Opinion
Docket No. 60090.
1959-07-22
JOSEPH B. AND JOSEPHINE L. SIMON, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Fred L. Rosenbloom, Esq., and Thomas P. Glassmoyer, Esq., for the petitioners. George H. Bowers, Jr., Esq., for the respondent.
Fred L. Rosenbloom, Esq., and Thomas P. Glassmoyer, Esq., for the petitioners. George H. Bowers, Jr., Esq., for the respondent.
Petitioner Joseph B. Simon was one of two stockholders who equally owned all the common stock of Exco Corporation which, in turn, owned the stock of Penn-Liberty Insurance Company. At sometime prior to September 28, 1951, he and his costockholder agreed to make contributions through Exco to Penn-Liberty whose legal reserves had been impaired by serious losses. At the time of this understanding he, Simon, was the owner of an office building against which two mortgages in the aggregate amount of $75,998.99 were outstanding. On September28, 1951, he negotiated a loan of $120,000 on the said property, from which he paid off the two prior mortgages and expended $2,686.50 on settlement costs, retaining the balance. On December 27, 1951, when his adjusted basis was $82,205.17, petitioner, for a recited consideration of $100, which in fact was not paid, transferred the property to Exco subject to the September 28 mortgage, the principal amount of the mortgage having been reduced to $119,098.22 by the required November and December payments on principal, which payments had been made by petitioner. On December 31, 1951, Exco transferred the property, subject to the mortgage, to Penn-Liberty for a recited consideration of $100, which similarly was not paid. On the same date, Penn-Liberty entered the property on its books at a value of $242,800, less the unpaid principal of the September mortgage, which was then $119,098.22, as stated; also less $471.43 representing accrued interest. All of the steps taken by petitioner, Exco and Penn-Liberty after the petitioner's agreement with his costockholder, and in respect of the said property, were part and parcel of the transaction whereby petitioner disposed of the said property to Exco, which in turn transferred it to Penn-Liberty. Held, that petitioner made a sale of the property to Exco, on which sale he realized a capital gain of $34,206.55.
For the year 1951 the respondent determined a deficiency in income tax against the petitioners in the amount of $10,715.94, and, under section 294(d)(2) of the Internal Revenue Code of 1939, an addition to tax in the amount of $824.41 for substantial underestimation of tax. The questions raised are (1) whether petitioner Joseph Simon realized income upon the transfer of property owned by him to a corporation in which he was the owner of 50 per cent of the common stock, where, in connection with, but preliminary to, the transfer, he mortgaged the property for an amount in excess of his basis therefor, paid prior mortgages and other small items of cost from the proceeds of the new loan and transferred the property to the corporation subject to the new mortgage, retaining as his own the said excess of mortgage proceeds, and (2) whether petitioners are liable for an addition to tax under section 294(d)(2) of the 1939 Code for substantial underestimation of tax.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
The petitioners are husband and wife and residents of Philadelphia, Pennsylvania. They filed their joint income tax return for the taxable year involved with the collector of internal revenue for the first district of Pennsylvania.
On February 14, 1941, petitioner Joseph B. Simon, hereafter referred to as petitioner, or as Simon, purchased certain real estate located at 244-252 North 13th Street and 249-257 North Clarion Street, Philadelphia, known and sometimes referred to herein as the RKO Building, for a total consideration of $104,220.45.
On September 9, 1941, petitioner delivered to RKO Radio Pictures, Inc., a mortgage on the RKO Building to secure a loan in the amount of $27,000. On June 3, 1947, he delivered to the Equitable Life Assurance Society of the United States a mortgage on the RKO Building to secure a loan in the amount of $80,000. The prior mortgage was subordinated to the 1947 mortgage which became a first lien on the building. On September 28, 1951, the unpaid balance of the Equitable mortgage was $65,123.12 and the unpaid balance of the RKO mortgage was $10,875.87.
In 1951, Simon was president of Exco Corporation, a Pennsylvania corporation, hereafter referred to as Exco, and was treasurer of the Penn-Liberty Insurance Company, a Pennsylvania corporation, referred to herein as Penn-Liberty, the latter being a subsidiary of Exco.
