Fairview Co. v. Commissioner , 13 B.T.A. 743 ( 1928 )

FAIRVIEW COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Fairview Co. v. Commissioner

Docket No. 11308.

United States Board of Tax Appeals

13 B.T.A. 743; 1928 BTA LEXIS 3188;

October 3, 1928, Promulgated

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The petitioner and the owners of certain land entered into agreements wherein it was provided that petitioner should subdivide and sell the land, the funds necessary for the development thereof, such as grading, laying sidewalks, installing water lines, sewerage, etc., to be furnished by petitioner. No commission was to be paid petitioner for the advancement of the funds for the development of the land, but after the owners of the land received from the sales of lots the scheduled price on each lot as same was sold, petitioner would be reimbursed for the development expenses (allocated to each lot sold, as agreed between owners and petitioner) and in addition thereto, a certain percentage of the remaining profits from such sale. Under certain specified conditions, the agreements could be terminated and, in the event thereof, petitioner would not be reimbursed for development expenses on the lots remaining unsold. Held, that the funds furnished by petitioner and expended for the development of the lots were of a capital nature and, consequently, not deductible from gross income.

A. L. Purrington, Jr., Esq., and Albert L. Cox, Esq., for the petitioner.

R. H. Ritterbush, Esq., for the respondent.

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LITTLETON

The Commissioner determined deficiencies in income and profits tax for the calendar years 1920, 1921, and 1923 in the aggregate amount of $7,423.86.

The question is whether certain expenditures made by petitioner in connection with the development and sale of lots constituted allowable deductions from gross income, or were capital expenditures. Petitioner claims them as deductions and the Commissioner as capital items.

FINDINGS OF FACT.

Petitioner is a North Carolina corporation with principal office at Raleigh.

August 12, 1919, Allen Brothers, a partnership engaged in the real estate business, and one B. G. Cowper entered into a contract for the subdivision, development and sale of 100 acres of land, located near the City of Raleigh and owned by Cowper.

Allen Brothers agreed to subdivide the land into lots and to put them into first-class salable condition by making improvements thereon intrinsically of a capital nature, namely, the grading of streets, laying of sidewalks, and the installation of water lines and sewerage. Cowper, the owner, agreed to schedule a price on each lot, the total amount of the scheduled price not to exceed $100,000.

None of the lots were to be sold by Allen Brothers for less than the scheduled price. Any lot, however, might be sold upon such terms of payment or sales price as the Allen Brothers should deem best, terms, however, to be not less than one-fourth cash, the balance payable in three equal annual installments of one, two, and three years, the unpaid balance on each lot to be secured by first-lien mortgage notes on such lot, to bear interest at the rate of 6 per cent per annum. Deferred installments could be discounted at 5 per cent for all cash. The notes given in payment for lots were to be accepted by Cowper at their face vale in settlement of so much of the sale price of the lots as was not paid in cash.

Profits on the sale of lots were to be determined as follows: Out of each lot sold, Cowper was to receive, first, the scheduled price, payable in cash, if such price was paid in cash. If such price was not paid in cash, Cowper was then to receive, first, the entire cash payment; secondly, so much of the first maturing notes as would, with the cash payment, aggregate the scheduled price. Allen Brothers were hen to receive that amount in excess of the schedule price as would equal the sums expended by them in the development of the particular lot sold together with the expenses incurred in connection with the sale of the same. All other moneys, notes or other effects received from the sale f each lot in excess of the schedule price and the development costs and marketing expense, as above mentioned, were to be divided 33 1/3 per cent to Cowper, 66 2/3 per cent to the Allen Brothers.

No commissions were to be charged by the Allen Brothers for making such sales, and all commissions paid other parties on account of sales were to be paid by Allen Brothers out of their share of the profits.

For the purpose of the division of profits the sale of each lot was to be considered as a separate sale and the division between the owner and Allen Brothers was to be made on the basis of each lot sold. Settlement for same (including schedule price, development expense and profits) should be made when the deed was delivered or as soon thereafter as was practicable.

