Opinion
Docket Nos. 26949 26950.
1952-04-24
ESTATE OF THEODORE GUTMAN, DECEASED, ELSIE GUTMAN, EXECUTRIX, AND ELSIE GUTMAN, SURVIVING WIFE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.GEORGE GOLDBERG AND MARIE GOLDBERG, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Jeremiah S. Gutman, Esq., for the petitioners. Michael J. Kenny, Esq., for the respondent.
1. During the taxable year 1944 Theodore Gutman and George Goldberg were the members of a partnership which, since its formation following the dissolution in 1929 of a partnership of which they were then members, had been engaged in the same kind of operations as the dissolved partnership, namely, the general practice of law and the purchase and sale of real estate, real estate mortgages and interests therein. In 1944 they were also owners of interests in mortgages designated Harrison Avenue and Crotona Avenue. These mortgage interests had been acquired by them in 1941 upon dissolution of a corporation which had been formed to liquidate the assets of the old partnership and which had acquired these interests as a part of such assets. From and after their receipt in 1941 of the Harrison Avenue and Crotona Avenue mortgage interests, Gutman and Goldberg held them for sale to customers in the regular course of their business. In 1944 they accepted from one party lesser amounts than face value in full satisfaction of their interests in the Harrison Avenue mortgage and sold to another party their interests in the Crotona Avenue mortgage for less than face value. Held, (1) that Gutman's and Goldberg's interests in the mortgages were not capital assets within the meaning of section 117(a)(1) of the Internal Revenue Code, (2) that the portion of the Harrison Avenue mortgage indebtedness which became worthless during the taxable year constituted business bad debts under the provisions of section 23(k)(1) of the Code and were deductible in full, and (3) that the losses sustained on the sale of their interests in the Crotona Avenue mortgage were losses incurred in trade or business and were deductible in full under section 23(e)(1).
2. In 1932 Elsie Gutman acquired a one-family house in Massapequa, New York, and in 1940 she acquired a one-family house in Jamaica, New York. Thereafter the two properties were used by her and her family for residence purposes. Each of the properties was fully appointed and equipped so that the family could go readily at any season from one to the other as convenience directed. In July 1944 the Massapequa property was sold at a loss and 35 days later, in an unrelated transaction, the Jamaica property was sold at a gain. Held, that the properties are not to be regarded as a single residence, the sales treated as a unit and the loss from one offset against the gain from the other. Jeremiah S. Gutman, Esq., for the petitioners. Michael J. Kenny, Esq., for the respondent.
The respondent has determined deficiencies as follows in the income tax of the petitioners for 1944:
+--------------------------------------------------------------------------+ ¦Estate of Theodore Gutman, deceased, and Elsie Gutman, surviving¦ ¦ +----------------------------------------------------------------+---------¦ ¦wife ¦$2,147.26¦ +----------------------------------------------------------------+---------¦ ¦George Goldberg and Marie Goldberg ¦2,035.61 ¦ +--------------------------------------------------------------------------+
The issues are whether the respondent erred (1) in disallowing an amount of $1,378.84 deducted as an ordinary loss in the return of each group of petitioners with respect to mortgage indebtedness on property designated Harrison Avenue property and determining that it represented a nonbusiness bad debt allowable as a short term capital loss, (2) in disallowing an amount of $4,853.46 deducted as an ordinary loss in the return of each group of the petitioners with respect to mortgage indebtedness on property designated Crotona Avenue property, and determining that it represented a long term capital loss, and (3) in disallowing in the proceeding of the Estate of Theodore Gutman, deceased, and Elsie Gutman, surviving wife, a deduction of $1,176.25 taken as a long term capital loss sustained on the sale of one of two residential properties, both of which were used simultaneously for a part of the year for personal residence purposes, and determining that such loss could not be offset against a long term capital gain realized on the sale of the other property.
FINDINGS OF FACT.
Part of the facts were stipulated and are found accordingly.
