Lipsitz v. Commissioner , 21 T.C. 917 ( 1954 )

Morris Lipsitz and Helen Lipsitz, Petitioners, v. Commissioner of Internal Revenue, Respondent. Morris Lipsitz, Petitioner, v. Commissioner of Internal Revenue, Respondent

Lipsitz v. Commissioner

Docket Nos. 24799, 24800

United States Tax Court

21 T.C. 917; 1954 U.S. Tax Ct. LEXIS 267;

March 18, 1954, Promulgated

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Decisions will be entered under Rule 50.

Held: 1. Respondent's right to compute income by use of the increase in net worth method upheld.

2. In determining income by use of the increase in net worth method, the creation of a Maryland "ground rent" is not a transaction wherein income is realized in the absence of circumstances which cause the transaction to be in substance a purchase money mortgage. The interest retained by the creator of the ground rent is included on the net worth statement in an amount equal to the investment in the land.

3. Where taxpayer files a return and pays taxes under a fictitious name as well as his true name, the amounts of income reported and taxes paid in the fictitious name must be taken into account in computing any deficiencies.

4. Deficiencies in income tax for years 1938 to 1944, inclusive, determined. Deficiencies for each of such years proved by clear and convincing evidence to be due to fraud with intent to evade tax.

Llewellyn A. Luce, Esq., and Walter H. Maloney, Esq., for the petitioners.

J. Nelson Anderson, Esq., for the respondent.

Raum, Judge.

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RAUM

The Commissioner determined deficiencies and additions to tax under section 293 (b) of the Internal Revenue Code, as follows:

			Addition to tax
Year	Docket No.	Deficiency	section 293 (b)
1938	24800	$ 898.38	$ 449.19
1939	24800	3,383.58	1,691.79
1940	24800	1,935.84	967.92
1941	24800	28,840.61	14,420.31
1942	24799	7,712.56	3,856.28
1943	24799	6,146.71	3,073.36
1944	24800	7,733.94	3,866.97
1945	24799	2,515.57	1,257.79
Total		$ 59,167.19	$ 29,583.61

The determination in Docket No. 24799 was made against Morris Lipsitz and Helen Lipsitz, since joint returns were filed for the years 1942, 1943, and 1945. Docket No. 24800 involves deficiencies against Morris Lipsitz, individually. The principal issues are whether the Commissioner was justified in resorting to the net worth method, and whether there were deficiencies that were due to fraud with intent to evade tax.

FINDINGS OF FACT.

All facts stipulated by the parties are incorporated herein by this reference.

The petitioner Morris Lipsitz is an individual who during the years here involved has resided at 4201 Fernhill Avenue, in Baltimore, Maryland. The petitioner Helen Lipsitz is the wife of Morris Lipsitz and has resided with him at the above address during all the years relevant herein. Morris Lipsitz filed individual Federal income tax returns for the years 1938, 1939, 1940, 1941, and 1944 and joint Federal income tax returns together with Helen Lipsitz for the years 1942, 1943, and 1945 with the collector of internal revenue at Baltimore, Maryland. Morris Lipsitz will be sometimes hereinafter referred to as the petitioner.

Morris Lipsitz is a citizen of the United States. He immigrated to this country in 1904 with his parents and five brothers and sisters. He engaged in the wholesale grocery business with members of his family and continued in that business until 1913. For a period of several years thereafter he was engaged in the liquidation of that business. Commencing about the year 1920, Lipsitz invested in real estate in Baltimore, Maryland. Sometime about 1930, he invested in and began operating a lumber and builders' supply business, known as the Northwestern Lumber Company. In 1930, he also invested in and began to operate a funeral supply business, known as the Northwestern Funeral Supply Company. From 1932 to 1941 he also engaged in the ice business, owning and operating ice manufacturing plants and ice stations in the city of Baltimore. An ice station is a refrigerated building used as a distribution and storage center and not for manufacturing ice. Lipsitz' real estate activities have been extensive. He owns or has owned many properties, which he holds for rental as residences, and "ground rents" in the State of Maryland which provide him with income.

Lipsitz purchased many properties which were in an old and run-down condition. He then repaired, improved, and rehabilitated them, making them available for rental. He ordinarily used supplies from the Northwestern Lumber Company in making such repairs. Since 1941, his only business activities have consisted of dealings in real estate.

Early in 1930, Lipsitz purchased a going lumber business at 1400 Winchester Street in Baltimore. He paid the owner of the business between $ 100 and $ 200 for the machinery and lumber and operated it under the name "Northwestern Lumber Company," referred to above. He purchased the property at 1400 Winchester Street and received a deed thereto, made to him and his wife, as tenants by the entirety, on July 7, 1930. The cost of the land and buildings thereon was $ 7,100. By entering into such business, Lipsitz intended to make use of the purchased lumber and supplies and other lumber and supplies, which he would be in a position to purchase at wholesale prices, in repairing his real estate properties. From 1930 to 1937 the lumber was stored on the premises. Thereafter, whatever supplies that were on hand were stored on other properties which he owned. Lipsitz also purchased, from time to time, additional machinery and equipment for the lumber business. As of June 1, 1937, the fair market value of machinery and equipment (exclusive of lumber and supplies) in the lumber business was $ 9,690. He reported income from the Northwestern Lumber Company in his income tax returns for the years 1933 to 1936, inclusive, as follows:

1933	$ 468
1934	362
1935	375
1936	275

On October 18, 1932, Lipsitz made an application for a loan from the Union Trust Company of Maryland. The application stated that he traded as the Northwestern Lumber Company and was in the lumber and building supply business and ice manufacturing business. It gave his financial status as of July 1, 1932, as follows:

