Jacobs v. Commissioner , 20 B.T.A. 529 ( 1930 )

E. LOUIS JACOBS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Jacobs v. Commissioner

Docket No. 26249.

United States Board of Tax Appeals

20 B.T.A. 529; 1930 BTA LEXIS 2097;

August 11, 1930, Promulgated

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1. An elder brother agreed to purchase a hotel property at a price asserted to be less than its true value. With the intention of conferring a benefit, he caused the property to be conveyed to a younger brother, who agreed to assume and pay the purchase price and an additional amount. Upon a sale by the younger brother, he claims a gift was made and that profit should be computed by using as a base the value of the property when acquired. Denied, upon the grounds (1) that the transaction lacked one of the elements of a gift, i.e., absence of a valuable consideration; and (2) that the evidence fails to establish that the property had a value clearly in excess of the amount paid by petitioner.

2. Quaere, whether in such circumstances the value of the property, if established to be clearly in excess of the amount paid, could be used as the basis for computing gain or loss, the transaction having occurred prior to January 1, 1921. "It could be done, if at all, only where the evidence of a gift and its value is most convincing."

3. Opinion evidence discussed and held, in the circumstances of the case, to be less reliable evidence of value than bona fide sales of the property in question.

Laurence Arnold Tanzer, Esq., and James Craig Peacock, Esq., for the petitioner.

Bruce A. Low, Esq., and Leslie H. Rushbrook, Esq., for the respondent.

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PHILLIPS

Respondent has determined a deficiency for the year 1923 in income tax of $11,733.58. It is alleged that respondent erred in including in petitioner's net income a capital gain of $110,646.56, representing the supposed profit on the sale of real estate based on the supposed cost of $885,750.

FINDINGS OF FACT.

Petitioner, an individual who resides at Woodmere, Nassau County, State of New York, is a lawyer engaged in active practice in New York City, and is married and the father of three children, all of whom are infants. He is the youngest of a family of brothers and sisters, of whom Samuel K. Jacobs was next to the oldest. At the times hereinafter mentioned Samuel K. Jacobs was unmarried and was an extensive operator of real estate in the city of New York and wealthy. He had stood in the relation of a parent to his brothers and sisters, including petitioner.

Prior to 1919 one Rankin, who was in that year about 78 years of age, acquired under foreclosure proceedings the Hotel Girard, which is a 13-story building constructed of steel, brick and stone, and situated on a lot 100 by 100 feet on West 44th Street between 6th Avenue and Broadway, New York City. The property was operated under a lease which expired April 1, 1920. The lessee was the owner of the furnishings and personal property in the hotel. At the time of the purchase, hereafter set forth, of the hotel by petitioner it was in a bad physical condition, it had acquired a very unsavory reputation, and had often had trouble with the police. It was closed by the police in November, 1919, for the reason that it had been used for immoral purposes. It remained closed until after the expiration of the lease mentioned above. Because of these facts Rankin decided to dispose of the hotel. His outlays, including what he had paid on account of the operation of the hotel, amounted to from $700,000 to $725,000. He placed the property in the hands of one Sussman, a real estate broker, for sale, Sussman to receive a commission. Sussman formed a syndicate of four persons, composed of himself, one Banner, one Gilbert, and one Kramer, for the purpose of purchasing the hotel. The syndicate operated through the Urbis Realty Co. In the early part of the year 1919 the syndicate entered into a contract with Rankin to purchase the hotel for $725,000, to be paid in the following manner: $25,000 paid when the contract was signed, $75,000 to be paid on delivery of the deed, and a purchase money mortgage of $625,000 due in three years from date. The syndicate had 60 days in which to close the deal or forfeit the cash payment of $25,000. The syndicate entered into the transaction for the purpose of reselling at a profit. As a whole they were financially able to comply with the terms of the contract, but they were unwilling to do so.