On December 27, 1951, the issued and outstanding capital stock of Exco consisted of 4,500 shares of preferred stock, with a par value of $100 each, and 200 shares of common stock, with a par value of $100 each. All of the issued and outstanding stock was owned by petitioner, Charles Denby, an unrelated party, and Penn-Liberty, as follows:
+----------------------------------------------+ ¦ ¦Number of shares ¦ +-------------------------+--------------------¦ ¦ ¦Common ¦Preferred ¦ +-------------------------+--------+-----------¦ ¦ ¦stock ¦stock ¦ +-------------------------+--------+-----------¦ ¦Joseph B. Simon ¦100 ¦1,750 ¦ +-------------------------+--------+-----------¦ ¦Charles Denby ¦100 ¦1,750 ¦ +-------------------------+--------+-----------¦ ¦Penn—Liberty Insurance Co¦None ¦1,000 ¦ +----------------------------------------------+
Denby was treasurer of Exco.
Throughout the year 1951, and thereafter until December 22, 1952, Exco owned all of the issued and outstanding stock of Penn-Liberty.
During 1951 Penn-Liberty suffered substantial losses due largely to claims for hurricane damage which had occurred at the end of 1950, and was in need of financial assistance in order to maintain its required legal reserves.
The situation was discussed by Simon, Denby and officers of Penn-Liberty. As a result of the several discussions had and agreements reached, the transactions set out below took place.
On September 28, 1951, Simon borrowed the sum of $120,000 from the Phoenix Mutual Life Insurance Company of Hartford, Connecticut, and, as security for such loan, delivered to the aforesaid company a bond secured by a mortgage on the RKO Building.
The ‘Whereas' clause of the mortgage recited that Simon, by the bond duly executed, stood bound unto the mortgagee in the sum of $240,000, conditioned for the payment to the mortgagee of the sum of $120,000.
The bond accompanying the mortgage of September 28, 1951, contained the following provision limiting Simon's liability:
It is hereby expressly understood and agreed that, notwithstanding anything to the contrary herein contained, the Obligee, its successors and assigns, will look solely to the mortgaged premises, and any other property or interest held as collateral security for the aforesaid indebtedness, and not to the Obligor personally, for recovery in the event of default hereunder, hereby waiving any right which the Obligee might otherwise have to obtain a deficiency judgment against the Obligor, or to collect said indebtedness from the assets of the Obligor, other than those held as security for the same.
No property or interest other than the real estate was in fact given as collateral security for the indebtedness evidenced by the bond accompanying the mortgage.
Certain officers of Penn-Liberty were present at the mortgage settlement.
Of the $120,000 of mortgage proceeds, Simon applied $75,998.99 in satisfaction of the debts secured by the two prior mortgages on the RKO Building, paid settlement costs of $2,686.50 and retained the balance of $41,314.51.
Under the terms of the mortgage of September 28, 1951, ‘constant’ monthly payments of $925 on account of interest and principal amortization were required beginning November 1, 1951. Petitioner made the payments due on November 1, 1951, and December 1, 1951, which were applied as follows:
+----------------------+ ¦Nov. 1, 1951: ¦ ¦ +--------------+-------¦ ¦Interest ¦$475.00¦ +--------------+-------¦ ¦Principal ¦450.00 ¦ +----------------------+
925.00 Dec. 1, 1951: Interest 473.22 Principal 451.78
925.00
Petitioner also made a payment of $47.50 on October 1, 1951, representing the interest on the mortgage from September 28 to September 30, 1951, inclusive. By the payments on principal in the aggregate of $901.78, the mortgage was reduced from $120,000 to $119,098.22. They also served to reduce the amount of the mortgage proceeds retained by Simon from $41,314.51 to $40,412.73.
On December 27, 1951, petitioners conveyed the RKO Building to Exco for a recited consideration of $100, but subject to the mortgage of September 28, 1951. The $100 was never paid to or received by petitioners.
During the period from February 14, 1941, to December 27, 1951, petitioner's aggregate annual allowance for depreciation upon the RKO building totaled $22,015.28. On the latter date, petitioner's adjusted basis for the RKO Building was $82,205.17.
On December 31, 1951, immediately following the transfer of the RKO Building by petitioner to Exco, Exco in turn transferred the building by deed to its wholly owned subsidiary, Penn-Liberty, for a recited consideration of $100, but subject to the mortgage of September 28, 1951. The $100 was never paid to or received by Exco.
