure should be applied as a reduction of the bid price, was denied. Such taxes constitute additional costs of the properties acquired. OPINION. VAN FOSSAN: The issue is whether taxes paid by the decedent, the mortgagee, either before or after foreclosure, should be included in the debt due to her in computing her gain or loss from the foreclosure transaction, or should be added to the cost of the property purchased by her, thus creating an increased base for the computation of future gain or loss upon its disposition. The petitioners contend that section 23(k) of the Revenue Act of 1934, 1 as interpreted by Regulations 86, article 23(k)-3, 2 is controlling *140 and should be applied whether the taxes and assessments are paid before or after the mortgagee acquires the property. They maintain that the taxes and water rates, whether paid or accrued, properly form a part of the debt due to the mortgagee and should be recognized in computing gain or loss on the foreclosure transaction. *1382 The petitioners quote section 254-6, Real Property Law of the State of New York, 3 in support of their position. The provisions in the mortgage agreement, as well as the interpretation thereof embodied in the law, grant the mortgagee the right to pay all taxes, assessments or water rates which may become liens against the mortgaged property, if the mortgagor fails to do so, and all amounts so paid serve to increase the mortgagee's investment in the debt secured by the mortgage. This privilege or right is obviously given in order to protect the mortgagee's investment. If he avails himself of that right his investment is enlarged by the amount so paid and upon foreclosure the augmented debt becomes the base of computing his gain or loss. *1383 The taxes on the Third Avenue property were paid by the decedent prior to her acquisition of it upon foreclosure. Thus, pursuant to contractual and statutory provisions, they became a specific obligation of the debtor to her, secured by the same character of lien and mortgage as that which secured the original mortgage indebtedness. The base of her investment was thereby enhanced. The amount of the taxes is a factor in determining the decedent's gain or loss upon the foreclosure of the Third Avenue property and hence the petitioner's contention is sustained. The taxes accrued on the Oceanic Avenue property present a different situation. They were not paid until the taxable year following the date of the foreclosure. The petitioner did not exercise her right to pay the taxes prior to foreclosure and consequently to increase her investment in the mortgage debt secured by that property. In (affirmed as to the point at issue, ), we said: It is well settled that if the purchaser of real estate pays taxes thereon which have accrued prior to the date of purchase, such payments are an additional cost*1384 of the property to the purchaser and are therefore not deductible by him as his taxes. In , the court stated: When one purchases land which is subject to a lien for taxes, the subsequent payment of those taxes by the purchaser does not constitute an allowable deduction *141 from gross income, for the reason that the taxes accrued while the land was in other ownership and the payment of them is merely a payment of a part of the cost of acquiring the property. See , and other similar cases. In the cases from which the above excerpts are quoted the issue was the deductibility of taxes as such, but the principles there set forth are equally applicable to the situation here. As to the Oceanic Avenue property, therefore, the taxes and water rates due thereon at the time of the foreclosure sale and paid by the decedent in the following taxable year constituted additional cost of the property purchased and form no part of the computation of the decedent's gain or loss upon foreclosure. Decision will be entered under Rule 50. Footnotes 1. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * (k) BAD DEBTS. - Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); * * * ↩ 2. ART. 23(k)-3. Uncollectible deficiency upon sale of mortgaged or pledged property.↩ - If mortgaged or pledged property is lawfully sold (whether to the creditor or another purchaser) for less than the amount of the debt, and the mortgagee or pledgee ascertains that the portion of the indebtedness remaining unsatisfied after such sale is wholly or partially uncollectible, and charges it off, he may deduct such amount (to the extent that it constitutes capital or represents an item the income from which has been returned by him) as a bad debt for the taxable year in which it is ascertained to be wholly or partially worthless and charged off. In addition, if the creditor buys in the mortgaged or pledged property, loss or gain is realized measured by the difference between the amount of those obligations of the debtor which are applied to the purchase or bid price of the property (to the extent that such obligations constitute capital or represent an item the income from which has been returned by him) and the fair market value of the property. The fair market value of the property shall be presumed to be the amount for which it is bid in by the taxpayer in the absence of clear and convincing proof to the contrary. If the creditor subsequently sells the property so acquired, the basis for determining gain or loss is the fair market value of the property at the date of acquisition. 3. Mortgagor to pay all taxes, assessments or water rates. A convenant "that the mortgagor will pay all taxes, assessments or water rates and in default thereof, the mortgagee may pay the same" must be construed as meaning that until the amount hereby secured is paid, the mortgagor will pay all taxes, assessments and water rates which may be assessed or become liens on said premises, and in default thereof the holder of this mortgage may pay the same and the mortgagor will repay the same with interest, and the same shall be liens on said premises and secured by the mortgage. ↩