The joint return of Theodore Gutman, deceased, and Elsie Gutman, surviving wife, was filed with the collector for the third district of New York. The joint return of George Goldberg and Marie Goldberg was filed with the collector for the first district of New York.
In 1913 Theodore Gutman, George Goldberg, and Leopold Levy, attorneys and counsellors at law, formed a partnership known as Levy, Gutman & Goldberg. In addition to engaging in the general practice of law, the partnership engaged in the purchase and sale of real estate, real estate mortgages and interests therein. During the real estate boom years in the 1920's the purchase and sale of real estate, mortgages, and mortgage and real estate interests constituted a major portion of the business conducted by the partnership.
During the period 1925 through 1929 the average annual number of mortgage transactions handled by the partnership exceeded one hundred and the approximate dollar volume of such business was as follows for the indicated years:
+----------------+ ¦1925¦$1,800,000 ¦ +----+-----------¦ ¦1926¦1,700,000 ¦ +----+-----------¦ ¦1927¦1,700,000 ¦ +----+-----------¦ ¦1928¦1,000,000 ¦ +----+-----------¦ ¦1929¦650,000 ¦ +----------------+
None of the mortgage participations or real estate interests purchased by the partnership were for the purpose of investment but were acquired for the purpose of sale to customers in the course of the partnership's real estate mortgage business. All profits earned from the purchase and sale of mortgages were reported as ordinary income.
On October 15, 1925, and for the sole purpose of resale to customers in the ordinary course of its mortgage business, the partnership acquired a one-half interest ($50,000 face amount) in a second mortgage for $100,000 on the premises situated at 1878-98 Harrison Avenue in the borough of Bronx, New York City, and sometimes herein referred to as the Harrison Avenue property. The remaining one-half interest in the mortgage was held by one Abe Goodman. The partnership continued to hold its interest in the mortgage until July 29, 1927, during which time it received payments of interest and payments on principal so that on the latter date the principal amount owing thereon was $48,750.
On July 29, 1927, and in the regular course of its mortgage business, the partnership sold to a customer a $45,000 participation in the mortgage on the Harrison Avenue property, sometimes hereafter referred to as the Harrison Avenue mortgage. The partnership continued to hold a $3,750 interest in the mortgage for lack of a willing purchaser. In connection with the sale of the $45,000 participation the purchaser demanded a guaranty by the partnership of said interest and this was given as a necessary inducement to the sale. The giving of such guaranties by the partnership was a necessary and usual incident of the sale by it of mortgages and participations.
During 1928 the obligor on the Harrison Avenue mortgage defaulted in the payment of taxes, interest and installments of principal on the first mortgage on the property, a lien outranking the instant mortgage. In addition, the obligor also defaulted in the payment of interest and installments of principal on the instant mortgage, the last payment being received on June 15, 1928. In accordance with its guaranty the partnership was called upon to cure the defaults and did so by advancing $20,000 for that purpose. As a result the interest of the partnership in the second mortgage on the Harrison Avenue property was increased from $3,750 to $23,750. This augmented interest in the mortgage was acquired by the partnership in the course of the regular operations of its mortgage business.
On April 10, 1928, and in the regular course of its mortgage business, the partnership purchased for sale to customers, a second mortgage in the amount of $50,000 on the premises situated at 1382 Crotona Avenue in the borough of Bronx, New York City, and sometimes herein referred to as the Crotona Avenue property. By sales made to seven different participants the partnership disposed of the entire mortgage by May 9, 1928. In connection with the sales guaranties were demanded and received from the partnership. The giving of such guaranties was necessary to conclude the sales.