Assets	$ 111,387.66
Liabilities	9,800.00
Net worth	$ 101,587.66

Lipsitz gave up his lumber business activities in 1937. Some of the lumber and building supplies were sold at a public auction conducted on the lumber company's premises on July 29, 1937. Some of woodworking machinery owned by Lipsitz was sold prior to that time in private sales and some of the remainder was disposed of at the auction. On December 31 of each of the years listed petitioners owned woodworking machinery which had a cost or other basis as follows:

Dec. 31
1937	$ 3,000
1938	2,000
1939	1,000
1940	0

The lumber and building supplies remaining after the sale were stored by Lipsitz on other property which he owned. The property at 1400 Winchester Street was disposed of in an exchange, with his brother-in-law, Louis Shane, which will be considered hereinafter. On December 31 of each of the years listed petitioners owned building supplies including lumber and materials which had a cost or other basis, as follows:

1937	$ 18,500
1938	16,000
1939	14,000
1940	12,000
1941	10,000
1942	$ 8,000
1943	6,000
1944	4,000
1945	2,500

The decrease in the amounts of such materials from year to year was due to sales and use of the materials in repairing property owned by petitioners. No income arising from such sales was ever reported in petitioners' income tax returns.

In connection with his lumber business Lipsitz established a funeral supply business, under the name "Northwestern Funeral Supply Company," referred to above. While in this business, he accumulated a stock of miscellaneous funeral supplies, which he liquidated starting in 1937 until 1941. The cost of petitioner's funeral supplies in stock on various dates was as follows:

Dec. 31
1937	$ 7,000
1938	5,000
1939	500
1940	0

Petitioners owned a number of properties, consisting of land and buildings, referred to herein as fee simple interests; they also owned a number of buildings on land owned by others, subject to ground rents, referred to herein as leaseholds. These properties were held for rental by petitioners. In order to prepare them for rental, repairs and improvements were made thereon. In making such repairs, Lipsitz used his own labor and his son's labor. When other labor was needed, cheap nonunion labor was hired and Lipsitz acted as his own contractor. Materials from his building supply business were used and such materials were acquired at a cost lower than the normal cost to a builder or a contractor. Some of the repairs were ordinary expenses; others were capital expenditures. The methods used by Lipsitz in repairing or remodeling his properties were not similar to the methods that would be used by building and remodeling contractors, and resulted in a cost to Lipsitz considerably less than the cost would have been if such work had been performed by usual methods.

The following schedule represents the cost or other basis (together with the reserve for depreciation) of fee simple properties, including capital expenditures for improvements thereon, owned by petitioners on the dates listed:

	Fee simple	Reserve for
Dec. 31	property	depreciation
1937	$ 59,535.96	$ 11,313.20
1938	59,965.96	12,476.53
1939	59,965.96	13,645.89
1940	61,124.29	14,815.25
1941	66,394.29	15,400.69
1942	147,473.82	15,836.68
1943	145.948.82	18,102.57
1944	139,686.32	19,029.88
1945	136,731.32	19,988.10

The following schedule represents the cost or other basis (together with the reserve for depreciation) of leasehold properties, including capital expenditures for improvements thereon, owned by petitioners on the dates listed:

	Leasehold	Reserve for
Dec. 31	properties	depreciation
1937	$ 25,209.42	$ 8,632.11
1938	25,209.42	9,380.29
1939	25,209.42	10,128.47
1940	25,209.42	10,876.65
1941	16,043.53	250.84
1942	4,726.53	302.81
1943	4,726.53	444.61
1944	2,876.53	406.03
1945	1,425.00	307.25

In 1925 and 1928, Lipsitz acquired some leasehold interests in property on St. Peter Street and Carroll Street in Baltimore. A few years prior to 1938 Lipsitz ceased paying real estate taxes on that property and had no intention of later resuming such payments. The property was vacant and rental of it was almost impossible. Lipsitz intended to and did abandon his interests in such property prior to December 31, 1937.

In addition to fee simple and leasehold interests, petitioners purchased some ground rents and created other ground rents out of properties in which they had fee simple interests.

Petitioners' investment in ground rents purchased by them, as of December 31 of each year involved, was as follows:

Dec. 31
1937	0
1938	$ 7,050.47
1939	20,189.89
1940	34,185.91
1941	69,013.12
1942	$ 78,977.71
1943	80,072.15
1944	98,723.51
1945	107,420.72

Petitioners' investment in property with respect to which they created ground rents, as of December 31 of each year involved, was as follows:

Dec. 31
1937	0
1938	0
1939	0
1940	0
1941	$ 2,353.33
1942	$ 5,662.62
1943	6,362.62
1944	6,362.62
1945	7,879.29

Petitioners had at the dates indicated investments in automobiles, used for business purposes, at cost, together with a reserve for depreciation, as follows:

		Depreciation
Dec. 31	Cost	reserve
1937	$ 760.00	$ 304
1938	760.00	456
1939	760.00	608
1940	760.00	760
1941	1,760.40	191
1942	$ 1,760.40	$ 382
1943	1,760.40	573
1944	1,760.40	764
1945	1,760.40	955

By a deed dated December 15, 1932, the petitioners, as tenants by the entirety, acquired an undivided one-half interest in two lots, and improvements thereon, located at 423-425 West Cross Street in Baltimore. The remaining undivided one-half interest in that property was acquired by Louis and Minnie Shane, as tenants by the entirety. The consideration paid for the property by Louis Shane and Lipsitz was $ 1,500. Louis Shane is a brother-in-law of Morris Lipsitz.

