S. & B. Realty Co. v. Commissioner ( 1970 )

S. & B. Realty Company, Petitioner v. Commissioner of Internal Revenue, Respondent; Samuel Goldberg and Bess Goldberg, Petitioners v. Commissioner of Internal Revenue, Respondent

S. & B. Realty Co. v. Commissioner

Dockets Nos. 3833-68, 3834-68

United States Tax Court

54 T.C. 863; 1970 U.S. Tax Ct. LEXIS 155;

April 27, 1970, Filed

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Decisions will be entered under Rule 50.

1. Petitioner owned rental property which was situated within an urban renewal area. With respect to this property petitioner was given four alternatives: (1) Improvement of the property in accordance with the urban renewal agency's direction; (2) sale to a third party who would make the required improvements; (3) sale to the agency; or (4) condemnation. Petitioner sold his property to a third party. Held, petitioner sold his property under threat of condemnation and, accordingly, is entitled to nonrecognition of his gain under sec. 1033, I.R.C. 1954. S. H. Kress & Co., 40 T.C. 142">40 T.C. 142 (1963).

2 Held, compensation paid by S. & B. Realty Co. to its controlling shareholder and president was reasonable, hence, deductible under sec. 162(a)(1), I.R.C. 1954.

3. Held, proper salvage value and allocable cost of certain furnishings determined for purposes of computing allowable depreciation under sec. 167, I.R.C. 1954.

Joseph J. Kaplan and Edward A. Rothschild, for the petitioners.

Frederick W. Krieg, for the respondent.

Sterrett, Judge.

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STERRETT

The respondent determined deficiencies in the income tax of petitioners Samuel and Bess Goldberg in the amount of $ 10,187.95 for the taxable year ended December 31, 1963, and in the corporation income tax of petitioner S. & B. Realty Co. in the amount of $ 1,119.74 for the fiscal year ended May 31, 1965. These cases have been consolidated for trial due to the relationship of the petitioners and the continuity of the facts involved; however three distinct issues are presented for determination. As to Samuel and Bess Goldberg, the question is whether they sold certain property under threat or imminence of condemnation sufficient to satisfy section 1033 of the Internal Revenue Code of 1954. ^{section 162(a)(1); and secondly, whether depreciation deductions taken by the corporation on certain "furnishings" were excessive.}

FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and the exhibits attached thereto are incorporated herein by this reference.

Petitioners Samuel and Bess Goldberg (Bess is involved herein solely by reason of the filing of a joint return; therefore, the designation "petitioner" will refer only to Samuel), husband and wife, resided in Louisville, Ky., at the time their petition was filed herein. They filed their joint Federal income tax return for the calendar year 1963 with the district director of internal revenue at Louisville, Ky.

S. & B. Realty Co. (hereinafter S. & B.) is a Kentucky corporation with its principal place of business in Louisville, Ky. S. & B. filed its Federal corporation income tax return for the fiscal year ended May 31, 1965, with the district director of internal revenue at Louisville, Ky.

Issue 1. Threat or Imminence of Condemnation

Petitioner purchased property consisting of land and a building for $ 32,829.62 on July 15, 1957. The property (hereinafter referred to as 1019-1023 West Broadway) was leased by the petitioner as commercial rental property until its sale in 1963.

The City of Louisville, Ky., entered into a planning contract with the Housing and Home Finance Administrator, pursuant to which Federal funds were provided for the urban renewal known as the West Downtown Renewal Area. Petitioner's property was located within this area. Public hearings were held on the matter of including the area in which petitioner's property was situated in the Urban Renewal Development Plan on March 27, 1961. This hearing was preceded by public notice printed in the Courier-Journal newspaper in Louisville. In addition, on March 14, 1961, the Louisville Times carried an article on the proposed hearings.

On December 17, 1962, all statutory prerequisites having been fulfilled, the Board of Commissioners of the Urban Renewal and Community Development Agency of Louisville (hereinafter Urban Renewal Agency) adopted a resolution providing in part as follows:

That all land or other property, rights-of-way or easements necessary to accomplish the purposes of the above described WEST DOWNTOWN RENEWAL AREA shall be acquired in the name of this Agency by purchase or condemnation.