In 1929 defaults occurred on the second mortgage on the Crotona Avenue property, sometimes hereafter referred to as the Crotona Avenue mortgage. In performance of its guaranties the partnership foreclosed the mortgage and title obtained at the foreclosure sale was taken in the name of 1382 Crotona, Inc., sometimes referred to as Crotona, formed for that purpose. The management of Crotona was handled by the partnership. In further performance of its guaranties the partnership advanced $15,400 to cure defaults in taxes and on the first mortgage. The partnership immediately caused Crotona to issue a new mortgage in the amount of $59,700 to the seven participants who held partnership guaranties and to the partnership itself to cover the advances made by it. The amount of the new mortgage, $59,700, represented the amount of the Crotona Avenue mortgage, $50,000, as reduced by amortization to the date of default plus the $15,400 advanced by the partnership in protection of the seven participants in the Crotona Avenue mortgage. The debt of $15,400 due to the partnership was acquired in the regular course of its mortgage business. The mortgage participation securing said debt was acquired and held by the partnership for sale to customers in the normal course of its mortgage business.
The partnership continued to hold the above-mentioned Harrison Avenue participation of $3,750 with the additional interest therein acquired by advances of $20,000, and the Crotona Avenue participation of $15,400 until October 29, 1929. Such mortgage interests were held on that date by the partnership as an incident to its mortgage business and for the purpose of sale to customers in the regular course thereof.
The partnership was dissolved on October 29, 1929, by the death on that date of partner Leopold Levy.
Almost simultaneously with the death of Levy, the real estate and mortgage markets broke. This break was followed by the depression which adversely affected the saleability of many items, including real estate, and especially interests such as second mortgages. Following the break in the real estate and mortgage markets first mortgages on real estate sold at from 20 cents to 25 cents on the dollar. This practically wiped out the chance of selling second mortgage liens.
Following the death of Leopold Levy, Theodore Gutman and George Goldberg, the surviving members of the dissolved partnership, formed a new partnership with the same name, Levy, Gutman & Goldberg, as the dissolved partnership. The new partnership carried on the same type of law practice as the dissolved partnership. It also carried on a real estate business similar to that conducted by the dissolved partnership, but this real estate business was greatly diminished in comparison with the real estate business carried on by the dissolved partnership, due to the break in the real estate and mortgage markets, and especially the market for second mortgages. The new partnership continued until the death of Gutman in 1948 and its real estate business consisted of the collection of rents, the purchase and sale of real estate, and the purchase and sale of mortgages and interests in mortgages. All the time from its formation through 1944 the partnership engaged in the purchase and sale of mortgages and during that period bought and sold many mortgages. Throughout the period its purchases of real estate and mortgages were for the purpose of resale, and not as investments.
In order to segregate the assets of the dissolved partnership for proper distribution from the going business of the new partnership, Theodore Gutman, George Goldberg, and the estate of Leopold Levy, on April 1, 1930, formed a corporation named Combined Resources, Inc., and sometimes referred to herein as Resources.
On January 6, 1931, Gutman, Goldberg, the estate of Leopold Levy, and Resources entered into an agreement, which, among other things, recited that Gutman and Goldberg were under an obligation to and were desirous of liquidating and distributing the assets of the dissolved partnership which consisted in large part of real estate and mortgages, that the condition of the market at that time was such that liquidation would entail great loss and that it would be to the best interests of all the parties to conserve such assets by holding them until such time or times as the market would permit them to be sold. By the agreement all such assets were conveyed to Resources in consideration of the issuance by it of one-third of its capital stock to each Gutman, Goldberg, and the estate of Leopold Levy, the assumption by it of all the liabilities of the dissolved partnership and the agreement by it to hold Gutman, Goldberg, and the estate of Leopold Levy free and harmless from all such liabilities. Gutman, Goldberg, and the estate of Leopold Levy each received one-third of the stock in Resources and they had complete domination and control of the corporation. In 1931 Gutman was president of Resources and so far as appears was such throughout its existence. From the time Resources acquired the assets of the dissolved partnership until Resources itself was dissolved, Gutman and Goldberg were the active managers of Resources' affairs relating to liquidation and disposition of the assets.
Resources disposed of many of the assets conveyed to it. However, throughout its existence it engaged in no business other than the liquidation and distribution of the assets conveyed to it under the above-mentioned agreement of January 6, 1931. The only reason for its existence was the orderly and economical liquidation of the assets of the dissolved partnership. Among the assets of the dissolved partnership transferred to Resources were the above-mentioned Harrison Avenue and Crotona Avenue mortgage participations.
