Foster v. Commissioner , 18 B.T.A. 819 ( 1930 )

FLORENCE A. FOSTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Foster v. Commissioner

Docket No. 17414.

United States Board of Tax Appeals

18 B.T.A. 819; 1930 BTA LEXIS 2583;

January 15, 1930, Promulgated

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1. TIMBER CONTRACT. - Where the owner of standing timber in Texas entered into a contract to sell it and the vendee agreed to cut, remove and pay for it as removed within a specified time, the title to the timber remained in the vendor until cut, and where the vendor died pending the performance of the contract his devisees inherited the timber subject to the contract.

2. GAIN OR LOSS. - The basis for computation of gain or loss on the timber is the difference between the value at the time it was acquired by the devisee after March 1, 1913, and the sale price.

3. LOSS - STORM. - The basis for the computation of loss on property acquired by the devisee after March 1, 1913, and lost by casualty in the year 1921, is not the value of the property at the time of its loss but the value at the time it was acquired by the devisee under the will, to wit, October 31, 1913.

T. E. Humphrey, Esq., and Harold C. Anderson, C.P.A., for the petitioner.

L. A. Luce, Esq., and R. B. Cannon, Esq., for the respondent.

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BLACK

The Commissioner determined deficiencies in income tax against the petitioner for the calendar years 1920 and 1921 in the amounts of $3,074 and $3,642.36, respectively. In seeking redetermination petitioner alleges that the Commissioner erred (1) by including in petitioner's income alleged profits from the sale of timber in 1920 of $14,334.90 and in 1921 of $13,500; (2) by disallowing an alleged loss of timber by storm in 1921 in the sum of $5,562.50, and (3) by disallowing deductions of $4,999.77 in 1920 and $2,695.02 in 1921 for taxes paid.

At the hearing it was conceded by counsel that the Commissioner had erred in disallowing the taxes claimed as deductions for 1920 and 1921, leaving for consideration the questions of profit on sale of timber, and loss of timber by storm.

FINDINGS OF FACT.

The petitioner is the widow of Thomas S. Foster. For many years prior to March, 1911, they resided in the State of Texas. On March 11, 1911, Foster was the owner of a sawmill plant at Elmira, Walker County, Tex., having a capacity of about 100,000 feet a day, and also owned in fee or the timber rights to a large body of virgin shortleaf pine timber located in Montgomery, Walker, and San Jacinto Counties, Tex. The amount of stumpage was unknown but it was estimated to be largely in excess of 200,000,000 feet.

Foster was in ill health and for the purpose of retiring from the sawmill and timber business sold his sawmill plant on March 11, 1911, to A. C. Ford et al., for $330,000 cash, and also contracted to dispose of his timber to the Walker County Lumber Co. by written contract substantially as follows:

In clause 1 it was provided:

Said Foster, for the consideration hereinafter stated, hereby agrees to sell to the said Walker County Lumber Company, its successors and assigns, and the said Walker County Lumber Company hereby agrees to buy from the said Foster, upon the prices, terms and conditions hereinafter stated, all of the merchantable pine timber, measuring ten (10) inches and over at the stump, standing upon the tracks or surveys of land located in the counties of Walker, San Jacinto, and Montgomery, State of Texas.

The contract gave the company the right to acquire all of the merchantable pine and hardwood timber then owned by Foster and situate on lands not owned by him; but with the right to cut and remove same over a period of 10 years or more, on the basis of $5 per thousand feet log scale for all merchantable pine 10 inches and over at the stump, except that on what is known as the Garza land, which was to be had on the basis of $4.50 per thousand feet. The Lumber Co. was given 20 years time within which to cut and manufacture into lumber all of said timber, but was required to cut or pay for not less than 16,000,000 feet annually for the first 5 years after March 1, 1911, and 18,000,000 feet per annum for the time subsequent to March 1, 1916, the timber to be scaled at the mill plant, when cut and removed from the forest to the mill, payment to be made monthly and/or after the timber was cut and manufactured into lumber.