The Urban Renewal Agency designated petitioner's property as "Parcels to be Conserved" and "Buildings to Remain"; i.e., conservable. These terms meant that the present owner of the property could retain it because the use of it was consistent with the development plan.

When property is designated conservable the owner is given four alternatives:

1. He may improve or repair the property in compliance with the direction of the Urban Renewal Agency.

2. He may sell the property to a third party who would have to make the specified improvements.

3. He may sell to the Urban Renewal Agency at a negotiated price.

4. He can do nothing and thereby permit condemnation.

The objective of the Urban Renewal Agency was to have the property meet the criteria as established by the renewal plan.

An owner of conservable property would be furnished a list of required improvements. If he proposed to retain his property he could work with the help of the agency staff to make these improvements. The standards imposed by the Urban Renewal Agency were high. A building would have to meet city building code standards, as well as safety standards. All ordinances as to wiring, plumbing, heating, etc., would be applicable. In addition, the appearance of buildings and landscapes were considered important. It was possible that a given parcel would need no repairs, but such eventuality was unlikely. Although the agency had a rigorous code, it was flexible in such things as the imposition of deadlines for completion. In addition, the agency tried to get the highest possible upgrading, but each building was considered individually and specifications were open to negotiations. The agency was willing to work with property owners and was cooperative in those cases wherein a sale was necessary. Condemnation was considered a last resort.

In the early part of 1963 petitioner contacted Kelly Lewis of the Urban Renewal Agency. He was told about the four above-mentioned alternatives that he had. Subsequent to this, in May or early June of 1963, Lewis informed petitioner that his property had been appraised at a value of $ 62,500 and that the agency would purchase it at that price if petitioner so desired.

Upon receiving a memo from Lewis, Marjorie Caplan, then assistant director for conservation of the agency, telephoned petitioner on June 12, 1963. During that telephone conversation and a subsequent office visit Caplan explained the conservation program to petitioner. She told him that a detailed survey of the property would be made and that he would be provided with a list of required improvements as well as a cost guide. She also explained that the agency would provide other services if necessary, such as, architectural guidance. At that time she also reiterated petitioner's alternatives.

On June 14, 1963, the property was inspected by a member of the Urban Renewal Agency. By letter dated July 12, 1963, Caplan informed petitioner of the results of the inspection. The letter was accompanied by a detailed cost estimate. The total estimated cost of specified improvements was $ 6,782.33.

On June 15, 1963, petitioner and Brown Bros. Realty, Inc. (hereinafter Brown Bros.), executed a real estate contract for the purchase and sale of the property. The expressed consideration was $ 70,388.50. At the time of contracting petitioner owned the property in fee simple, unencumbered. His adjusted basis was $ 29,665.74.

At the time of the execution of the contract for sale petitioner was unaware of the exact cost of the requisite improvements. He decided a day or two after speaking to Caplan to sell the property rather than incur any additional expenses, and he did not wait to find what the cost would be. The property was conveyed to Brown Bros. on July 19, 1963, for the expressed consideration. On that date petitioner received the net proceeds of the sale.

On no occasion prior to the start of negotiations with Brown Bros. had petitioner made other attempts to sell his property. In addition, it was an agent of Brown Bros. who initially approached petitioner regarding the proposed acquisition of the property. Petitioner was not actively seeking a buyer.

On November 16, 1964, Brown Bros. entered into restriction agreement with the Urban Renewal Agency providing for the required repairs.

All of the proceeds of the sale were applied by the petitioner to the purchase of two apartment buildings. The two buildings, Lincoln Apartments and Reeser Place Apartments, and furnishings were purchased for $ 185,000 and $ 132,500, respectively, within the statutory period for reinvestment as provided in section 1033.

S. & B. was incorporated on May 15, 1964, for the purpose of operating the two buildings. The buildings were conveyed to S. & B. in exchange for the corporation's capital stock.