In 1941, and in order to facilitate an accounting by, and a distribution of, the estate of Leopold Levy, the estate, Gutman, and Goldberg dissolved Resources and caused distribution in kind among themselves of the assets of the dissolved partnership which had been transferred to the corporation on January 6, 1931, and which still remained unliquidated. Among the assets so distributed by Resources were the Harrison Avenue and Crotona Avenue mortgages. Goldberg took and, so far as shown, was allowed a deduction in his 1941 income tax return for a loss sustained on the liquidation of Resources.
Upon receipt of their interests in the Harrison Avenue and Crotona Avenue mortgages by the dissolution of Resources, Gutman and Goldberg attempted to dispose of them. They approached, and were approached by, brokers respecting their sale and they employed brokers to see if they could sell their interests in the mortgages. Under rent assignments or under receiverships Gutman and Goldberg entered into possession of some of the properties covered by the mortgages and collected the rents and tried to effect a sale of the real estate underlying the mortgages. Because the mortgages were bad they were unable to dispose of their interests therein until in 1944. After reacquiring interests in the mortgages Gutman and Goldberg held such interests primarily for sale and if that was not possible then to realize whatever was possible from a liquidation of the properties securing the mortgage and the distribution of the proceeds among the lien holders.
In 1944 the interests of Gutman and Goldberg in the Harrison Avenue mortgage had a face value of $7,916.67 each. In that year the owner of the Harrison Avenue property received an offer to buy it for an amount which was somewhat above the amount of the first mortgage thereon. In order to facilitate the sale the owner offered Gutman and Goldberg $6,537.83 each for a release of their interests in the second mortgage on the property. On December 20, 1944, each accepted $6,537.83 in full satisfaction of his interest of $7,916.67.
In 1944 the face value of the interests of Gutman and Goldberg in the Crotona Avenue second mortgage was $4,978.33 each. In 1944 one Kuhne, as a purely speculative venture, paid to each Gutman and Goldberg $125 for their respective $4,978.33 interests. The loss thus sustained by each was $4,853.33. Thereafter said second mortgage was fully wiped out by the foreclosure of the prior first mortgage.
In their respective income tax returns Gutman and Goldberg deducted $1,378.84 as a loss sustained on their interests in the Harrison Avenue mortgage. Determining that their interests in the indebtedness secured by the mortgage constituted nonbusiness debts and that the losses of $1,378.84 claimed thereon were to be considered as losses from the sale or exchange of short term capital assets, the respondent disallowed the deductions.
In their respective income tax returns Gutman and Goldberg deducted $4,853.46 as a loss sustained on their interests in the Crotona Avenue mortgage. Determining that their interests in the indebtedness secured by the mortgage were long term capital assets and that the losses of $4,853.46 claimed thereon were to be treated as long term capital losses to the extent of 50 per cent thereof, or $2,426.73, the respondent disallowed the deductions taken.
On July 26, 1932, Elsie Gutman acquired a one-family house situated at 125 Fairview Road, Massapequa, Long Island, New York. On November 25, 1940, she acquired a one-family house situated at 180-03 Tudor Road, Jamaica, Queens County, New York.
From the time of the acquisition of the Jamaica property, both properties were used simultaneously during the entire year by Elsie Gutman and her family. For approximately eight months of the year they resided approximately five days a week at the Jamaica property and for the remaining portion of the week (week ends and holidays) they resided at the Massapequa property. During the remaining approximately four months of the year they resided at the Massapequa property. Each of the properties was fully appointed and equipped so the family could go readily at any season from one to the other as convenience directed.
Due to the failing health of her husband, Theodore Gutman, and his inability to continue the strenuous daily trips from either Massapequa or Jamaica to his office in Manhattan, Elsie and Theodore decided to sell the properties. The Massapequa property was sold on July 11, 1944, at a loss of $2,352.50 and the Jamaica property was sold on August 15, 1944, at a gain of $5,900. The loss on the sale of the Massapequa property was reported as a long term capital loss and a deduction of $1,176.25 was taken therefor. The respondent determined that the loss could not be taken into account for any purpose and accordingly disallowed the deduction.