On March 28, 1933, the Warner Ice Manufacturing Corporation, hereinafter referred to as Warner Ice, completed its process of incorporation, under the laws of the State of Maryland. The incorporators were Morris Lipsitz, Louis Shane, and Minnie Shane. The corporation had an authorized capital stock of 100 shares of common stock with no par value, but 132 shares were issued. Louis Shane and Morris Lipsitz owned all of such stock, except for so-called qualifying shares, in equal amounts.

By deed dated March 29, 1933, "in consideration of the sum of Five Dollars ($ 5.00) and other good and valuable considerations," the property at 423-425 West Cross Street was transferred to Warner Ice. The cost basis of the buildings on that property to Warner Ice, as reflected in its income tax return for 1933, was $ 4,390.10. The land at 423-425 West Cross Street had a cost basis to the corporation of $ 1,500.

On September 23, 1933, Warner Ice acquired the adjacent property at 421 West Cross Street, subject to an annual ground rent of $ 35, at a cost of $ 1,889.10. Machinery and equipment for an ice plant were installed in the property at 421-423-425 West Cross Street at a cost of $ 28,040.28. Such machinery and equipment had a useful life of 20 years.

As of December 31, 1936, Warner Ice had a deficit of $ 3,519.29, and owed Lipsitz $ 9,500 for back compensation. Its balance sheet, as of December 31, 1936, as disclosed on its tax return for 1936, is as follows:

Current Assets			Liabilities
Cash	$ 2,851.57		Taxes	$ 622.71
Accounts			Due officers	19,000.00
receivable	616.49		Capital stock:
			Common	13,200.00
Total		$ 3,468.06	(Less --
			deficit)	(3,519.29)
Capital Assets
Buildings	$ 6,429.20
Machinery and
equipment	28,040.28
Furniture and
fixtures	118.71
Delivery
equipment	606.67
Total	$ 35,194.86
Less reserve for
depreciation	9,631.11
Balance		25,563.75
Other Assets
Due for capital stock		271.61
			Total
Total Assets		$ 29,303.42	liabilities	$ 29,303.42

Lipsitz, in 1932, constructed a building on the property at 1400 Winchester Street (referred to above). The building was erected with Lipsitz acting as his own contractor, using supplies and materials which he purchased at wholesale prices through his lumber and builders' supply business. The cost of the construction was $ 10,000. Complications arose in the construction of such building in relation to the construction permit and zoning regulations of the city of Baltimore. It was necessary for Lipsitz to retain legal counsel to represent him in the matter and, in so doing, he incurred a cost of $ 2,500. The building when constructed was leased as an ice plant to Shane. The machinery therein was purchased by and installed on behalf of Shane; it did not belong to Lipsitz.

On June 30, 1934, the real estate at 672 West Franklin Street, in Baltimore, was purchased by Lipsitz in the name of Helen Berkowitz, the maiden name of petitioner Helen Lipsitz. This property was purchased subject to an annual ground rent of $ 60. The cost of such property was $ 150. Machinery was installed to equip the building for use as an ice station at a cost of $ 1,000.

On August 25, 1935, Lipsitz and Shane purchased property at 530-532 Wilson Street. The cost of such property, which included land and a frame building, was $ 4,400. The frame building was replaced during 1935 and 1936 by a cinder block building and machinery was installed at an aggregate cost of $ 1,000.

During the year 1936, Lipsitz purchased, for $ 250, property at 1418-1420 McHenry Street, in Baltimore. A building was constructed thereon at a cost of $ 1,500. The building was equipped for use as an ice station at a cost of $ 1,500.

Toward the middle of 1937 Lipsitz and Shane came to a parting of the ways, and by agreement they undertook to divide their various assets and properties relating to the ice business. Pursuant to the understanding reached between them, Lipsitz, on or shortly prior to June 30, 1937, acquired Shane's one-half interest in the stock of Warner Ice, thereby becoming the sole stockholder. Lipsitz, in turn, transferred to Shane the property at 1400 Winchester Street and the Lipsitz interest in 530-532 Wilson Street. Immediately upon becoming the sole stockholder of Warner Ice, Lipsitz, on June 30, 1937, caused the corporation to be liquidated. The assets thus acquired by him had a fair market value of $ 36,000 at that time. He continued to operate the business as a sole proprietorship, referred to at times as the Warner Ice Company. In connection with that business, he purchased late in 1937 nearby property (at 1010-1012 South Fremont Avenue) for $ 150, and thereafter in 1938 constructed a garage on it at a cost of $ 3,000. After liquidation of the corporation, Lipsitz in 1937 and 1938 made improvements on the Warner ice plant at 421-425 West Cross Street for which he paid a total of $ 6,000, one-half in each of those years. From 1938 to 1940 miscellaneous capital additions to the Warner Ice Company business and improvements to the plant were made at a cost of $ 2,000. In 1939, Lipsitz purchased an outstanding interest in the lot at 423-425 West Cross Street for $ 250.

On February 27, 1938, a fire causing minor damage occurred at the plant of the Warner Ice Company. Some of the office equipment and interior woodwork were partially burned.

In 1940, the McHenry Street properties were abandoned. The total cost of those properties as set forth was $ 3,250. As of December 31, 1939, their adjusted basis due to depreciation allowed or allowable was $ 2,890.

On May 1, 1941, petitioners sold all their interests in their various ice businesses and properties to the Merchants Terminal Corporation for $ 57,500, including not only the Warner Ice Company assets, but also the ice station at 672 West Franklin Street and related assets. The sale was not reported on any Federal income tax returns filed by petitioners.

