Cochrane v. Commissioner , 23 B.T.A. 202 ( 1931 )

HENRY F. COCHRANE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Cochrane v. Commissioner

Docket No. 34435.

United States Board of Tax Appeals

23 B.T.A. 202; 1931 BTA LEXIS 1912;

May 13, 1931, Promulgated

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1. Held that numerous expenditures made by petitioner in a professional capacity as a lawyer on behalf of his clients are not deductible as ordinary and necessary business expenses of petitioner for the year in which the expenditures were made. Held, further, that amounts paid petitioner in the following year as reimbursement for such expenditures did not constitute income to petitioner in such year and should be excluded from income reported for that year.

2. An amount paid by petitioner to reimburse another of his clients for losses sustained by such client, due to petitioner's error in representing such client in a legal capacity, held to be deductible from petitioner's gross income of the year in which the amount was paid.

3. Claimed deduction on account of taxes on real estate disallowed in absence of evidence as to the nature of the taxes.

4. Claimed deductions on account of depreciation sustained on houses disallowed for lack of evidence.

5. Claimed deductions on account of expenditures on houses disallowed in the absence of evidence as to whether they constituted payments for repairs or capital expenditures.

6. The amount of rent received by petitioner from real estate held properly included in his gross income.

Henry F. Cochrne, Esq., pro se.

P. A. Bayer, Esq., for the respondent.

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MCMAHON

This is a proceeding for the redetermination of asserted deficiencies in income tax for the calendar years 1923 and 1924 in the respective amounts of $4,930 and $6,276.19.

It is alleged that the respondent erred in:

(1) Failing to allow as a deduction from gross income of 1923 an amount of $1,784.45, representing bad debts;

(2) Failing to allow as a deduction from gross income of 1923 an amount of $5,000 representing other business expenses;

(3) Failing to allow as a deduction from gross income of 1923 an amount of $5,000 representing taxes paid;

(4) Failing to allow as a deduction from gross income of 1923 an amount of $15,749.61 representing losses;

(5) Failing to allow as a deduction from gross income of 1924 an amount of $3,540 representing bad debts;

(6) Failing to allow as a deduction from gross income of 1924 an amount of $8,206.23 representing "loss from income from real property"; and

(7) Determining that there was a profit of $9,976.74 chargeable against the petitioner for the year 1924.

FINDINGS OF FACT.

The petitioner is an attorney engaged in the practice of law with offices at 62 William Street, New York, N.Y. He has practiced law in New York City for about 30 years.

Sometime in the month of August, 1923, Mrs. Eugene W. Candidus came to the petitioner and stated that her daughter, Mrs. Gesine W. Sullivan, was unhappily married and that she wanted some steps taken to obtain a divorce. Mrs. Candidus had been a personal friend of the petitioner and his family since 1896. Petitioner had done legal work for Mrs. Candidus for about 25 years. In dealing with her it was his custom to perform any services and make any reasonable disbursements which were necessary and then receive reimbursement from her for both services and disbursements as bills were rendered by him therefor. As Mrs. Sullivan was one of her heirs, Mrs. Candidus, who was the owner of a large amount of real and personal property, told petitioner that she wanted the divorce proceedings of her daughter conducted in a thorough manner so that no disagreeable consequences would arise afterwards. Mrs. Candidus' first suggestion was to obtain a divorce in the State of New York and she asked petitioner to investigate the behavior of her son-in-law. Petitioner refused to do this himself, but stated he would turn it over to others. Mrs. Candidus agreed that after the divorce was obtained she would pay the petitioner whatever expenses were involved. Accordingly, the petitioner turned the matter over to his brother-in-law, a Mr. Clark, who hired a detective agency to make an investigation. In 1923 the petitioner paid Clark and the detective agency $1,100 for the investigation. As a result of this investigation it was determined that Mrs. Sullivan could not get a divorce in New York. After Mrs. Candidus had received this report from the petitioner, she instructed him to study the laws of other States in order to find out where a divorce could be speedily obtained. Petitioner went to Rhode Island and to Philadelphia for this purpose. The expense incurred by the petitioner in this study of the laws of the other States was $1,128. Later Mrs. Candidus instructed petitioner to take steps to have the divorce obtained in Nevada. Petitioner informed her that he did not know any one in Nevada, but she instructed him to go there at once and get any assistance that he needed and that she would pay the expenses. Accordingly, in the early part of September, 1923, petitioner proceeded to Reno, Nev. Petitioner's railroad fare to and from Reno was $136. The trip lasted fourteen days. Petitioner estimates that other expenses brought that figure up to $200. He also estimates that he had additional expenses for meals, hotels and other expenses in an amount of $40 or $50.