About the middle of November, 1919, Sussman entered into negotiations with S. K. Jacobs for the sale of the hotel. These negotiations resulted in two contracts; one between S. K. Jacobs, the Keystone Hotel Corporation, and Gilbert & Kramer, dated January 17, 1920, and the other between Urbis Realty Co., the syndicate and Samuel K. Jacobs, dated January 21, 1920. The Keystone Hotel Corporation was a corporation under which one Thompson operated. Before entering into the contract of January 17, 1920, S. K. Jacobs instituted a thorough investigation of Thompson's standing. It was disclosed that Thompson was operating two hotels very successfully, and that his credit standing was excellent. Jacobs was assured that Thompson would be able to put up $50,000 as security for the performance of the terms of a lease upon the hotel and would expend about $20,000 in addition in the rehabilitation of the hotel. The contract between S. K. Jacobs and the Keystone Corporation and Gilbert & Kramer provided that whereas Jacobs had contracted to purchase the Hotel Girard, he and said hotel corporation would enter into a lease identical with a form attached. The contract provided that the hotel corporation had deposited with Jacobs the sum of $5,000, which was to be returned to the corporation if Jacobs could not obtain title to the property, in which event the contract would become null and void; that when Jacobs notified the hotel corporation that he was ready and able to execute the lease the corporation would deposit with him the further sum of $20,000, and on April 1, 1920, or on the date of acquiring possession, it was to deposit with him the further sum of $25,000, making $50,000 in all, to be used for the purposes set forth in the lease. It was also provided that if the hotel corporation failed to execute the lease Jacobs, or the record owner of the title, should retain as liquidated damages the said sum of $25,000 paid by the hotel corporation. The contract was to enure to the benefit of Jacobs, his assignees, and nominees, and provided that the record holder of the title should execute the lease. The Keystone Corporation by the same contract agreed to purchase from Gilbert & Kramer for the sum of $33,000, paid and to be paid, the furnishings and personal property in the hotel.

The lease to be executed by the Keystone Corporation was for the term of 21 years, beginning April 1, 1920. The tenant was to pay all charges, rents, and taxes against the property; to keep is insured and repaired and to pay as rent the sum of $80,000 per annum, payable in ten installments in each year on the twelfth of each month, except July and August. The lease contained a provision to the effect that upon failure to pay the rent when due or to pay any sum of money agreed to be paid the landlord could reenter with or without notice, by legal proceedings or by other means, and relet the premises. The lease further provided that the tenant should deposit with the landlord the sum of $50,000 (the sum heretofore referred to in the contract of January 17, 1920) as security for the payment of the rent and all other payments to be made by the tenant, the landlord to pay the tenant interest on the deposit at the rate of 4 per cent.

By the contract of January 21, 1920, the syndicate and Urbis Realty Co. agreed to seel and S. K. Jacobs agreed to purchase the land with the buildings thereon known as the Hotel Girard for the sum of $853,750, payable as follows: $5,000 cash then paid, the assignment of a bond secured by a mortgage on other property to the Silk Realty Co. in the amount of $175,000; and two notes of S. K. Jacobs, one for $20,000 due February 15, 1920, and the other for $28,750, due April 1, 1920, and subject to a first mortgage for $625,000, which bore interest at 5 per cent and was payable in five years and with a provision for the payment of the principal to the extent of $15,000 every six months and for an extension for an additional five years if the conditions of the mortgage had been complied with. It was also provided in the contract that if the Keystone Corporation failed to pay the additional sum provided for in its contract with Jacobs, then Jacobs had the option to rescind the contract of purchase and receive back all moneys paid and his notes and a reassignment of the mortgage to the Silk Realty Co., the sellers, however, to retain the $5,000 cash payment in lieu of the $5,000 received from the Keystone Corporation. The contract was subject to the further condition that it was to become void if the sellers could not obtain title from Rankin pursuant to their contract with him.

After the execution of the above two contracts S. K. Jacobs, with the intention of benefiting the petitioner by permitting him to obtain this property, entered into an oral agreement with him as follows: Petitioner was to receive the property subject to the mortgage for $625,000; he was to assume and pay to S. K. Jacobs the cash payment of $5,000 and the notes of the latter aggregating $48,750; he was to execute a second mortgage on the property for $175,000 to Walter Emerich & Co., of which S. K. Jacobs was a member and which owned the mortgage for $175,000 heretofore referred to; and he was further to execute a third mortgage on the property to S. K. Jacobs for $32,000, the latter amount arising from the following family matter: S. K. Jacobs was living in a house of the value of $32,000, which had been acquired through the death of an aunt and for which S. K. Jacobs felt that he should compensate his brothers and sisters. The money arising from the third mortgage was to be used for this purpose.