OPINION.
TURNER, Judge:
Taking the position that at all times material from the formation of the new partnership through 1944, Gutman and Goldberg were in the business of buying and selling real estate, mortgages and interests in mortgages and that at all times during which they were the owners of interests in the Harrison Avenue and Crotona Avenue mortgages they held such interests primarily for sale to customers in the ordinary course of their real estate and mortgage business, the petitioners contend that the respondent erred in disallowing the deductions taken as losses on account of such interests and determining that they were to be treated as losses sustained on the disposition of capital assets. They urge that the amounts deducted with respect to the interests in the Harrison Avenue mortgage represented business bad debts and as such were deductible in full and that the amounts deducted with respect to the interests in the Crotona Avenue mortgage represented business losses, likewise deductible in full. The respondent concedes that the mortgages in question were acquired and held by the old partnership for sale to customers in the regular course of its business. However, on brief, he contends that from 1929 through 1944 Gutman and Goldberg did not handle any mortgage business and that since the mortgages in question were acquired by them in 1941 as stockholders in the liquidation of Resources, which had been formed by them and the estate of Leopold Levy in 1930, the losses sustained on the interests in the Harrison Avenue mortgage were nonbusiness bad debts and the losses sustained on the interests in the Crotona Avenue mortgage were capital losses. Pertinent portions of the Internal Revenue Code are set out below.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(e) LOSSES BY INDIVIDUALS.— In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—(1) if incurred in trade or business; or(2) if incurred in any transaction entered into for profit, though not connected with the trade or business;(g) CAPITAL LOSSES.—(1) LIMITATION.— Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.(k) BAD DEBTS.—(1) GENERAL RULE.— Debts which become worthless within the taxable year; or (in the discretion of the Commissioner) a reasonable addition to a reserve for bad debts; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. * * * This paragraph shall not apply in the case of a taxpayer, other than a corporation, with respect to a non-business debt as defined in paragraph (4) of this subsection.(4) NON-BUSINESS DEBTS.— In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term ‘non-business debt‘ means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.SEC. 117. CAPITAL GAINS AND LOSSES.(a) DEFINITIONS.— As used in this chapter—(1) CAPITAL ASSETS.— The term ‘capital assets‘ means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23(1), or an obligation of the United States or any of its possessions, or of a State or Territory, or any political subdivision thereof, or of the District of Columbia, issued on or after March 1, 1941, on a discount basis and payable without interest at a fixed maturity date not exceeding one year from the date of issue, or real property used in the trade or business of the taxpayer;
The stipulation of facts submitted by the parties is clear, and the parties are in agreement that the old partnership was engaged in the real estate and mortgage business for several years prior to its dissolution by the death of Levy in October 1929 and that the real estate and mortgages owned by it at the time of dissolution were held for sale to customers in the ordinary course of business. However, a controversy has developed on the briefs of the parties as to the effect to be given a portion of the stipulation relating to the type of business other than law, carried on by the new partnership. In addition to stipulating that the new partnership, composed of Gutman and Goldberg, carried on the same type of law practice as the old partnership, the parties stipulated that ‘The new partnership also carried on a real estate business similar to the old partnership, but this real estate business was greatly diminished in comparison to the real estate business carried on by the old partnership.‘ Using as a basis the quoted stipulation and the testimony of Goldberg that the real estate business of the new partnership consisted of the collection of rents, the purchase and sale of real estate, the purchase and sale of mortgages and interests in mortgages, that the new partnership continued until the death of Gutman in 1948, that throughout the existence of the partnership the partnership engaged in the purchase and sale of mortgages and that all purchases of real estate and mortgages were for the purpose of resale and not as investments, the petitioners contend that they have established that Gutman and Goldberg were in the business of buying and selling real estate, mortgages, and interests in mortgages during 1944. They further contend that the respondent's contention that from 1929 through 1944 Gutman and Goldberg did not handle any mortgage business is contrary to the stipulation. In view of the respective positions of the parties, it is not clear just what effect they intended should be given to the above-quoted portion of the stipulation. However, after considering that provision of the stipulation in connection with other provisions of the stipulation and the testimony of Goldberg, we are of the opinion that the business carried on by the new partnership from its formation through 1944 was of substantially the same character as that carried on by the old partnership, but that due to the break in the real estate and mortgage markets was of a greatly reduced volume both as to the number of transactions and the sums involved. Having reached that conclusion, the respondent's contention that Gutman and Goldberg never handled any mortgage business from 1929 through 1944 must be denied.