The petitioners' net interest (reflecting cost or other basis, adjusted for additions, abandonment, and depreciation) in their various ice businesses and properties at the dates indicated was as follows:

Dec. 31
1937	$ 42,165.92
1938	45,704.75
1939	45,433.58
1940	$ 40,142.51
1941	0

No part of the foregoing assets relating to the ice business is reflected in any other schedule herein setting forth petitioners' interests or investments in fee simple property or any other kind of property.

The petitioners had the following amounts of cash on deposit in banks on the dates listed:

Dec. 31
1937	$ 14,027.86
1938	21,100.21
1939	33,190.25
1940	27,478.25
1941	11,208.82
1942	$ 13,776.75
1943	6,204.36
1944	16,005.00
1945	27,377.42

Lipsitz built a vault in the cellar of his residence at 4201 Fernhill Avenue in Baltimore. Two large safes were installed inside that vault. Such safes were used, from time to time, to hold deeds and various documents and records. No cash was in the safes on December 31, 1937, or on December 31 of any of the years in controversy.

Petitioners had on the dates indicated the following amounts invested in building and loan associations:

Dec. 31
1937	0
1938	$ 9.22
1939	9.38
1940	11,529.90
1941	18,115.57
1942	$ 3,162.56
1943	3,276.35
1944	3,616.47
1945	3,695.13

The following represents amounts expended by Lipsitz for United States Government bonds, issued either in his name or in the names of his wife and children, which were outstanding as of December 31 of each of the years indicated:

Dec. 31
1937	0
1938	$ 1,500.00
1939	1,500.00
1940	1,500.00
1941	1,575.00
1942	$ 1,912.50
1943	2,475.00
1944	2,943.75
1945	2,981.25

A $ 500 series G bond issued in the name of Lipsitz was inherited by him from his father and is not included in the foregoing tabulation.

In 1925, petitioners invested in stock of the Sun Mortgage Company. Such stock was issued at $ 1.41 per share for no-par common stock and $ 50 per share for preferred stock. The stock became worthless prior to December 31, 1937.

In 1935, the petitioners made a loan in the amount of $ 20,000 to Benjamin Lipsitz, a brother of Morris Lipsitz. The loan was made to enable Benjamin Lipsitz to enter into the wholesale grocery business. The loan was never reflected in the books of Benjamin Lipsitz or in reports made by him to Dun & Bradstreet, a mercantile credit reference establishment. The loan was repaid by payments of cash and customers' checks as follows:

Year	Amount paid
1938	$ 5,000
1939	5,000
1940	10,000

No interest was paid on the loan. Petitioners had no other loans receivable as of December 31, 1937, or at any other time during the taxable years except as indicated below.

In 1940, Lipsitz received from a Mr. Levinson an assignment of a mortgage note for $ 1,600 owed by one Jack Jones. The mortgage had been given in 1937, and the loan had been paid off in part by 1940, when it became in default. Lipsitz purchased the mortgage from Levinson in order to prevent Levinson from foreclosing on Jones, who was a friend of Lipsitz'. Lipsitz paid $ 1,000 for the mortgage on which he received payments as follows:

1941	$ 250
1942	250
1943	250
1944	250

Petitioners had investments in mortgages receivable apart from the aforementioned Levinson mortgage, in the following amounts at the dates indicated:

Dec. 31
1941	$ 38,174.52
1942	28,859.70
1943	14,880.53
1944	$ 8,105.16
1945	4,312.09

Petitioners had outstanding liabilities for mortgage loans payable as follows on the dates indicated:

Dec. 31, 1942	$ 40,000
Dec. 31, 1943	2,000

Petitioner received from purchasers of property sold by petitioners amounts intended to be used for payment of taxes, insurance, and the like on the purchased property. Petitioners on December 31 of each of the years listed had the following amounts of such payments which had not yet been used for the intended purposes:

Dec. 31
1942	$ 300
1943	300
1944	300
1945	300

During the period when he was attending high school, the petitioners' son, Alvin, worked for Lipsitz. His work consisted of making repairs on the property owned by petitioners, making collections of rent, and the like. He graduated from high school in 1940, and he continued working for his father. Alvin was in the Army from September 1943 to January 1944, when he became an employee of the Atlantic Wholesale Grocery Company. However, he continued to work for his father after hours and on weekends. Beginning in 1942, Lipsitz, at Alvin's request, withheld $ 1,500 per year from Alvin's salary and gave him notes therefor. Such notes were noninterest bearing. This practice was followed over the 5-year period 1942-1946. In 1947, Lipsitz repaid Alvin the $ 7,500 which he thus owed by making a payment towards the purchase of a house for Alvin.

For the years 1942-1945, inclusive, petitioners filed, or caused to be filed, income tax returns as follows:

Year	Name	Net income	Tax payable
1942	Morton and Lorraine Pilstiz	$ 2,157.62	$ 414.68
1943	Morton and Lorraine Pilstiz	3,326.76	322.05
1944	Morton Pilstiz	3,948.32	608.00
1945	Mrs. Morton Pilstiz 4,062.17	978.04

These returns all listed, as the address of the taxpayers, 4201 Fernhill Avenue, Baltimore, Maryland. The income reported on the returns and the deductions claimed thereon were all attributable to a 4-story brick apartment building at 31 West Lexington Street in Baltimore. No personal exemptions or deductions were claimed on the returns for 1942 and 1943. Two exemptions were claimed on the 1944 return which was signed only by "Morton Pilstiz." The 1945 return of "Mrs. Morton Pilstiz" listed only a personal exemption and took advantage of the standard deduction. In answer to the question "Is your wife (or husband) making a separate return for 1945?", the return states "? separated -- Whereabouts Unknown."