On December 31, 1951, the RKO Building was entered on the books of Penn-Liberty at an appraised value of $242,800, less the unpaid principal of the mortgage of $119,098.22 and accrued interest of $471.43. In the asset column of the Penn-Liberty annual statement for 1951, the RKO Building appeared as follows:
+-------------------------------------------------------------------------+ ¦Real Estate, less $119,098.22 Encumbrances & Accrued Interest¦ ¦ +-------------------------------------------------------------+-----------¦ ¦$471.43 ¦$123,230.35¦ +-------------------------------------------------------------------------+
In December 1952, Exco sold all of the Penn-Liberty stock to Fred A. Carnell, as agent for three Swiss reinsurance companies, and in January 1953, all of the stock of Exco, including petitioner's, was sold for $100,000.
Petitioners' income tax liability for the year 1950, as reported by them on their return, was $10,477.28. Petitioners' estimated tax for the year 1951 amounted to $8,250, which was paid by installments, and their income tax liability for the year was reported in the amount of $11,274.26.
In his determination of deficiency, respondent determined that petitioner sold the RKO Building to Exco in 1951, and that he realized capital gain on the said sale in the amount of $35,108.33. The respondent made no allowance for the November and December principal payments under the mortgage in the total amount of $901.78. The gain so realized by petitioner on the transaction was $34,206.55.
Petitioners declared a substantial underestimation of their estimated income tax for the year 1951.
OPINION.
TURNER, Judge:
Starting with the proposition that the borrowing of the $120,000 in September of 1951 was not an income-realizing transaction, it is the contention of the petitioners that Simon for a purported consideration of $100, which in fact was not paid, transferred the RKO Building to Exco as a contribution to capital and Exco in turn, similarly without consideration, transferred the building to its wholly owned subsidiary, Penn-Liberty; that since, under section 113(a)(8)(B) of the Internal Revenue Code of 1939,
property acquired by a corporation as a contribution to capital takes the same basis in the hands of the corporation as it had in the hands of its transferor-stockholder, the transfer of the building by Simon to Exco and then by Exco to Penn-Liberty was not a gain or loss transaction, and under Mendham Corporation, 9 T.C. 320, and Woodsam Associates, Inc., 16 T.C. 649, affd. 198 F.2d 357, there could be no realization of gain by anyone unless or until the building should be sold by Penn-Liberty, and then the realization would be that of Penn-Liberty and not Simon.
SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.(a) BASIS (UNADJUSTED) OF PROPERTY.— The basis of property shall be the cost of such property; except that—(8) PROPERTY ACQUIRED BY ISSUANCE OF STOCK OR AS PAID-IN SURPLUS.— If the property was acquired after December 31, 1920, by a corporation—(A) by the issuance of its stock or securities in connection with a transaction described in section 112(b)(5) (including also, cases where part of the consideration for the transfer of such property to the corporation was property or money, in addition to such stock or securities), or(B) as paid-in surplus or as a contribution to capital,then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.
It was the testimony of Simon that due to tornadoes and hurricanes at the end of 1950, Penn-Liberty had sustained serious losses in 1951, and would need contributions to surplus in order to maintain its legal reserves; that he and Denby discussed the matter, and as a result of those discussions he ‘contributed the property described here as the RKO property, and Mr. Denby agreed to make a similar contribution.’ He also testified that the contribution was made in kind because it was inconvenient to ‘provide cash at the moment instead of the real estate.'
Simon further testified that the transaction was discussed with Penn-Liberty, and that it ‘became a Penn-Liberty deal even before the mortgage,‘ the mortgage referred to being the $120,000 mortgage of September 28, 1951.
And yet, as hereafter pointed out, the transaction was so set up and carried out as to permit Simon to receive and retain free and clear from the claims of anyone $40,412.73 of the mortgage proceeds, which amount in cash could readily have been made available to Penn-Liberty had the transfer of the property to Exco and then to Penn-Liberty been only a contribution to capital.