Petitioner employed the law firm of Norcross, Thatcher & Woodburn in Reno to assist him in obtaining the divorce. He paid them a retainer fee of $500. Mrs. Sullivan immediately went to Reno to establish a residence there. At Mrs. Candidus' instruction, petitioner purchased the railroad tickets for Mrs. Sullivan and her maid. These cost petitioner $357.

About December 1, 1923, petitioner paid William Woodburn of the law firm in Reno an amount of $1,000 by check. Petitioner also sent Woodburn an amount of $25 or $30 as reimbursement for some expenditures which Woodburn had made.

At the request of Mrs. Candidus, petitioner made two other trips to Reno in 1923. These trips were rather extended and on each trip the petitioner took with him $1,000. Nearly all of the $1,000 was expended in each instance. The petitioner returned with about $18 on one occasion at least. A part of the money which petitioner expended while on these trips was for entertaining Mrs. Sullivan, who was in a nervous condition. Petitioner took her on trips to Carson City and Virginia City by automobile. He paid $20 for an automobile for one of these trips.

Petitioner did not customarily advance or expend moneys for his clients as he did for Mrs. Candidus.

On July 1, 1924, after the divorce had been granted, petitioner informed Mrs. Candidus that the expenses had been $5,000 and that his fee was $5,000. She immediately gave petitioner a check for $10,000. Petitioner reported this total amount of $10,000 as income in 1924, but did not claim any deductions therefrom on account of the incidental expenses, all of which had been paid in 1923.

In computing the deficiency for the year 1923, the respondent has failed to allow the claimed deduction of $5,000 as expenses in the matter of obtaining the divorce.

In 1923, petitioner rendered services for, and made disbursements on behalf of, the National Sugar Refining Company, for which they, in 1924, paid him $25,000. This payment of $25,000 was for services and disbursements in connection with the Van Nest litigation and for services in connection with certain income-tax refunds for the years 1919 and 1920. The petitioner returned the full amount of $25,000 as income in 1924 without deducting any disbursements. In 1923, the petitioner, in connection with the Van Nest investigation, spent $1,739.64 for railroad fares, sleeping-car accommodations, and for auditing the Van Nest books. Petitioner was not reimbursed in 1923 for any of these expenditures. In his income-tax return for the year 1923 petitioner claimed this amount as a deduction.

In October, 1923, the petitioner undertook to advertise and sell at auction a number of houses for one of his clients. The houses were advertised by the petitioner as being free of encumbrances. Later, after the houses had been sold, the purchasers contended that certain leases then existing on the properties were encumbrances and the purchasers rejected the houses. The houses were resold in November, 1923, and petitioner paid $10,000 as part of the expense of the resale. If petitioner had inserted the proper provisions in the advertisements the purchasers would have been precluded from rejecting jecting the houses and petitioner's client would have been protected, but as a result of petitioner's failure to properly advertise the houses his client suffered losses. Petitioner paid the $10,000 upon the ground that he had not properly protected the interests of such client.