The contract between Cowper and Allen Brothers was subject to cancellation upon the happening of either of two contingencies, viz: (a) B. G. Cowper had the option of terminating the contract, if the amount received from the sale for any period of years failed to aggregate that amount which would permit Cowper to receive an average of $12,000 per annum on account of his schedule price and share of the profits; (b) if Allen Brothers failed to dispose of the acreage within a period of 10 years at the price scheduled therefor. If the option specified in (a) were exercised, Allen Brothers were not to be reimbursed for the development costs incurred by them on account of each lot, their entire interest in the same being thus subject to forfeiture. If the contingency stated in (b) occurred, Cowper was to be under no obligation to Allen Brothers for costs incurred by them on account of the improvement of the lots.

Upon sale of any lot Cowper was to make good and sufficient deed therefor and to deliver same in accordance with the terms of sale as indicated. Rents, emoluments and other income received from the land while in the hands of Allen Brothers, pending sale thereof, were to be applied against the cost of developing the property. Rent paid by the Allen Brothers to Cowper was to be paid at the rate of $1,200 per year for the entire 100 acres, such rental payments being subject to charge, in favor of the Allen Brothers, as a part of the expense of development. All taxes and insurance on such acreage paid by the Allen Brothers were to constitute a part of the development cost. Taxes and insurance paid by Cowper were to be added to the prices of the acreage scheduled by Cowper.

It was distinctly understood and agreed that the fundamental and controlling condition of the contract was that Cowper should receive such schedule price (aggregating not more than $100,000) of the lots and also, in addition thereto, one-third of the excess left after deducting the cost of development and marketing, which was not to exceed $20,000, except if increased by mutual consent.

September 25, 1919, Allen Brothers entered into a similar contract with Ella S. Williamson for the subdivision, development and sale by Allen Brothers of approximately 63 acres of land owned by Mrs. Williamson, and adjoining the Cowper lands.

In February, 1920, a contract was entered into by anbd between petitioner and Allen Brothers whereby the petitioner agreed to furnish to the partnership of Allen Brothers the money deemed necessary to the development of the Cowper and Williamson properties. The Cowper and Williamson contracts with Allen Brothers were, therefore, made a part of petitioner's contract as to terms of sale. The consideration to be received by petitioner for the furnishing to Allen Brothers of the money necessary for the development of the properties was to be one-half of the profits to be derived by Allen Brothers, under the terms of the Cowper and Williamson contracts, from the sale of the lots. The profits from the sale of the Cowper and Williamson land due under petitioner's contract, were to be determined as follows: (1) The owners of such acreage were to receive their price for the lots as scheduled; (2) petitioner was to receive all amounts advanced and spent by it in the development of such acreage, such amount to be apportioned pro rata upon each lot; (3) Allen Brothers were to be paid 10 per cent of the gross receipts from the sales of each lot sold, such 10 per cent to cover the entire cost of advertising and commission on sales and all other expenses of sale; and (4) the balance of the moneys, notes or other effects received from the sale of such acreage - in excess of the schedule price to be paid to the owners and the development costs and expenditures to be paid to the petitioner - was to be divided 33 1/3 per cent to the owners of the acreage, 33 1/3 per cent to the Allen Brothers, and 33 1/3 per cent to the petitioner.

By virtue of a contract dated December 23, 1920, petitioner acquired title to the aforesaid Williamson acreage. Acquisition of this acreage resulted from the payment by the Allen Brothers partnership and petitioner of the price of such acreage as scheduled by Mrs. Williamson under the terms of her contract. As no settlement of the profits which would accrue from the sale of this acreage had been made at the time the Williamson-Fairview Co. (petitioner) contract was entered into, and inasmuch as the ipetitioner had not at the date of such contract received its development costs in coinnection with such acreage, it was provided that it should receive from the first moneys derived from the sale of such acreage, the payment of its development costs and expenses as incurred in connection with the sale of such acreage, the remaining receipts to be divided one-third to Mrs. Williamson, one-third to the Allen Brothers, and one-third to petitioner.