On their joint Federal income tax return for 1963 petitioners stated that the realized gain was attributable to involuntary conversion and, therefore, recognized no gain. In its statutory notice respondent stated:

(a) It is determined that you realized a long-term capital gain of $ 40,722.76 from the sale of property located at 1019-23 West Broadway. The gain is taxable income subject to the deduction provided by section 1202 of the Internal Revenue Code. * * *

Issue 2. Unreasonable Compensation

S. & B., the petitioner as to this issue, was incorporated on May 15, 1964, and received two apartment buildings from Samuel Goldberg (hereinafter Goldberg) in exchange for capital stock. Goldberg was, during the year at issue, president and controlling shareholder of S. & B. He was the only officer who received compensation from S. & B. during the fiscal year ended May 31, 1965. His salary of $ 5,000 was authorized at a special meeting of the board of directors on June 1, 1964. *867 Two apartment buildings, the Lincoln and Reeser Place Apartments, and their contents were substantially the only assets of S. & B. The two buildings contained 90 apartments. At the close of the fiscal year involved the buildings were carried on S. & B.'s balance sheet at a depreciated value of approximately $ 258,211.15. The balance sheet also indicated mortgage indebtedness of $ 151,108.25

During the year at issue Marvin D. Green (hereinafter Green) was the rental manager for Bass & Weisberg who were rental agents for S. & B. Bass & Weisberg received $ 4,578.08 from S. & B. for services rendered. This sum was 6 percent of the gross rentals from the two buildings.

Some of the services rendered by Green consisted of obtaining tenants when the apartments became vacant; the writing of leases; rent collection; having repairs of $ 25 or less made; the hiring and firing of maids, maintenance men, janitors, and the preparation of a monthly statement of income and disbursements which was sent to Goldberg. The rental agent, Bass & Weisberg, paid the bills.

On all repairs costing over $ 25 Green consulted with Goldberg before any work was contracted for or done. Expenditures involving general maintenance, such as painting, and repairs of plumbing were frequently discussed with Goldberg. Sometimes necessary repairs were called to Green's attention by tenants and many were pointed out by Goldberg. On occasion Green and Goldberg would meet at one of the buildings to discuss ways of handling repairs. Goldberg would sometimes contact a plumber or maintenance man. The agent would speak to Goldberg once or twice a week.

Green did not execute leases without consulting Goldberg. On several occasions Goldberg did not approve proposed tenants. Bass & Weisberg investigated prospective tenants.

When tenants moved out Green inspected the apartment to determine whether the tenant's security deposit should be returned. If Green had doubts then he and Goldberg would check the apartment.

In addition to working with Green, Goldberg performed the following services:

(1) He deposited the rental agent's monthly checks and made payments on loans.

(2) He checked bills; as well as Bass & Weisberg's monthly statements.

(3) He supervised payment of payroll taxes.

(4) He checked and signed income tax returns.

(5) He supervised bookkeeping and recordkeeping.

(6) He personally received some tenants' complaints.

(7) He inspected the buildings and saw tenants each Saturday afternoon from 1 to 4 p.m.

(8) He conferred with S. & B.'s attorney and certified public accountant when necessary.

Goldberg had long prior experience in the management of rental property. In past years he had owned several apartment buildings.

During the year in issue S. & B. had gross rents of $ 78,140.03. Taxable income as shown in S. & B.'s corporation income tax return was $ 7,362.14.

On its income tax return for the fiscal year ended May 31, 1965, S. & B. deducted the $ 5,000 it had paid to Goldberg, as compensation of an officer. In its statutory notice, dated May 31, 1968, respondent disallowed the deduction stating:

(a) It is determined that compensation paid your president is excessive in the amount of $ 3,200.00. Such amount exceeds a reasonable allowance for salaries or other compensation for personal services actually rendered within the ambit of section 162 of the Internal Revenue Code; * * *

Issue 3. Depreciation Deduction

When Goldberg purchased the Lincoln Apartments and the Reeser Place Apartments during 1964 for $ 185,000 and $ 132,500, respectively, certain personalty was included in the purchase price without allocation. This personalty consisted of 84 small apartment-sized refrigerators, 84 small apartment-sized stoves, and 10 rooms of furniture, i.e., the contents of four or five apartments. In addition to the appliances in the apartments there were some in the basements that were unusable. The refrigerators and the stoves, at the time of purchase, were 8 to 12 years old.