The Lumber Co. reserved the right to reject the timber on any tract of land should it find the title thereto defective. If any timber covered by the contract should die or become destroyed or be blown down by storm, the loss incident thereto should be borne by the said Foster and not by the Lumber Co., under the terms of said contract.

The contract further provided that should the Lumber Co. be in arrears for timber to be paid for by it at any one time, for as long as 2 months in the aggregate, the said Thomas S. Foster or other holder under him should have the right to rescind or forfeit such contract of sale on account of such failure, and should such failure occur and said Foster or other holder elect to rescind and forfeit the contract, notice should be given to the Lumber Co. and it should thereafter forfeit all its right to the uncut timber, and all other rights under the contract should revert to the said Foster or other holder under him, and "all parties hereto shall be released from any further obligation, except that the Lumber Co. should still be liable for timber theretofore cut and not paid for." The only penalty the Lumber Co. should suffer for such failure should be a forfeiture of the contract as to timber then uncut and forfeit all other rights in the contract.

The contract also provided that Foster should list and pay taxes on the lands and timber and that the Lumber Co. should repay a portion thereof. Other provisions in the contract related to reforestation by Foster, if required by law, rights of way, and other usual provisions in logging contracts.

Foster died October 31, 1913, at Kansas City, Mo., and by his will, which was duly filed for record in Texas, devised one-half of all his estate to the petitioner, and one-half to his daughter, with the exception of a few specific devices. Whatever interest the decedent Foster had in the timber or contracts in controversy passed under the will one-half to petitioner and one-half to Foster's daughter.

In the timber contract Foster obligated himself to acquire within three years 50,000,000 additional feet of timber of the dimensions required in said contract and that same should be immediately subject to the terms of the contract. Foster failed to complete this before his death and on account of this failure the Lumber Co. set up a claim for damages. This was finally adjusted by a supplemental contract dated August 1, 1915, by which the Foster estate agreed to pay the Lumber Co. $25,000, or allow it credit for that amount, and it was further agreed that the price of timber on such lands as Foster had acquired since the making of the original contract should be $3 per thousand instead of $5 and $4.50 as originally provided. Foster acquired certain additional timber on June 9, 1913, at a cost of $2,750, known in the record as the Montgomery or McMurrey timber, to which the $3 rate per thousand applied. A small portion of this McMurrey timber was cut in 1919, and the balance, 2,000,000 feet, in 1920 and was paid for at the rate of $3 per thousand, and petitioner's profit thereon was included in her tax returns for said years and the tax thereon paid.

In 1920 there were cut and removed from the Foster lands and manufactured into lumber approximately 19,000,000 feet of timber, but of this amount 2,000,000 feet represented what is known as the McMurrey timber that was sold at $3 per thousand feet, and the profit in the sale price thereof, over the cost of said timber, was reported in the petitioner's return for 1920. Therefore, there were 17,000,000 feet of timber cut and removed by the Lumber Co. in 1920, for which it paid $5 per thousand feet, the contract price, and the taxpayer had only a one-half interest in said timber and the proceeds of the sale thereof.

During the year 1921 there were 12,588,163 feet of timber cut and removed by the Lumber Co. and paid for under the contract at the rate of $5 per thousand feet, or a total of $62,940.66.

As petitioner owned an undivided one-half interest in this timber, so cut and paid for by the Lumber Co., any taxable income charged against her on that account would be based on 6,294,067 feet, for which the Lumber Co. paid $31,470.33.

The Lumber Co. made no advance payments during the year 1921 to cover the shortage in its cut between the amount actually cut and that required to be cut under the contract, but interest on the shortage was paid. This interest was included in petitioner's return for 1921 and the tax thereon paid.

In May, 1921, storm damaged 2,225,000 feet of timber covered by the contract and no salvage was realized. Petitioner was the owner of one-half of this timber and has not been compensated for said loss by insurance or otherwise.

