Johnson v. Commissioner , 7 T.C. 465 ( 1946 )

OPINION.

Tyson, Judge:

This proceeding involves determination of the amount of petitioner’s taxable gain derived from the sale in 1938 of property consisting of land designated in our findings as tract No. 3, and a building located thereon.

The first issue is whether petitioner’s basis of the land and building is to be computed without including therein the fair market value of the building when acquired by her in 1929.

The building was erected in 1925 by petitioner’s lessee of the underlying real estate at the lessee’s expense. The lessee having subsequently defaulted in payment of rent, petitioner in 1929 recovered possession and enjoyment of the land and acquired the building through court action. In 1938 petitioner sold the land and building for the consideration shown in our findings.

The petitioner contends that the fair market value of the building when acquired in 1929 (subject to adjustment) should be included in its cost basis. The respondent allowed no cost basis for the building, but allowed a cost basis of $6,598.34 for the land upon which the building was located.

Section 113 (a) of the Revenue Act of 1938, here applicable, provides that the basis (unadjusted) of property shall be the “cost of such property” with certain exceptions not material here. The Supreme Court, in Detroit Edison Co. v. Commissioner, 319 U. S. 98, left no doubt as to the meaning of “cost,” as used in an identical section of the Revenue Act of 1936, when applied to a situation where the taxpayer, owner of property, had acquired improvements thereon paid for by its customers (and costing the taxpayer nothing) in order to procure distribution of electrical energy to those customers by the taxpayer. The Court, in holding that the taxpayer was not entitled to depreciation on the improvements, because the improvements had cost it nothing, stated:

But we think the statutory provision that the “basis of property shall be the cost of such property” (§113 (a)) normally means, and that in this case the Commissioner was justified in applying it to mean, cost to the taxpayer.

See also Jones v. Commissioner, 139 Fed. (2d) 564; and Reisinger v. Commissioner, 114 Fed. (2d) 475.

The Court in Detroit Edison Co. also expressly held against a contention of the taxpayer that the improvements acquired were either gifts or contributions to its capital, paid for by its customers, and that consequently it had the right under section 113 (a) (2) and 8 (B) to take the basis of the donors or transferors.

Since the building here involved cost the petitioner nothing, we think that the Detroit Edison Co. case is dispositive of the first issue, and, applying the principle therein established and applied in the other cited cases, we conclude that the basis of the land and building is to be computed without including therein the fair market value of the building when acquired by the petitioner.

The fact that the cited cases involved determination of cost basis for purposes of depreciation rather than determination of gain or loss on a sale is of no significance, cost basis in both classes of cases being determined by the same provisions of the statute, section 113 (a), supra. That cost as used in that section means cost to the taxpayer when applied to determination of gain or loss upon a sale of property, was held in Reis v. Commissioner, 142 Fed. (2d) 900, 903. See also J. C. Vandenberge, 3 T. C. 321; affd., 147 Fed. (2d) 167; certiorari denied, 325 U. S. 875.

The case of Greenwood Packing Plant v. Commissioner, 131 Fed. (2d) 787, cited by petitioner, was decided prior to the decision in the Detroit Edison Co. case and, so far as its effect might otherwise be apposite here, sueh effect is nullified by the holding in the latter case. However, it may be said that, while such a question as was presented and decided in Detroit Edison Co. lurks in Greemwood Packing Plant, that question was not considered in the latter case nor was the .decision therein based upon the solution of such a question; the question there considered being only such as is mentioned in the second paragraph below as being presented by the further contention of the respondent herein.

On the first issue, we hold that petitioner’s gain on the sale of the property in 1938 is to be computed without including in the unadjusted cost basisthereof the fair market value of the building in 1929.

Having reached the above conclusion on the first issue, it is unnecessary to consider the further contention of the respondent or the numerous authorities cited pro and con by the parties thereon; that contention being to the effect that it was the duty of the petitioner to report the value of the building when acquired by her in 1929 as income in her return for that year, under the doctrine of Helvering v. Bruun, 309 U. S. 461, and that, having failed to do so, the petitioner can not, on the sale of the land and building in 1938, include in her basis the fair markéfc value of the building when acquired.

We have not found the fair market value of the building when acquired by petitioner in 1929 because, in view of our conclusion just above set out, it is immaterial as to what such value was.

As to the second issue, the respondent, in computing the amount of petitioner’s gain from the sale of the land (tract No. 3) and building thereon, determined that the cost basis of the land was $6,598.34. Petitioner contends that its proper cost basis is $12,350. Based upon a careful consideration of all the facts and circumstances disclosed by the evidence bearing on this issue, we have found the basis of the land to be $10,000. Consequently we hold that the $10,000 should be included in the cost basis of the property sold by petitioner in 1938.

On the third issue, the petitioner asks that numerous items be included in the basis of the property sold as additional costs thereof. Among such items are taxes and special assessments enumerated in the tabulation in our findings as having been paid by petitioner in 1928, 1929, and 1930, as well as $1,500 attorney fees also shown in our findings as having been paid in connection with the litigation through which petitioner repossessed tract No. 3 and acquired the building located thereon. Neither the amount of the taxes nor the amount of the attorney fees, nor any portion thereof, is a proper addition to the cost basis of the property as capital expenditures. They were, in fact, only deductible from gross income in the respective years in which they were paid. See Mary E. Evans, 42 B. T. A. 246, and Estate of Austin C. Brant, 44 B. T. A. 1306. We hold that the taxes and attorney fees referred to are not a proper addition to petitioner’s cost basis of the property for the purpose of determining the gain derived from the sale thereof.