As a result of the rejection by some of the purchasers of these houses, petitioner was compelled to purchase seven of these houses for $64,500. During the year 1924, petitioner received as rent from these houses $7,018. For the year 1924, the petitioner returned his income and that of his wife in a joint return. He received $2,958.74 as rent from certain property belonging to his wife. The total rent amounting to $9,976.74 was returned as income in the joint return for 1924, but petitioner claimed depreciation in the amount of $4,344; repairs in the amount of $9,118.97, and "other expenses" in the amount of $4,720, and showed a loss from these properties of $8,206.23. The respondent, in determining the deficiency, included in income the amount of $9,976.74, representing rent, and disallowed the claimed deductions.

Petitioner's wife owned a house upon which there was a mortgage of $18,000. Petitioner was guarantor on this mortgage. The property was in a dilapidated condition and city authorities threatened to tear it down. The petitioner thereupon expended, in 1923 and 1924, an amount of $6,402.92 upon this building. Of this amount $6,002.92 was expended in 1924. These payments were made by checks, the purposes of which are taken from the evidence, as follows:

1924	Paid to -	Object of expenditures	Amount
Jan. 22	B. Lane	Not shown	$300.00
Feb. 8	L. De Nicola	For carpentry work in repair
		of roof which had caved in,
		side of house which had caved
		in, and an awning that had
		fallen on street.	300.00
19	B. R. Meserole	Not shown	30.00
Mar. 10	B. C. Miller & Son	For jacking the house up to
		support the foundations	250.00
21	L. De Nicola	For carpentry work	500.00
Apr. 4	J. Mentz's Sons	For plastering walls	210.00
12	L. De Nicola	For carpentry work	200.00
17	John Treiber	Not shown	120.72
May 7	John F. Clark	do	100.00
7	Michael F. Farrell	do	28.00
15	Central Metal Ceiling Co	Installing of metal ceilings
		in the stores in the building.	260.00
23	L. De Nicola	General carpentry work	300.00
23	Michael F. Farrell	Plumbing work	75.00
June 4	Central Metal Ceiling Co	Further cost of metal ceilings	200.00
6	Matt Stockfleth	For excavation in rear of
		building to assist plumber	150.00
6	Michael F. Farrell	For plumbing	75.00
18	Matt Stockfleth	For assisting plumber	115.00
18	John J. Hillin	Not shown	89.00
July 8	John F. Clark	Expenditures made for a
		number of small bills, for
		plumbing, gas fixtures, and
		repairing the upper part of
		the house.
11	Jas. J. Holt & Sons	For work on windows and store
		fronts	$175.00
11	J. Mentz's Sons	Not shown	17.20
Sept. 11	Geo. H. Brunner	do	230.00
Oct. 9	B. Lane	do	175.00
23	Michael F. Farrell	For installing plumbing in
		the apartments	143.00
23	L. De Nicola	For carpentry work	200.00
27	O. H. Rieder	For putting stucco coating on
		outside of the house	600.00
31	L. De Nicola	For carpentry work	200.00
Nov. 14	O. H. Rieder	Not shown	400.00
21	John Jos. Carroll	For consultation with the
		board of health with regard
		to the plans for work on this
		house.
	Total		6,002.92

At least a part of this house was rebuilt as a result of these expenditures. There was put over the old frame walls of the house a stucco finish.

At some time the petitioner paid an amount of $7,000 representing taxes on his wife's property which were in arrears. In determining the deficiency for the year 1923 the respondent disallowed as a deduction $5,000 of the amount of $7,000 claimed in the return as taxes paid.

During 1924, the petitioner paid out money upon the seven houses which he owned. This money was paid out to comply with the requirements of the Board of Health and the Tenement House Department of the Borough of Brooklyn, City of New York. The money was spent to put in condition the hallways, stairways, the plumbing, the cellar, the windows and the steps. These expenditures were made in order to keep the tenants from moving out. Part of the expenditures was for new plumbing and fixtures which had been broken. Clark, petitioner's brother-in-law, informed the petitioner that he estimated that these expenditures amounted to $3,300.

In determining the deficiency in tax for 1923, the respondent disallowed as deductions bad debts in the amount of $1,784.45, other expenses in the amount of $5,000, taxes paid in the amount of $5,000, and losses in the amount of $15,749.61. In determining the deficiency for 1924, the respondent disallowed bad debts claimed in the amount of $3,540, and a claimed loss of $8,206.23 in the operation of real property, and added to the gross income of petitioner as rent the amount of $9,976.74.