The property at 31 West Lexington Street was purchased by petitioners in the names of "Morton Pilstiz and Loraine Pilstiz." The contract for the purchase was executed by petitioners on June 17, 1942. On May 29, 1942, the petitioners purchased another property in Baltimore under the name of "Pilstiz." Income from that property was not reported on the "Pilstiz" returns. Petitioners also used the fictitious names "Fred Jacobi," "Vernon Birk," "Regine E. Eisenstover," and "Morton Lipps," in purchasing property. They never filed tax returns under those names. At an early conference between Lipsitz and the special agents, Lipsitz stated that he owned property only in his own name or the name of "Pilstiz." The agents in the course of their investigation discovered that petitioner owned property in the aforementioned fictitious names, and this fact was later admitted by Lipsitz. The Pilstiz returns for 1942, 1943, and 1944 were signed and filed by one of petitioners' sons; the return for 1945 was signed by Helen Lipsitz; these returns were signed and filed under the direction of Lipsitz and on his behalf.

On March 4, 1946, the income tax return of Morton Pilstiz for the year 1944 was referred for investigation to Thomas B. Carney, a special agent of the Bureau of Internal Revenue. In the course of his investigation Carney discovered that Lipsitz represented Pilstiz in the purchase of the property on West Lexington Street. Carney, on March 6, telephoned the address shown for Pilstiz on the 1944 return and asked to speak to Morton Pilstiz. The person who answered the phone acknowledged that he was Pilstiz. When told that Carney represented the Bureau of Internal Revenue and was investigating Pilstiz' tax liability, the person again inquired as to whom Carney wished to speak and upon being informed that Carney wished to speak to Pilstiz, the person told Carney that he was Morris Lipsitz, a good friend of Pilstiz, and that he would come to Carney's office to take care of any tax difficulties that might arise. An appointment was made for March 8, 1946.

At the conference on March 8, at which another special agent was present, Lipsitz stated that he met Pilstiz while traveling in Canada and they had become close friends. He stated also that he had represented Pilstiz in the purchase of the Lexington Street property and had managed it for him without commission. He told the agents that Pilstiz was in North Carolina or another place and was separated from his wife. He also gave descriptions of Pilstiz and his wife which were unlike the descriptions of himself and his wife.

On March 12, 1946, Lipsitz again went to Carney's office and spoke in terms of a Mr. Pilstiz who was someone different than himself. On March 14, Lipsitz, together with his then attorney, once more went to the office of Carney and, during the conference that ensued, voluntarily admitted that Pilstiz was a fictitious name and that he filed returns under that name for 1942 to 1945, inclusive. At the request of Carney, Lipsitz executed an affidavit containing that admission and turned it over to Carney. Lipsitz' attorney informed Carney that an accountant had been retained by Lipsitz and that a return for 1945 would be filed incorporating the income on the Pilstiz return with Lipsitz' other income for the year 1945. Such a return for Morris and Helen Lipsitz was filed the next day, March 15, 1946.

Following the March 14 conference, Carney along with a revenue agent began an investigation of petitioners' tax liability. On or about March 14, 1946, Carney requested Lipsitz to furnish a list of all of the assets owned by him and his wife, all books and records, canceled checks and stubs, and a list of all building and loan associations in which petitioners, jointly or individually, had ever had any funds for any year. On March 20, 1946, the agents were given a looseleaf book containing the records of rent received from certain properties owned by petitioners. It did not contain any records of the ground rents owned by petitioners nor records of rentals received from 31 West Lexington Street. The book had no record of expenses or costs attributable to the properties listed therein. At a later date the agents were given a book containing records of ground rents received by Lipsitz.

It was generally Lipsitz' custom to have a deputy collector of internal revenue fill out his personal income tax return. When this was done, Lipsitz submitted a lump-sum figure representing his "profit" to the deputy collector. No substantiating records were submitted and no apportionment of such profit among his various interests was generally given to the deputy collector.

Petitioners filed no income tax returns for any year prior to 1933.

The following schedule lists the amount of net income reported and tax due from petitioners from 1933 through 1945:

Year	Net income	Tax
1933	0
1934	1,489.78	0
1935	932.70	0
1936	2,061.00	0
1937	2,303.90	0
1938	2,278.14	0
1939	2,017.29	0
1940	$ 2,294.47	0
1941	2,956.56	$ 93.83
1942	6,432.89	1,005.55
1943	6,950.89	1,615.86
1944	4,369.67	707.41
	2 1,402.50
1945	3 3,499.32

Petitioners' net worth on the dates indicated was as follows:

Dec. 31
1937	$ 169,949.85
1938	176,987.21
1939	187,376.12
1940	188,478.38
1941	219,546.05
1942	$ 236,491.10
1943	247,536.58
1944	259,079.85
1945	268,532.27

Petitioners executed "consents fixing the period of limitations upon assessments of income and profits tax" (Form 872) as follows:

		Period of limitations
		extended
Date of execution	Tax year	until June 30
Mar. 8, 1947	1943	1948
Feb. 14, 1948	1943	1949
Feb. 14, 1948	1944	1949
Feb. 25, 1949	1945	1950

The deficiency notices which serve as the basis for this action were dated and mailed June 9, 1949.