The timber at the time acquired by petitioner, October 31, 1913, was of the fair market value of $3.50 per thousand feet.

In making her returns for taxation for 1920 and 1921, petitioner did not include therein any profit on sales of timber except sales of the McMurrey timber in 1920, as she claimed that the timber was worth $5 and $4.50 per thousand when she acquired it and that as the sale price was the same there was no profit. The Commissioner determined a deficiency based on the theory that petitioner did not inherit the timber, but inherited rights under the contract, which were worth only $3.50 per thousand when acquired, and for which she ultimately received $4.50 and $5 per thousand, resulting in a profit and deficiency. The Commissioner also refused to allow $5,562.50 claimed by petitioner for damage by storm, and included in his computation, at $5 per thousand, the McMurrey timber for which only $3 per thousand was received. Petitioner's accounts were kept on a cash receipts and disbursements basis.

OPINION.

BLACK: The respondent confessed error in failing and refusing to allow deductions for taxes claimed by the taxpayer for years 1920 and 1921 in the respective amounts of $4,999.77 and $2,695.02. Said sums represented taxes actually paid by petitioner in said years over and above any amount of taxes refunded by the Lumber Co. under the terms of the contract. Therefore, respondent in computing deficiencies of petitioner for 1920 and 1921 should allow as deductions from gross income the sums just above stated.

The principal question for decision is whether the petitioner acquired the timber under the will of her husband subject to the terms of the contract, or whether she merely received rights under the contract to receive certain payments in the future. The Commissioner insists upon the latter view and submits that contract rights to receive $5 per thousand feet in 1920 and 1921 were worth approximately $3.50 per thousand in 1913, when acquired by petitioner, as the sums to be received in 1920 and 1921 should be discounted to arrive at their value in 1913. It is further contended that the difference between the discounted value and the amount received constitutes taxable income.

In the alternative the Commissioner contends that if the petitioner acquired timber rather than the contractual right to receive payments under the contract of sale, the value of said timber on October 31, 1913, was not in excess of $3.50 per thousand feet and that petitioner's profits would be the difference between this value of $3.50 per thousand feet and the $5 per thousand feet received for the timber.

In the case of , Mr. Justice Bradley stated the law thus:

Since the ordinary administration of the law is carried on by the State courts, it necessarily happens that by the course of their decisions certain rules are established which become rules of property and action in the State, and have all the effect of law, and which it would be wrong to disturb. This is especially true with regard to the law of real estate and the construction of State constitutions and statutes. Such established rules are always regarded by the Federal courts, no less than by the State courts themselves, as authoritative decisions of what the law is.

The contract here in question was executed in Texas, between Texas parties, it concerned Texas land and timber and was to be performed in that State. Manifestly the law of that State should govern its interpretation. The two leading cases seem to be , and ; , in which the rule is laid down that a timber contract, such as the one in the instant case, is only an executory contract of sale, whereby the title to the timber passed only when it was actually cut, removed from the soil and paid for.

In the instant case, the language of the contract is, "Said Foster, for the consideration hereinafter stated, hereby agrees to sell to the said Walker County Lumber Company, its successors and assigns and said Walker County Lumber Co. hereby agrees to buy from the said Foster upon the prices, terms and conditions hereinafter stated." The consideration and conditions thereinafter stated were that the vendee was to cut, remove, and pay for the timber when cut and removed. Any loss before cutting was that of the vendor. It appears to us that it was plainly the intention of the parties that title to the timber was to remain in the vendor and that the contract was an executory contract in the nature of an option.

In , the Supreme Court of Texas said, construing a similar contract:

The adjudged cases are generally in accord, and meet our full approval, in construing instruments like the above, which merely convey timber with a license to remove same, without stipulating the time within which it may or must be removed, as implying the removal of the timber within a reasonable time. 17 R.C.L. 1082; (3).