It was Goldberg's experience that in the purchase of new appliances sellers would grant no trade-in allowance on used refrigerators or stoves of the age of the ones S. & B. possessed.

For purposes of Jefferson County personal property taxes the property in question was given an assessed value of $ 5,000 as of January 1, 1964. This figure purportedly represented 33 1/3 percent of the fair market value of the property; i.e., $ 15,000. This personal property tax assessment was an arbitrary assessment by the office of the tax commissioner of Jefferson County.

In allocating a purchase price of $ 75 per refrigerator, $ 75 per stove, and $ 240 per room of furniture Goldberg relied on the records containing the tax assessment furnished by the seller. In this fashion the total value of the personalty was fixed at $ 15,000.

S. & B. on its corporation income tax return for the fiscal year ended May 31, 1965, deducted $ 5,000 as the depreciation allowance, applicable to the furnishings. It used a cost of $ 15,000, a 3-year useful life, and no salvage value.

Respondent in its notice of deficiency determined a cost of $ 9,100, a 5-year useful life, and an aggregate salvage value of $ 4,900.

ULTIMATE FINDINGS OF FACT

1. The useful life of the refrigerators, stoves, and furniture was 5 years.

2. The refrigerators and the stoves had no salvage value.

3. The furniture had a salvage value of $ 400.

4. The cost of the refrigerators and the stoves was $ 10,080.

5. The cost of the furniture was $ 2,000.

OPINION

Issue 1. Threat or Imminence of Condemnation

Section 1033(a) provides in part:

(a) General Rule. -- If property (as a result of its destruction in whole or in part, theft, seizure, or requisition or condemnation or threat or imminence thereof) is compulsorily or involuntarily converted --

and the proceeds of the conversion are invested in property "similar or related in service or use to the converted property" within the period specified by section 1033(a)(3)(B); then "gain shall be recognized only to the extent that the amount realized * * * exceeds the cost of such other property * * *."

In the case at bar the respondent concedes that the cash proceeds of the sale by petitioner were invested in property "similar or related in service or use" to that sold and further concedes that the proceeds were invested within the statutory period required by section 1033. Therefore, the sole question that concerns us, as regards this issue, is whether petitioner sold his property under threat or imminence of condemnation. We hold that he did.

There is no substantive dispute as the facts involved herein. Petitioner had actual notice that his property was conservable property within the urban renewal area. *171 petitioner was made aware of the fact that the Urban Renewal Agency was considering the acquisition of his property when he was informed, by Lewis, that the property had been appraised at $ 62,500. Between June 12 and June 14, 1963, Marjorie Caplan reiterated petitioner's four alternatives concerning his property; he could: (1) Improve or repair in compliance with the direction of the Urban Renewal Agency; (2) sell to a third party who would have to make the specified repairs; (3) sell to the Agency at a negotiated sales price; (4) do nothing and await condemnation.

On June 14, 1963, petitioner's property was inspected by the Agency in order that the cost and type of repairs could be determined. On June 15, 1963, before the results of the inspection were made known to him, petitioner contracted for the sale of his property. *173 property by making improvements.

As a relief provision, section 1033 is to be liberally construed. John Richard Corp., 46 T.C. 41">46 T.C. 41, 44 (1966). In addition, it is well established that the words of revenue acts should, where possible, be interpreted in their ordinary, everyday senses. Malat v. Riddell, 383 U.S. 569">383 U.S. 569, 571 (1966). With these guides in mind we must determine whether there were facts in the instant case sufficient to constitute a threat. ^{*174 of threat). In our opinion, had it not been for this sword of Damocles petitioner would not have sold his property.}

It is significant that the word "threat" was used in section 1033. This is indicative of the fact that the statute does not require that the possibility of condemnation be reduced to a certainty. Any reasonable construction of the word must recognize the possibility that the impending, undesirable consequence may never occur. The crucial factor is that the petitioner was compelled by this impending consequence to take evasive action.