These transactions were closed by S. K. Jacobs making the cash payment, giving his notes and transferring the mortgage notes for $175,000 to the sellers, who executed and delivered a deed of the property to petitioner, who in turn executed the lease to the Keystone Hotel Corporation. Petitioner executed the mortgages he had agreed to execute and assumed and paid the cash payment and his brother's notes for $48,750.

Thompson took possession of the hotel; changed its name to the Hotel Langwell; installed new bathrooms; reconstructed the elevators; sand blasted the front; painted it inside and out; carpeted the floors, and made other changes and improvements, and spent in this way between $40,000 and $60,000, of which about $20,000 was furnished by petitioner or his brother. For a year or more Thompson paid his rent when due. Then he became in arrears in his payments to petitioner. By reason of these facts petitioner failed to pay the interest due in 1922 on the second and third mortgages. Petitioner offered the property for sale at $1,050,000 and sold it in the early part of 1923 for $950,000. The sale was made for a cash payment, the amount of which does not appear, subject to the first mortgage, which had been reduced somewhat, and a second mortgage for $300,000 to S. K. Jacobs, which was in lieu of the $175,000 mortgage to Walter Emerich & Co.; the $32,000 third mortgage and $32,000 or $33,000 which petitioner owed him; the balance, if any, realized upon the second mortgage to be paid to petitioner.

Respondent determined that this property cost petitioner $885,750 and after making adjustments for depreciation and expenses, computed a net profit of $110,646.50 on the sale.

OPINION.

PHILLIPS: During the taxable year petitioner sold property which he had acquired in 1920 at a cost to him of $885,750. It is the contention of petitioner that this property was acquired by him as a gift from his brother and that in computing his gain the fair market value, and not the cost, is to be used.

It seems clear that the brother never became the owner of this property. All that he had was a contract for its purchase. If there was any gift, it was of the contract to purchase the property and the contract for its lease. Even with respect to these there was an element of purchase, for petitioner undertook to pay his brother $32,000 in addition to the amount which the brother was obligated to pay; this $32,000 being secured by a third mortgage upon the property. The transaction lacks one of the vital elements of a gift, i.e., lack of a valuable consideration. ; ; ; ; ; ; ; ; ; ; ; ; ; . The most that can be said in favor of the contentions of the petitioner would be that because of the relationship existing between petitioner and his brother, petitioner acquired this property for an inadequate consideration and that the element of gift was involved to the extent of the difference between the value of the property and the price paid. Whether such difference could be added to the purchase price to arrive at the basis to be used in computing gain or loss, where the alleged gift was made prior to January 1, 1921, is a question which we find it unnecessary to discuss; certainly it could be done, if at all, only where the evidence of a gift and its value is most convincing.

It is the contention of the petitioner that at the time he acquired this property is was worth $1,000,000. To substantiate this value there have been offered the opinions of real estate dealers. If these opinions are to be accepted the value of the property was substantially in excess of the price paid. One of the witnesses was the broker who undertook to sell the property for Rankin and became a member of the syndicate which contracted to sell the property to S. K. Jacobs. At least two members of this syndicate could have carried out the terms of their agreement to purchase, yet they sold for $850,000 property which one of their members now says had a market value of $1,000,000. Several reasons for this are suggested, but none of them seem sufficient to justify the belief that a profit of $150,000 would have been passed on to Jacobs had the syndicate members felt assured that the property could have been disposed of for $1,000,000. No doubt Jacobs drove a close bargain; no doubt there were circumstances which induced the syndicate to accept a price less than their estimate of the price which might be obtained from some person who was desirous of purchasing this property; no doubt they were justified in asking $1,000,000 as a price for which they could find some support; the fact is that the syndicate, while desirous of selling, was under no overwhelming necessity to do so and certainly not laboring under any necessity of sacrificing such a substantial part of the market value.