OPINION.

MCMAHON: The petitioner, an attorney at law, claims that he is entitled to a deduction in the amount of $5,000 from his gross income for 1923 as ordinary and necessary business expense incurred and paid by him in obtaining a divorce for the daughter of one of his clients. In 1924 petitioner presented his bill to his client for $10,000, representing his fee of $5,000 and expenditures incurred in the amount of $5,000. In that year petitioner returned the full amount of $10,000 as income, but claimed no deductions on account of expenditures made in connection with obtaining the divorce. Section 214 of the Revenue Act of 1921 provides in part:

(a) That in computing net income there shall be allowed as deductions:

(1) All the ordinary and necessary expense paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while away from home in the pursuit of a trade or business; * * *

The evidence discloses that the petitioner, in 1923, paid $1,100 for the purpose of investigating the behavior of the party from whom his client's daughter wished to be divorced, $1,128 for investigation of divorce laws in various States, $1,525 for securing assistance of legal counsel in Reno, Nev.; $136 for his own railroad fare to and from Reno on his first trip; approximately $1,000 on each of two other trips to Reno, some of which was for automobile hire in the interests of his client's health; and $357 for railroad tickets for the daughter of his client and her maid.

After due consideration of all the evidence in this proceeding upon the expenditures made in obtaining the divorce, we are of the opinion that the above amounts did not constitute ordinary and necessary expenses of petitioner's business. The petitioner testified that in dealing with Mrs. Candidus, it had been his custom to perform any service and make any reasonable disbursements which were necessary and then receive reimbursement from her for both service and disbursements. Mrs. Candidus was desirous of speedily obtaining a divorce for her daughter and told petitioner to make any expenditures which were necessary and she would reimburse him after the divorce was obtained. When petitioner rendered his bill to Mrs. Candidus in 1924 he claimed $5,000 as his legal fee and $5,000 as expenses incurred in obtaining the divorce. We conclude that the amounts expended by the petitioner in obtaining this divorce constituted advancements by petitioner on behalf of Mrs. Candidus for which she had agreed to reimburse him. See ; and . No part of the $5,000 claimed by the petitioner as a deduction is therefore allowable.

In view of our holding above that the amounts expended by petitioner in obtaining the divorce constituted advancements by petitioner on behalf of Mrs. Candidus, it necessarily follows that when they were repaid to petitioner in 1924 they did not constitute income to him. The petitioner included in his income-tax return for 1924 the full amount of $10,000 representing, according to the bill which he rendered to Mrs. Candidus, $5,000 as petitioner's fee, and $5,000 representing reimbursement of expenditures made in obtaining the divorce. It clearly appears from the evidence that the advancements made by the petitioner on behalf of his client in the divorce proceeding, and which were repaid to him in 1924, amounted to at least $5,000. While the petitioner has not, in his pleadings, or elsewhere, requested that his gross income for 1924 be reduced by eliminating the $5,000 repayment, yet, that year being before us, it is our opinion that this should be done. Upon the redetermination the amount of $5,000 will be excluded from petitioner's gross income for 1924.

The petitioner also claimed in his petition that the respondent erred in failing to allow as a deduction from gross income of 1923 an amount of $15,749.61, representing losses. While we are without the benefit of a brief from the petitioner, we assume that the evidence regarding the expenditure of $1,739.64 and $10,000 is directed toward proving that allegation of error. The amount of $1,739.64 was spent for railroad fares, sleeping-car accommodations, and for auditing certain books of account, and was spent in rendering services to petitioner's client, the National Sugar Refining Company. The proof did not disclose the amount paid out for any one of these purposes or give us any further detail as to these expenditures. The National Sugar Refining Company paid petitioner, in 1924, for his services and disbursements. This amount of $1,739.64 was not an ordinary and necessary expense of petitioner's business, since it represented advancements on behalf of petitioner's client. It is therefore not deductible from gross income for 1923. However, it was clearly not income in 1924 and upon the redetermination it will be excluded from income of that year. The amount of $10,000 was paid by petitioner to one of his clients upon the ground that petitioner had not properly protected the interest of such client. The facts regarding this payment are set forth in our findings of fact. We regard this expenditure as an ordinary and necessary expense of petitioner's business and, therefore, deductible. On the latter point see .