Petitioners' living expenses from 1938 to 1945, inclusive, were as follows:

1938	$ 3,050.60
1939	3,001.00
1940	3,000.94
1941	3,947.46
1942	$ 4,000.00
1943	4,000.00
1944	4,000.00
1945	4,000.00

Petitioners made payments of Federal income tax during the years indicated under the names of Lipsitz and Pilstiz as follows:

Year	Lipsitz	Pilstiz
1938	0	0
1939	0	0
1940	0	0
1941	0	0
1942	$ 93.83	0
1943	1,201.96	$ 522.56
1944	1,425.44	847.08
1945	1,324.31	175.02

Petitioners had net long-term gain from the sale of capital assets as follows:

1941	$ 13,340.49
1942	5,692.06
1943	568.98
1944	$ 2,137.00
1945	1,687.66

Petitioners owned assets received from the estate of the father of Morris Lipsitz as an inheritance, other than the $ 500 series G United States Government bond referred to previously, as follows:

Dec. 31, 1944	$ 3,000.00
Dec. 31, 1945	1,648.35

The correct taxable net income for 1938 to 1944, inclusive, is as follows:

1938	$ 10,087.96
1939	13,389.91
1940	4,103.20
1941	28,344.88
1942	$ 18,192.85
1943	16,485.51
1944	13,747.29

There is no deficiency in income tax for the year 1945. The income for each of the years 1938 to 1944, inclusive, was understated. A part of the deficiency for each of those years was due to fraud with intent to evade tax.

OPINION.

The Commissioner determined the deficiencies in controversy by using the increase in net worth and expenditures method of computing net income. Under that method the increase in net worth (without including any unrealized gains) during the taxable year, after making appropriate adjustment for such items as the nontaxable portions of capital gain, tax-free receipts (e. g., gifts and inheritances), depreciation, and unallowable deductions (e. g., living expenses and Federal income taxes paid), may be taken as evidence of a taxpayer's net income for such year.

The net worth method is not a system of accounting; it is not a substitute for either the cash or the accrual basis of accounting or any other recognized method of keeping books. When correctly applied to the facts of a particular situation it is merely evidence of income. And when the increase in net worth is greater than that reported on a taxpayer's returns or is inconsistent with such books or records as are maintained by him, the net worth method is cogent evidence that there is unreported income or that the books and records are inadequate, inaccurate, or false. It is not correct to say that the use of the net worth method is forbidden where the taxpayer presents books from which income can be computed, for the net worth method itself may provide strong evidence that the books are unreliable. Moreover, such fragmentary books and records as were maintained by petitioners herein were wholly inadequate and we are fully satisfied that the Commissioner was justified in resorting to the net worth method. We cannot agree with petitioners that the use of the net worth method is inappropriate for some of the years in controversy.

The case was tried before us on the net worth theory, each side attempting to support its version of the petitioners' net worth statement running from December 31, 1937, through December 31, 1945. There was agreement between the parties as to some of the items on the statement and the trial was concerned in large part with evidence as to the disputed items. We have followed the net worth method here, and our findings as to the petitioners' net income for each of the years 1938-1945 are the result of applying that method to agreed facts and facts as we have found them, in much the same manner as the parties themselves have applied it to the facts asserted by each of them. ^{*296 Petitioner Morris Lipsitz was engaged in a large number of transactions. Although his counsel made conscientious efforts to present a coherent picture of Lipsitz' affairs, the record before us is a confused jungle of evidence. Lipsitz was the principal witness, and much of the confusion is attributable to him. Notwithstanding his lack of formal education, he is an alert, shrewd, and perceptive person. He was evasive and his memory conveniently failed him at important points. We had ample opportunity to observe him for long periods on the witness stand and to appraise his testimony in the light of other evidence before us, and we are satisfied that he did not have scrupulous regard for the truth.}

Throughout the Government's investigation of Lipsitz' affairs it encountered great difficulty in obtaining records from him. There was evidence about a fire at the Warner Ice Company in February 1938, in which petitioner claims his records were destroyed. However, we are left in considerable doubt not only to what extent, if any, the Warner Ice Company records were lost in this fire, but also whether Lipsitz' personal records were ever kept at the Warner Ice Company. He had 2 large safes in his home, and it is more than likely that the important papers bearing upon his personal finances were kept in those 2 safes. Furthermore, this case involves the years 1938-1945, and except for a small part of the first year this period was subsequent to the date of the fire. Notwithstanding specific requests for canceled checks and bank statements none was offered to the Government for inspection, and only 2 checks were produced at the trial. We do not believe his explanation that he had no canceled checks or stubs. It was all too plain that he was determined not to permit too close an examination into his affairs.

His affairs were often conducted in a secretive and confusing manner. Petitioners had interests in real estate in the names of nonexistent persons. They acquired property in the following fictitious names: "Fred Jacobi," "Vernon Birk," "Regine E. Eisenstover," and "Morton and Loraine Pilstiz." Government agents were able to discover a number of the properties involved only as a result of examination of Recordak films of checks at a bank. Disclosure by Lipsitz as to these fictitious names occurred only after the transactions had been discovered by the Government. When asked at the trial as to what, if any, other names he used in acquiring property, Lipsitz was evasive and sought refuge in his alleged inability to remember.

Our findings of fact are largely dispositive of this case. In making these findings our path was beset with many difficulties. In some instances we did not believe petitioner's testimony at all, such as his testimony that he had $ 25,000 in cash at his home at the beginning of the period under review. A prior sworn statement which he made before internal revenue agents pointed in the opposite direction, and his effort on the witness stand to explain away the prior statement was unconvincing.