We have held that a sale to a third party meets the tests of section 1033. See, e.g., Harry G. Masser, 30 T.C. 741">30 T.C. 741 (1958); S. H. Kress & Co., 40 T.C. 142">40 T.C. 142, 153 (1963). In S. H. Kress & Co., supra, the taxpayer found itself in a situation markedly similar to the one at bar. In Kress the taxpayer was faced with three alternatives: It could build a parking facility, sell its property to a private party willing to build a parking facility, or permit the City of San Francisco to condemn the property for a parking facility. The taxpayer chose to sell its property to a private party. In holding for the taxpayer we did not require it to invest additional funds in constructing a new building. We stated that the only realistic alternatives were sale or condemnation. We do not deem Kress distinguishable from the instant case because the operation of a parking facility would have been a departure from Kress' past and contemplated business activities.

On brief respondent seizes upon language in S. H. Kress & Co., supra at 153, wherein we stated that the basic purpose of section 1033 is to allow the taxpayer to replace his property without realization ^{section 1033) it obviously intended to grant a measure of tax relief to those who were, compelled by the specified circumstances, to convert their property into cash. This intended relief should not be abrogated merely because the omnipotent, condemning authority affords the taxpayer the opportunity to retain his property by making an additional investment. Such an opportunity neither assuages the compulsion nor contravenes the intent of Congress.}

Further, respondent raises the argument that the petitioner sold his property before the results of the inspection of June 14, 1963, were known to him and that, since the possibility existed that no repairs would be necessary, the petitioner could have retained his property by doing nothing. This argument fails on two grounds. Firstly, as we stated in our Findings of Fact, the possibility that no repairs would be necessary was remote. Secondly, the threat still existed at the time of sale.

Finally, respondent directs our attention to our decision in C. G. Willis, Inc., 41 T.C. 468">41 T.C. 468 (1964), affirmed per curiam 342 F. 2d 996 (C.A. 3, 1965), which he claims, though factually distinct, is illustrative of his position in the instant case. In Willis the taxpayer's freighter was severely damaged when it collided with a submerged object. Instead of having the ship repaired the taxpayer sold it and invested the proceeds along with its insurance recovery in a new vessel. We made it clear, at page 475, that the record suggested that the decision to sell was caused by motives other than that arising from the damage to the vessel. The taxpayer had made prior efforts to sell the freighter and had "a strong economic incentive, completely unrelated to the damages caused by the collision, to sell the [freighter]." Therefore we found that the sale could not be deemed involuntary within the meaning of section 1033(a). Hence our decision there that the statute was inapplicable where the owner "had a choice of keeping the property or converting or selling it" was rendered in light of a factual background so different as to render the legal conclusion stated therein inapposite.

Issue 2. Unreasonable Compensation

Section 162(a)(1) provides that a corporation shall be allowed a deduction for all the ordinary and necessary expenses 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." Respondent determined that $ 3,200 of the $ 5,000 salary paid by S. & B. to Goldberg was excessive.

The question is one of fact to be determined from all of the facts and circumstances of the particular case. Boyle Fuel Co., 53 T.C. 162">53 T.C. 162, 169 (1969). The burden of proving reasonableness is upon the petitioner. Botany Worsted Mills v. United States, 282">278 U.S. 282 (1929). We find that S. & B. has satisfied its burden and shown, by a fair preponderance of the evidence, that compensation was reasonable.

While it is true that S. & B. employed a managing agent it appears that his duties were merely ministerial. It was Goldberg who had responsibility for the success or failure of S. & B.'s business.

As we set forth in our Findings of Fact Goldberg had long experience in the management of rental properties. And he performed valuable services during the year at issue. In general, he supervised all of the activities of the managing agent. In particular, he was responsible for all repairs which would cost more than $ 25. He inspected the apartment buildings; was available to tenants and received their complaints; was available for conferences with the managing agent concerning repairs and the retention or return of vacating tenants' security deposits; and, he performed various bookkeeping and financial duties. In addition, he had the responsibility of giving final approval of prospective tenants.