The situation is otherwise, however, as to $1,088.39 enumerated in the tabulation as paid on special assessments for sidewalks, curbs, gutters, sewers, paving, etc. These are “assessed against local benefits of a kind tending to increase the value of the property assessed.” Sec. 23 (c) (4), Revenue Act of 1938. The amount ($1,088.39) paid on such assessments consequently constitutes a proper part of the cost basis of the property, and we so hold. Champion Coated Paper Co., 10 B. T. A. 433; F. M. Hubbell Son & Co., 19 B. T. A. 612; affd., 51 Fed. (2d) 644; certiorari denied, 284 U. S. 664. Cf. F. A. Smith, 11 B T. A. 301, and Belfast Investment Co., 17 B. T. A. 213. The improvements for which the assessments were paid are not subject to depreciation allowances. F. M. Hubbell Son & Co., supra.

As shown by the tabulation in our findings, petitioner made numerous other expenditures with respect to tract No. 3 and the building and improvements thereon. The first of those, a payment of a balance of $2,451 due on a sprinkler system installed by the lessee prior to the petitioner’s repossession in 1929, is clearly a capital expenditure and should be included in petitioner’s cost basis, less depreciation of 2 per cent to date of sale. The expenditures of $3,537.11 made in 1929 and 1930, as shown by the tabulation (which are other than those made for taxes of which we have already disposed), the 1932 expenditure of $237 for the construction of a roof over two balconies, and the 1933 expenditure of $808.58 for changing the stairway and entrance to the building, are all, we think, clearly capital expenditures, and the total of these expenditures, $4,582.69, less 2 percent annual depreciation to the date of sale, should be added to petitioner’s basis as of 1938. The evidence as to the remaining expenditures showed their general purposes, as indicated in our findings of fact, but the evidence was insufficiently detailed or convincing to establish their exclusive relation to improvements of a permanent nature. We hold, therefore, that as to these items, petitioner has failed to overcome the presumption of correctness of the respondent’s determination, and they may not be included in her basis.

On the fourth issue, petitioner contends that three items not involved in the foregoing discussion should be deducted as selling expense in determining her gain on the sale of the property. One of those items, $25 for a quitclaim deed to clear title to the property sold, should be deducted, the respondent so conceding. Also, the item of $2,000 paid an attorney for his services in connection with the sale should be deducted. Respondent allowed $500 for this fee, but this amount should be increased to $2,000. The remaining item of $231 for revenue stamps should not be deducted, since the petitioner has already received the benefit thereof by reason of the fact that respondent in his adjustments allowed that item as an “additional deduction.”

On the fifth issue, it is the petitioner’s contention that her profit from the sale of the land and building should be reported on the installment basis, as provided by section 44 (b) of the Revenue Act of 1938 ¹ and articles 4A-1, 44 — 2, and 4A-3 of Regulations 101. Under the provisions of section 44 (b), supra, for a sale of realty to qualify as an installment sale, it is required, inter alia, that the “initial payments” received shall not exceed 30 per cent of the “selling price.” Article 44-2 of Regulations 101² provides that in the sale of mortgaged property, “whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser,” the amount of the mortgage shall be included “as a part of the selling price,” but, to the extent the amount of the mortgage does not exceed the basis to the vendor of the property sold, it shall not be considered as a part of the initial payment.

The disagreement of the parties as to whether the initial payment is less than 30 per cent of the selling price hinges solely upon the amount by which the $25,500 assumed mortgage exceeds petitioner’s basis without deducting selling expenses; for the initial payment is the amount of such excess plus the $25,000 paid in cash.

We have found the cost of the land to be $10,000, the cost of non-depreciable special assessments made for local benefits to be $1,088.39, and the cost of depreciable improvements to be $7,033.69, and that in computing the petitioner’s basis the latter amount should be reduced by depreciation at the rate of 2 per cent annually to the date of the sale. The basis of the petitioner, when computed in accordance with such findings, will be less than the assumed mortgage of $25,500, and the excess of the assumed mortgage over the adjusted basis, when added to the cash received of $25,000 will result in an initial payment of less than $34,413, which latter figure is 30 per cent of the selling price of $114,710. This entitles petitioner to report the taxable gain on the sale of the land and building on the installment basis, and we so hold. It, therefore, is unnecessary to consider the petitioner’s alternative contention under the sixth issue that she is entitled to report the gain on the deferred-payment-sale method.

Reviewed by the Court.

Decision will be entered under Rule 50.

1 ise. 44. INSTALLMENT BASIS.

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(b) Sales op Realty and Casual Sales op Personalty. — In the case * * * of a sale or other disposition of real property, If * * * the initial payments do not exceed 30 per centum of the selling price * • • the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis [installment basis] and in the manner above prescribed in this section. As used in this section the term “initial payments” means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made. [Brackets supplied.]

2 Art. 44-2. Sale of real property involving deferred payments. — Under Section 44 deferred-payment sales of real property include * * * (6) sales in which there is an immediate transfer of title, the vendor being protected by a mortgage or other lien as to deferred payments. Such sales * * * fall Into two classes when considered with respect to the terms of sale, as follows:

(1) Sales of property on the installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made do not exceed 30 per cent of the selling price;

(2) Deferred-payment sales not on the Installment plan, that is, sales in which the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable year in which the sale is made exceed 30 per cent of the selling price.

In the sale of mortgaged property the amount of the mortgage, whether the property is merely taken subject to the mortgage or whether the mortgage is assumed by the purchaser, shall be included as a part of the “selling price”, but the amount of the mortgage, to the extent it does not exceed the basis to the vendor of the property sold, shall not be considered as a part of the “initial payments” * * *