In other instances, such as petitioner's testimony about expenditures to rehabilitate dilapidated property, we were satisfied that he made such expenditures but not in the amounts claimed by him. We think that the respondent erred in failing to give petitioners credit for any such expenditures. Our findings as to petitioners' interests in the various properties involved include an amount for such expenditures, but not as much as claimed by Lipsitz. In an effort to corroborate the amounts asserted by him, appraisals were introduced by disinterested, reputable experts. But these appraisals were designed to show merely what the improvements to the properties would have cost at the time they were said to have been made. These appraisals lose much of their weight not only because they are based in part upon Lipsitz' representations to the appraisers, but also because the appraisers assumed that the work was done by contractors paying customary prices for materials and labor. The evidence before us, however, is to the effect that Lipsitz did most of the work himself with the assistance of his son, supplemented by cheap labor, and with materials that he procured at wholesale prices. Accordingly, in giving petitioners credit for capital expenditures on the various properties, we have scaled down the amounts claimed so as to accord with what in our best judgment was actually paid for capital improvements. Cf. Cohan v. Commissioner, 39 F. 2d 540, 544 (C. A. 2). Similarly, in some other instances where Lipsitz testified as to amounts expended, we have made findings in reduced amounts where we were satisfied that he was presenting inflated figures. *300

We do not mean to suggest that we have resolved all doubts against Lipsitz' testimony. Our problem was one of appraising the testimony in the light of the entire record and its inherent credibility. Thus we found, in accordance with his contention, that a $ 500 bond standing in his name did not represent an investment made by him but had been inherited by him from his father. Similarly, we accepted his testimony, corroborated by his son, Alvin, that he became indebted to Alvin in the amount of $ 1,500 a year during the years 1942-1946. We made this finding without strong conviction, for there was much to suggest that the alleged indebtedness did not in fact exist; yet, on studying all the evidence, we felt that the balance was slightly in favor of the finding we made. Again, we found, in accordance with petitioners' contention, that Lipsitz made a loan in the amount of $ 20,000 to his brother in 1935, which was repaid during the tax years. Here, too, our finding was without strong conviction, for prior inconsistent statements made by the brother cast doubt upon the alleged transaction; however, we concluded from the evidence as a whole that the scales tipped slightly in favor of petitioners on this matter, and made our finding accordingly.

The record is complex and diffuse. Fragments of evidence relating to particular facts in controversy are scattered over many hundreds of pages of testimony and in many exhibits. What may appear to be uncontroverted testimony at one point may take on an entirely different aspect when examined in the light of the record as a whole. We do not deem it necessary to explain our thought processes or chain of reasoning in making all our findings. To do so would expand this opinion beyond all reasonable length. Suffice it to say, our findings represent our best judgment, based on the entire record, on all the disputed items, and those findings form the basis for our ultimate findings of fact as to the amount of income for each of the years in question.

There remain for discussion only three aspects of this case: (1) The amounts at which petitioners' investments in certain properties are to be included in the net worth statement where petitioners entered into long-term leases providing for the payment of ground rents; (2) whether taxes paid with respect to the so-called Pilstiz returns must be taken into account in determining the deficiencies; and (3) whether fraud has been proved.

Ground Rents Created. -- A dispute exists between the parties as to the amount at which certain interests in property should be included in the net worth statement, where petitioners have sold a building, retaining title to the land, and where the purchaser has executed a 99-year lease on the land agreeing to pay so-called ground rent. Petitioners insist that it is their cost of the land involved that is to be included in the net worth statement. Respondent, on the other hand, contends that the ground rent must be capitalized at 6 per cent, and that it is the capitalized figure that must be included in the net worth statement.

Whatever may be the correct method of treating other aspects of ground rent in other circumstances (cf. Pennsylvania Co. for Insurance on Lives & Granting Annuities, 19 B. T. A. 699, affirmed 52 F. 2d 601 (C. A. 3); I. T. 2679; XII-1 C. B. 103; G. C. M. 2042, VI-2 C. B. 182), we are satisfied that for purposes of determining petitioners' increase in net worth in the circumstances of this case the correct amount to be included in the net worth statement is petitioners' actual investment in the property, not a capitalized value based on ground rents. The comparison of a taxpayer's net worth between two points of time for the purpose of determining taxable net income must be made in such manner as not to include any unrealized gains. Otherwise, the taxpayer would be charged with income that may not legally be attributed to him. In the case of the ground rents created by petitioners herein there was no evidence that any purchaser of a building made any downpayment on the land or in any way treated the transaction as one looking toward the acquisition of the land in such circumstances that the ground rent arrangement might be regarded as the equivalent of a purchase money mortgage. The ground rents here were nothing more than what they appeared to be, notwithstanding that Maryland law gave the lessee the right to "redeem" after 5 years. We think that the so-called creation of the ground rents in this case was no more than the execution of leases, which are productive of income only to the extent that rent is received. It was not proper to capitalize the rents and thus in effect charge the owner with realization of income in the year the leases were executed, as though the land had then been disposed of at a profit. Moreover, even if the creation of a ground rent be regarded in some manner as the equivalent of an installment sale, which was not the fact here, petitioners certainly could not be forced to account in one year for the full amount of profit to be realized on such sale. We conclude that petitioners' position on this aspect of the case is correct.

Income Reported on the Pilstiz Returns. -- As shown by our findings, tax returns in the fictitious name of "Pilstiz" were filed for the years 1942 through 1945, with respect to income from the building at 31 West Lexington Street, Baltimore. Such returns were in addition to returns filed during those years under petitioners' true names which did not include any income from that building. In determining petitioners' unreported income and the deficiencies before us, the Commissioner did not give petitioners credit for the income reported on the Pilstiz returns or the taxes paid with respect thereto. Since Litpsitz and Pilstiz were the same person we think that the deficiencies must take into account the taxes already paid in connection with the Pilstiz returns.

Fraud. -- The respondent determined that petitioners were liable for additions to tax under section 293 (b) because of fraud with intent to evade tax. The burden is on the respondent to establish such fraud. In the case at bar, the issue of fraud assumes added importance since the years 1938 through 1942 are closed for tax purposes because of the statute of limitations if the respondent fails to prove fraud. We think, however, that the respondent has sustained his burden.