In view of the foregoing facts respondent's disallowance of any portion of the $ 5,000 salary paid Goldberg is unnecessarily parsimonious, to say the least. Moreover, it is totally unrealistic. We hold for S. & B.

Issue 3. Depreciation Deduction

Due to S. & B.'s concession that the useful lives of certain furnishings; i.e., refrigerators, stoves, and furniture, were 5 years, there are two questions remaining for decision as to this issue: Firstly, whether respondent erred in its determination that the above-mentioned furnishings had a salvage value of $ 4,900 during the taxable year ended May 31, 1965; and secondly, whether respondent erred in determining that these furnishings had a cost of $ 9,100 as opposed to the $ 15,000 claimed by S. & B. Both of these determinations are necessary for the purpose of computing allowable depreciation during the year in issue. Needless to say that these questions are purely factual and S. & B. has the burden of proof.

As to the proper salvage value, at the time of their purchase the refrigerators and the stoves were from 8 to 12 years old. We think it safe to say that at the end of their 5-year useful lives these appliances would have no salvage value whatsoever. As this time they would range in age from 13 to 17 years. It would, indeed, be a philanthropic purchaser who would give anything at all to obtain these relics. In fact, S. & B. would probably, if it wished to dispose of these liabilities after 5 years, be forced to pay someone to cart them away. We therefore, in accordance with our findings of fact and Income Tax Regs. section 1.167(a)-1(c), find no salvage value.

As to the furniture, the same reasoning is applicable with one exception. We were not informed, at trial, of the age of the furniture although there is every indication that it was used to some extent. At the end of over 5 years it, too, would have little realizable value. We, therefore, hold that at the time of purchase the furniture had an aggregate salvage value of $ 400.

Concerning the cost of the refrigerators, stoves, and furniture, when Goldberg purchased the apartment buildings no express allocation of part of the purchase price was made to the furnishings. However, the seller furnished records containing a Jefferson County personal property tax assessment according to which the personalty was valued at $ 15,000. Of this S. & B. allocated $ 75 for each of 84 refrigerators and 84 stoves as its cost and $ 240 for each of 10 rooms of furniture. We find these amounts somewhat excessive. The parties have stipulated that the personal property tax assessment was arbitrary and hence we cannot hold those figures to be controlling. Rather, viewing the facts presented at trial we find that in view of the age and type of the refrigerators and stoves their value is $ 60 per unit. This provides an aggregate cost of $ 10,080. Concerning the 10 rooms of furniture, due to its used condition, we find an allocable cost of $ 200 per room; or a total of $ 2,000.

A further matter involving S. & B. concerns the cost of the Lincoln Apartments and Reeser Place Apartments. The parties have stipulated in the case of S. & B. Realty Co., docket No. 3833-68, that should decision be rendered for petitioners in Samuel and Bess Goldberg, docket No. 3834-68, i.e., issue 1, then the purchase prices of Lincoln Apartments and Reeser Place Apartments are to be reduced by $ 28,810.12 and $ 19,952.89, respectively. We hereby incorporate that stipulation.

Decisions will be entered under Rule 50.

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Footnotes

• 1. All section references are to the Internal Revenue Code of 1954 unless otherwise stated.↩

• 2. The board of directors was composed of Goldberg, Bess S. Goldberg and Julian S. Goldberg.↩

• 3. On brief, respondent conceded that petitioner had actual notice by June 14, 1963. In addition, as we set forth above, there is no doubt that petitioner in fact had knowledge at a substantially earlier time.↩

• 4. For purposes of this opinion we will consider June 15, 1963, the date of sale. In his reply brief petitioner raises the argument that July 19, 1963, was the date of sale because he could have rescinded the contract prior to that time. We see no reason, nor has any been offered, why the contract should be considered unenforceable.↩

• 5. Obviously without notice there can be no threat.↩

• 6. Because the statute is worded in the disjunctive, if we find a threat it will be unnecessary to determine if condemnation was imminent.↩

• 7. In S. H. Kress & Co., 40 T.C. 142">40 T.C. 142, 153↩, we used the term "realize" when, perhaps "recognize" would be more appropriate.