The cases are in utmost conflict, however, in declaring the legal consequences of clauses in conveyances of growing timber, express or implied, for removal of the timber within a limited time, be it within a stipulated or reasonable term. * * *

Many cases, and perhaps the weight of modern authority, support the rule that timber deeds and contracts, containing time limits for the removal of the timber, pass no title whatever, save to so much of the timber as the vendee may remove within the time limited. (Citing authorities.) The reason for the rule last stated is well expressed in the opinion of Justice Levy in the case of , in the following language:

"Having agreed to a limitation upon the right of removal, then the right of the purchaser to the timber is acquired by the act of removal and appropriation; and, as appropriation of the timber as such is dependent upon the removal from the soil, the intention of the parties would appear to be a contract of sale of such timber only as is removed within the time limited."

It is the plain duty of this court to interpret these contracts, like all others, in such manner as will best carry out the intentions of the parties. And we conclude that no rule will better accomplish that end than the one already approved by some of our Courts of Civil Appeals, under which title passes, under contracts like those set out herein, to only so much timber as may be removed within a reasonable time.

See also ; ; ; ; .

It is contended in behalf of the Commissioner that the rule of the Federal courts is to the contrary and , and , are cited in support thereof. But we do not so understand these cases. In the former, the court followed the courts of Washington and Idaho to the effect that a conveyance of standing timber was a conveyance of realty and required a deed to pass title, and in the latter the court followed the decisions of Virginia, North Carolina, and South Carolina and reached the same conclusion as the Texas courts. The following excerpt from ; , was cited with approval:

Looking to the whole deed, and all of its provisions must be considered in order to arrive at its proper construction, we are of opinion that it was not the intention of the parties to give an absolute and unconditional title to the timber, but only such as was cut and removed within the time limited by the deed and such extensions thereof as the grantee was entitled to demand upon a fair construction of the deed, or as might be agreed upon between the parties.

We think it clear that under the law of Texas the petitioner became entitled to and acquired the timber under the will of her husband and not rights to receive certain payments in future under the logging contract, and that it is our duty to follow the Texas rule.

The fair market value of the timber in question at the time petitioner acquired it, October 31, 1913, was $3.50 per thousand feet and the price received for it in the taxable years was $5 per thousand feet.

In 1920, 17,000,000 feet of said timber covered by the original contract were sold and petitioner's one-half of the profits therefrom was $12,750.

In 1921, 12,588,133 feet of said timber were sold and petitioner's one-half of the profits therefrom was $9,441.09.

The measure of the gain in this case is the difference in the fair market value of the timber at the time it was acquired and the price for which it was sold. ; .

Relative to the timber known as the McMurrey or Montgomery timber, which was purchased on June 9, 1913, at a cost of $2,750 and was sold in 1919 and 1920 for $3 per thousand, amounting to $6,187.27, the petitioner realized one-half of the profit thereof, and should be charged therewith.

A deduction is also claimed in the sum of $5,562.50 for the year 1921, being for one-half of the value of 2,225,000 feet of timber destroyed by storm on May 9, 1921, at $5 per thousand feet.

Losses of this character are governed by section 214(a)(6) of the Revenue Act of 1921, as follows:

Losses sustained during the taxable year of property not connected with the trade or business if arising from fires, storms, shipwreck, or other casualty, or from theft, and if not compensated for by insurance or otherwise.

The rule governing the measure of such losses is this: In the case of property acquired by gift, bequest, devise or descent, the basis for computing loss is the fair market price or value of the property at the date of acquisition, and not at the time of loss. .

Petitioner's loss on her one-half of the 2,225,000 feet of lumber destroyed by the storm in 1921 was $3,893.75, based on a valuation of $3.50 per thousand feet at the time of acquisition and respondent should allow this as a deduction from gross income in computing petitioner's deficiency for said year 1921.

Reviewed by the Board.

Judgment will be entered under Rule 50.