It waf further agreed in this contract that in case the profits accruing to Mrs. Williamson from such acreage during any calendar year did not amount to the sum of $3,000, the petitioner would then advance such sum, by way of anticipated payment of profits, as would bring the amount paid as profits and the amount advanced in anticipation to the sum of $5,000.

Mrs. Williamson was obligated in the contrct to accept at their face value, notes which had been received by petitioner as deferred payments upon the acreage.

Cowper died in the spring of 1920, and, in order that his estate could be settled, an agreement was made between his executor and the petitioner, whereby, in the early part of 1922, the lots remaining unsold at that time were conveyed to petitioner.

In its return of income for each of the years in question, the petitioner deducted from gross income all of the expenditures made in the particular year in connection with the development for sale by lots of the land covered by the Cowper and Williamson contracts. The parties are in accord as to the amounts expended.

Upon audit of the returns, the Commissioner determined that the development costs, being of a capital nature, were not deductible from gross income, but should be apportioned to the property benefited, that is, to the lots, and should be returned to the petitioner, by way of a capital return, in the year in which the sale of the specific property benefited occurred.

OPINION.

LITTLETON: The parties are in accord as to the amounts furnished by petitioner for the development of the Cowper and Williamson land for sale by lots and as to the allocation of those amounts to the lots improved, the question for decision being with respect to the deductibility thereof, that is, whether the amounts constituted capital expenditures or business expenses.

Petitioner contends that it is entitled to deduct from gross income for the year in which the expenditures were made, all sums expended for the development of the Cowper and Williamson land, without regard to the time when the lots were sold, and, in support of this contention, takes the position that (1) it was not the owner of the land subdivided, improved and sold, and consequently had no capital interest therein; and that (2) it was merely the selling agent for the owners of the land.

The Commissioner, on the other hand, contends that the amounts expended for the development of the land in question were of a capital nature and should be apportioned to the lots according to the benefit received, the amount thereof being returnable to petitioner in the year in which the sale of the specific property benefited occurred.

We think that it is unnecessary separately to discuss the positions taken by petitioner for the reason that, under the contract and arrangements made and entered into, they are not well taken. We are of opinion, however, that petitioner entered into a joint venture for the sale of the land in question and that the amounts expended for the development thereof constituted petitioner's contribution to the capital of the enterprise and as such are not deductible from gross income.

The evidence adduced shows that Cowper and Mrs. Williamson furnished certain land for subdivision and sale by lots; that petitioner furnished certain sums of money for the development and improvement of the land so that it would be readily salable; and that Allen Brothers furnished the selling organization. The profits derived from the sale of the lots were to be shared equally by the parties to the enterprise.

It is further shown that the owners of the land scheduled a price on each lot and that the development costs, borne by petitioner, were apportioned by the parties to the lots improved.

In determining the profit from the sale of any lot, among other things, petitioner was to be reimbursed, first, in the amount expended for the development thereof. In other words, petitioner's capital investment in the particular lot would be returned to it before the computation of any profit from the sale thereof. Under such circumstances, we think that the development costs borne by petitioner in connection with the land in question amounted simply to its contribution of capital to the joint venture or enterprise, by virtue of which contribution it was entitled to share in the profits thereof. Consequently, the amounts constituted capital expenditures, and, the mere fact that, under certain conditions as provided by its contract, petitioner might lose some of the amount so expended, does not in any way change the intrinsic nature thereof. .

Petitioner calls our attention to the decision of the Board in , and insists that it is controlling in the instant case, though admitting the question therein and that herein are not identical. We have examined the Birdsall case and are of the opinion that it is not in point, as the petitioner therein sold certain land on a commission basis solely.

We are of opinion, therefore, that the Commissioner's action with respect to the amounts expended by petitioner for the development of the land in question was correct, and it is approved.

We are unable to determine from the record the amount of the deficiency as to each of the years in question.

Reviewed by the Board.

Judgment will be entered under Rule 50.