The facts show that on February 14, 1941, Simon purchased the RKO Building for $104,220.45; that on September 9, 1941, he borrowed $27,000, and on June 3, 1947, $80,000, having in each instance a mortgage on the building, with the 1941 mortgage being subordinated to the 1947 mortgage. By September of 1951, the unpaid balance of the 1941 mortgage was $10,875.87 and that of the 1947 mortgage $65,123.12, or a total of $75,998.99. The facts also show that from February 14, 1941, Simon's allowable depreciation on the building had by December 27, 1951, amounted to $22,015.28, and that on the latter date his adjusted basis for the building was $82,205.17.
Also shown of record is the fact that Simon, in disposing of the building after it ‘became a Penn-Liberty deal,‘ obtained $120,000 in cash on the mortgage of September 28, 1951, and after expending $75,998.99 in satisfying the prior mortgages, $2,686.50 in settlement costs and $901.78 to cover the November and December principal payments on the new mortgage, transferred the building to Exco subject to the September mortgage, then in the principal amount of $119,098.22, retaining as his own the remaining $40,412.73 of the mortgage proceeds.
It is thus apparent, we think, that all the steps enumerated were part and parcel of the same transaction whereby Simon transferred and sold the RKO Building to Exco subject to the said mortgage, or at a cost to Exco of $119,098.22, the then principal amount of the mortgage, and we so hold. That in financing the sale the loan was negotiated prior to the transfer and by or in the name of the seller, rather than simultaneously with or after the transfer and by or in the name of the purchaser, is, we think, immaterial. Furthermore, the fact that the sale may have been, and apparently was, a bargain sale, as result of which Penn-Liberty was able to improve its financial condition by a writeup of the building on its books by the amount of the appraised value over the principal amount of the mortgage, did not, in our opinion, make the transaction any the less a sale. Simon, according to his testimony, had agreed with Denby to make a contribution through Exco to the capital of Penn-Liberty, which contribution was to be effected through the transfer of the RKO Building, but either Penn-Liberty did not require a contribution of the full value of the building or Simon was unwilling to make a contribution of that magnitude. Hence the sale whereby Exco acquired the building at a cost, or stated otherwise, subject to the mortgage liability of $119,098.22, which in effecting the transaction had been placed against it, and whereby Simon was enabled to realize a profit of $34,206.55, that amount being the excess of the mortgage proceeds received by Simon over his adjusted basis of $82,205.17, the $2,686.50 of settlement costs and the $901.78 expended by him to cover the November and December principal payments on the new mortgage, which payments had become due prior to the transfer on December 27,1951.
Mendham Corporation, supra, and Woodsam Associates, Inc., supra, are not this case. In both of those cases, there were transfers of property to a corporation in exchange for stock within the meaning of section 112(b)(5) of the 1939 Code, whereunder no gain or loss was to be recognized. In the instant case, not only was there no exchange covered by the nonrecognition of gain provisions of section 112(b), but on the facts as concluded above, there was a sale of the RKO Building to Exco at a price of $119,098.22. And, as we have pointed out, the transaction was not any the less a sale by reason of the fact that the value of the property transferred was in excess of the selling price at the time of the transfer, thereby enabling Penn-Liberty to improve its financial condition by a writeup of the building on its books. By reason of the differences indicated, it is unnecessary, we think, to comment here on what was said in the opinions in the two cases referred to concerning the liability of the transferorstockholder under the facts in those cases, or to discuss the question of basis to Exco or Penn-Liberty for the RKO Building for gain or loss or depreciation purposes. But see and compare Crane v. Commissioner, 331 U.S. 1, and Blackstone Theatre Co., 12 T.C. 801, to the effect that the basis for a given property includes liens thereon, even though not personally assumed by the taxpayer.
Respondent has filed an amended answer asking for an increased deficiency based on a claim, in the alternative, that if petitioner disposed of his property other than by sale or exchange, the gain realized would be ordinary income rather than capital gain. Our determination that petitioner has effected a sale of his property disposes of this alternative issue.
Petitioners appear to have abandoned the issue with respect to substantial underestimation of their estimated tax, probably because their estimated tax for 1951 was less than 80 percent of the tax liability they reported, and also because their 1951 estimate was less than the tax liability reported on their 1950 return.
It appears that respondent in his determination of deficiency fails to take into account the $901.78 representing the November and December principal payments under the mortgage which had been made by petitioner, and for that reason a recomputation of the deficiency will be required.
Decision will be entered under Rule 50.