It must be borne in mind that the testimony of this witness, as well as of the others, was given ten years after the date as of which this property is valued. Since that date values have increased substantially in the section in question. The doubt with respect to the future trend of price, which is always present, was a matter of the past. Looking back, they could see that prices had increased, while in 1920 there might be opinions, but certainly there could be no assurance, that prices would increase. At the time of the sale the witness was dealing with present and future values; at the time he give his testimony he was dealing with values of the past. The longer the period which has elapsed since the date as of which value is expressed, the less reliable is the opinion of value likely to be.

It must be remembered that we are dealing here with value at a particular date and not with intrinsic worth as disclosed by subsequent events. This value is most likely to be reflected in sales of the property, if freely made. In weighing the testimony of the first witness we are inclined to place greater weight upon the price at which he sold the property as reflecting his opinion at that time of its market value than upon the opinion which he expressed ten years later.

Another witness called by petitioner was the broker who sold the property for petitioner in 1923 for $950,000. He testified to an increase in values in this section of 20 to 25 per cent between 1920 and 1923; yet he was of the opinion that the property in question had a market value of $1,000,000 when acquired by petitioner in 1920. Questioned concerning the sale of property upon a neighboring street, he replied that this should not be taken into consideration; "there was a gambling house in there that had been raided and they sold it very cheap." Such an attitude upon the part of the witness indicates that he was either unfamiliar with the property here in question at the time the petitioner acquired it or ignored the fact that the hotel was in bad repute, had been raided and closed, was closed at the time petitioner acquired it and remanded closed until its operation was taken over by the new tenant and its name changed.

There is another factor which deserves mention. This property was in the middle of the block with Broadway on the west and Sixth Avenue on the east. Broadway and 44th Street were in the midst of the amusement center of New York; Sixth Avenue, with its elevated railway structure, was occupied by small stores and lofts. The Broadway value did not continue down the side streets; yet there can be no reasonable doubt that property on the side streets near Broadway had a value substantially in excess of that near Sixth Avenue. Such a situation leaves room for much divergence of opinion with respect to value of property lying between. Such divergence of opinion would normally be reflected in a sale and must be considered when value is in question.

As against the opinion testimony we have the evidence of actual sales of this property. The brother of petitioner contracted to pay $853,750 for it; petitioner paid $885,750; early in 1923 he sold it for $950,000 and later in that year or in 1924 it was again sold for $1,050,000. There is testimony that between 1920 and 1923 there was an increase of from 20 to 25 per cent in values and, while there is a conflict on this point, it is fair to assume that there was some increase. In 1920 the hotel was closed and its reputation was bad; in 1923 this was no longer so. Those who sold in 1920 were under no necessity of selling at any susbtantial sacrifice; the petitioner, in 1923, was under pressure to sell, but, in view of the interest of his wealthy brother, can not be said to have been in the position of making a forced sale. The failure of previous owners to operate the property successfully, its reputation, the fact that it was closed and its location all serve as speculative elements to make the value difficult of exact measurement. The price paid by petitioner and the values stated in the opinion testimony are within the range of difference which might be expected of reasonable men in these peculiar circumstances. The price paid is not out of line with subsequent sales, while the values stated in the opinion testimony are. We are of the opinion that the price paid by petitioner more nearly represented a fair price in an open market than the value now claimed. Certainly the proof of an excess value over the price paid is not so clear and convincing in this case as to require that what appears to be a purchase shall be treated as a gift. See ; .

We do not intend to indicate that S. K. Jacobs sold this property to petitioner in order that he might realize a profit of $32,000 or that he would have been content to have sold it to another on the same terms. Unquestionably he wished to benefit his brother, but the principal benefit lay in the fact that here was property which could be acquired with an expenditure of little or no cash which if successfully operated would pay for itself and which if unsuccessful could probably be sold without loss. The proposition looked sound; it was the kind that petitioner was prepared to handle and of which his brother wished him to have the benefits. The purpose was beneficent, but in our opinion the proof fails to establish that any gift was involved which would permit the petitioner to use as a base, in computing gain or loss, an amount in excess of that which he paid.

Decision will be entered for the respondent.