Throughout the years in issue, petitioners consistently understated their income. The returns for all of the years, except 1945, *307 whatever for any year prior to 1933, and, beginning with 1933, he filed returns disclosing only comparatively nominal amounts of income, despite the fact that he portrayed himself as being worth about $ 400,000 or $ 500,000. His affairs were at times conducted in the names of nonexistent persons; and other motives, apart from tax evasion, only partly explain the use of such fictitious names. Cf. Jack M. Chesbro, 21 T. C. 123, 130. The foregoing considerations are by no means all-inclusive, and taking into account the entire record we have concluded that at least a part of the deficiency for each year 1938 to 1944, inclusive, has been shown by clear and convincing evidence to be due to fraud with intent to evade tax.

Decisions will be entered under Rule 50.

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Footnotes

• 1. The name printed by hand at the top of the return is "Mrs. Martin Pilstiz." The signature however seems to be "Mrs. Morton Pilstiz."↩

• 1. Parentheses denote net loss.↩

• 2. Amended return.↩

• 3. This return was prepared by accountants and filed by Lipsitz after the start of the investigation of his tax liability by special agents of the Bureau of Internal Revenue. It incorporates the income from 31 West Lexington Street which had already been reported for 1945 on the return of "Mrs. Morton Pilstiz."↩

• 1. Petitioners contend on brief that the Commissioner has disregarded and ignored the assets of petitioner Helen Lipsitz in the December 31, 1937, net worth statement; and they also argue that for some of the years here involved the deficiencies are asserted against petitioner Morris Lipsitz alone but are based in part upon increases in net worth of assets belonging to petitioner Helen Lipsitz. We think these contentions are without merit in the circumstances of this case. For some of the years involved petitioner Morris Lipsitz filed separate returns in his own name; for the other years he filed joint returns with his wife, Helen. The deficiencies determined by the Commissioner are geared to the returns; they were proposed against petitioner Morris Lipsitz alone for the years in which he filed separate returns and against both spouses for the other years. The net worth statements are based on the joint assets of Morris and Helen Lipsitz. Throughout the trial of this case it was assumed that the assets of both were involved and that the increases in net worth based upon assets of both petitioners, if it was permissible to resort to the net worth system at all, could properly be used to determine income of the petitioner or petitioners for each of the years in controversy. It was repeatedly indicated during the trial that their assets were to be regarded as belonging to both and that the assets of either might be treated as attributable to the other. Our findings are responsive to that assumption, and the term "petitioners" is used indiscriminately to refer either to Morris Lipsitz or to Morris and Helen Lipsitz.

  There was some uncertainty at one or two stages of the trial as to the status of possible separate assets of each spouse, and the Court, realizing the almost insuperable difficulties that it would encounter in this otherwise confusing record if it were to be required to break down the various assets between husband and wife, called for clarification from counsel. Petitioners' counsel had just stated: "Your Honor, this is a net worth statement directed cases both parties [sic], Mr. and Mrs. Lipsitz, regarded as one. They are not treated as separate taxpayers." The Court thereupon addressed itself to both counsel and then inquired: "Now, do I understand both parties to agree that the assets of both these Petitioners may be considered together?" Mr. Luce, petitioners' counsel, replied: "Yes, your Honor; and that is the way the net worth statements have been set up." Mr. Anderson, Government counsel, replied: "That is correct." And except for an instance when petitioner Morris Lipsitz attempted to be evasive on cross-examination, he repeatedly treated his wife's assets as his own. Thus, referring to alleged cash in his vault he said: "It all belongs to me and all belongs to my wife. There is no distinction, between man and wife." Referring to a loan said to have been made by Mrs. Lipsitz he said: "The loan was made by my wife. Still, it is our money just the same."

  This case was unambiguously presented to us by counsel for both sides on the theory that the net worth statement of both spouses was to be used for all the years in controversy, and it was clear to us that both sides endeavored to present in evidence all known assets of both spouses. Our findings and conclusions are based on the same theory.↩

• 2. Thus, in connection with expenditures for construction of and improvements to an ice manufacturing plant, we have given full weight, for example, to testimony of a representative of the York Corporation as to equipment which that company sold to petitioner. But we were unwilling to accept at face value so-called corroborating testimony that the cost of an ice plant was about $ 1,000 per ton capacity; for, to the extent that original cost is relevant, the plant in question was not constructed in the usual manner, under the direction of a contractor incurring normal costs for labor and materials. Moreover, in connection with the assets formerly in the hands of the Warner Ice Manufacturing Corporation, it must be remembered that the corporation was liquidated on July 31, 1937. That liquidation was a taxable transaction and the assets thereupon took on a new basis, namely, their then market value. Some indication of the value of those assets at that time is the fact that they, together with other assets relating to the ice business, were sold in 1941 for $ 57,500. The witness Keeny testified that the value of an ice plant between 1937 and 1941 "ran along about even to the beginning of the war, and then it increased quite a bit." He later made it clear that he was using the term "war" to refer not to the time of actual commencement of hostilities by this country but to the time when the country was beginning to adapt itself to a war economy, after 1939. Accordingly, notwithstanding his general testimony of value measured at $ 1,000 a ton capacity, the fact that the very properties in question were included in assets sold in 1941 at $ 57,500, at a time when values had risen, is strong evidence that those properties had a lower value in 1937. Our findings in relation to the ice properties are predicated not only upon the foregoing considerations, but also upon an examination of all the relevant details in the record, which are too numerous to set forth.↩

• 3. The return for 1945 was prepared by an accountant after Lipsitz became aware that the investigation into his affairs had commenced. We have found no understatement of income for that year.↩