The petitioner alleges that the respondent erred in failing to allow as a deduction from gross income of 1923 an amount of $5,000 representing taxes paid. The evidence discloses that the petitioner, at some time, paid $7,000 taxes in arrears on his wife's property. The evidence does not show when these taxes were paid. Since it is not shown that the taxes were paid in the year 1923, no deduction can be allowed from gross income of that year on this account. Furthermore, there is no evidence to show the nature of the taxes which were paid. Taxes assessed against local benefits of a kind tending to increase the value of the property assessed do not constitute allowable deductions. Section 214(a)(3) of the Revenue Act of 1921. As far as the record shows, the taxes paid may have been of this character. The action of the respondent in disallowing the claimed deduction of $5,000 must be approved.

The petitioner alleges that the respondent erred in failing to allow as a deduction from gross income of 1924 an amount of $8,206.23 representing "loss from income from real property." The petitioner arrives at this so-called loss by setting off against rent received in the amount of $9,976.74, depreciation in the amount of $4,344, repairs in the amount of $9,118.97, and other expenses in the amount of $4,720. In his last assignment of error the petitioner contests the respondent's inclusion in his gross income of rent in the amount of $9,976.74. The result of these two assignments of error is simply to attack the respondent's disallowance of deductions for depreciation, repairs, and "other expenses" in the amounts noted above, since the evidence discloses that the total rent received by petitioner in 1924 from his own real estate and that of his wife and returned on their joint return for 1924 was $9,976.74. This amount of rent received must, under the specific provisions of section 213(a) of the Revenue Act of 1924, be included in petitioner's gross income. We will therefore consider whether petitioner is entitled to the claimed deductions.

At the hearing petitioner contended that he sustained about $500 depreciation on each of the seven houses which he owned and that the remainder of the claimed depreciation was sustained on his wife's houses. However, no evidence was adduced as to the character of the houses, as to their probable length of life, or as to the cost of some of them. In the absence of such evidence, we are not in a position to determine the amount of depreciation which was sustained. Nor is there any evidence as to the character of the "other expenses" in the amount of $4,720, claimed by the petitioner in his return. At the hearing, the petitioner testified that his brother-in-law in 1924 made certain expenditures on the houses belonging to the petitioner while the petitioner was in Europe and that his brother-in-law estimated that these amounted to $3,300. In our opinion this is not sufficiently definite to allow us to fix the amount of a claimed deduction on account of repairs. Furthermore, the evidence is not specific as to the exact amount and character of the expenditures. Some of them may have been, and the evidence tends to indicate that some of them were, for replacements, alterations and improvements, which are additions to capital investment, the cost of which may not be applied against current earnings. See . Likewise, the petitioner has failed to prove his right to any deduction on account of repairs to buildings. Petitioner has introduced into evidence a list of checks which were drawn in 1924 to pay for expenditures on a house belonging to his wife. These expenditures amount to $6,002.92. Petitioner testified as to the purpose of some of these payments, but as to others he testified that he did not know the purpose. He testified that a part of this house was rebuilt as a result of these expenditures. From the evidence we can not determine what part of these expenditures were for repairs and what part were for alterations, replacements and improvements, and we are, therefore, unable to fix the amount of any deduction to which the petitioner is entitled on account thereof. The respondent's disallowance of the total claimed deductions of $8,206.23 must, therefore, be approved.

There was no evidence submitted as to assignments of error numbered 1 and 5 and the respondent's determination in those respects will be sustained.

Reviewed by the Board.

Judgment will be entered under Rule 50.