The evidence also shows that after reacquiring the interests in the mortgages in 1941, Gutman and Goldberg held them for sale to customers in the regular course of their business and that they made various efforts to sell them but were unsuccessful because the mortgages were bad since they were on old type properties and were not productive of income.
In the circumstances presented we hold that the Harrison Avenue and Crotona Avenue mortgage interests were not capital assets within the meaning of section 117(a)(1).
Since Gutman and Goldberg accepted a lesser amount than the face value of their interests in the Harrison Avenue mortgage in full satisfaction of such interests there was no sale or exchange of their interests. Hale v. Helvering, 85 F.2d 819. Consequently a question arises as to whether the indebtedness represented by their interests was a business bad debt or a nonbusiness bad debt. To escape classification as a nonbusiness bad debt as defined by section 23(k)(4), a debt and the loss from its worthlessness must bear a proximate relation to a business in which the taxpayer is engaged at the time the debt becomes worthless. Robert Cluett, 3rd, 8 T.C. 1178; Jan G. J. Boissevain, 17 T.C. 325. In the instant case Gutman and Goldberg during 1944, the year in which the portions of the Harrison Avenue mortgage indebtedness in controversy became worthless, were engaged in the real estate and mortgage business. Therefore, there was a proximate relation of the indebtedness and the loss from its worthlessness occurred. Accordingly the indebtedness did not constitute a nonbusiness bad debt but was a business bad debt within the meaning of section 23(k)(1) and as such was deductible in full. Robert Cluett, 3rd, supra.
Having concluded above that the Crotona Avenue mortgage indebtedness was not a capital asset, and since Gutman and Goldberg held their interests therein primarily for sale to customers in the ordinary course of their real estate and mortgage business, the losses sustained on the sale of such interests constituted losses falling within section 23(e)(1) and likewise were deductible in full.
With respect to the respondent's disallowance of a deduction of $1,176.25 taken as a long term capital loss sustained on the sale of the Massapequa property by Elsie Gutman, the petitioners contend that this property and the Jamaica property, which was sold 35 days later at a gain, constituted a single residence of the Gutman family, one property complementing the other, and that the sales by which they were disposed of should be treated as a unit with the loss sustained on the sale of one being offset against the gain realized on the sale of the other. The respondent contends that these properties, which were situated in different towns, were acquired in separate transactions several years apart, and disposed of in separate transactions more than a month apart, constituted separate and distinct personal residences used by the Gutman family and that the law and regulation prohibit the allowance of any loss sustained on the sale of the one or the offsetting of such loss against the gain realized on the other.
We have here two separate and distinct properties, each fully appointed and equipped for occupancy at any time. They were situated in different towns a considerable distance apart. There is no showing or claim that they were sold as a unit or that they were offered for sale as such. Neither does it appear that they were ever regarded by the owner as anything other than separate and distinct properties at any time prior to the reporting of the results of the sales for income tax purposes. See and compare Richard P. Koehn, 16 T.C. 1378. Although in the Koehn case the residences were occupied consecutively and the residences involved in the instant case were occupied alternately, the reasoning there is also applicable here. The position of the respondent is, in our opinion, well taken and his determination of the matter is accordingly approved.
Decisions will be entered under Rule 50.