Penn Athletic Club Bldg. v. Commissioner , 10 T.C. 919 ( 1948 )

Penn Athletic Club Building, Girard Trust Company, Trustee for First Mortgage Bondholders, Petitioner, v. Commissioner of Internal Revenue, Respondent

Penn Athletic Club Bldg. v. Commissioner

Docket No. 9007

United States Tax Court

10 T.C. 919; 1948 U.S. Tax Ct. LEXIS 180;

May 24, 1948, Promulgated

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Decision of no deficiency will be entered as to each taxable year.

The petitioner, mortgagee-trustee for bondholders, after default and pursuant to a remedy provided in the mortgage, giving it a right to demand and receive a conveyance of the property and lease the same and apply proceeds upon the mortgage and expenses, gave such notice and received a deed to the property from the owner containing the usual expressions of absolute conveyance, but providing that the mortgage should continue in effect and title not merge with the mortgage. The debt was released. The parties did not intend the conveyance as absolute. The conveyance was necessary in order to make an advantageous long term lease without the delay which court proceedings would have caused and because without conveyance only a short term lease would be approved by the court. The petitioner, as mortgagee in possession, accounted to the court for its operation of the property, and an accounting was approved by the court and the petitioner was ordered to distribute future income under the mortgage. Held, that the petitioner, in receiving rentals upon the property which in the taxable years were used to pay taxes, largely for prior years, and expenses, did not receive taxable income.

Sanford D. Beecher, Esq., for the petitioner.

Wm. D. Harris, Esq., for the respondent.

Disney, Judge. Harlan, J., dissenting. Arundell, Murdock, Leech, and Hill, JJ., agree with this dissent.

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DISNEY

The respondent determined deficiencies in the income tax of petitioner in the amount of $ 106,328.43 for the calendar year 1942 and in the amount of $ 94,851.60 for the calendar year 1943.

The questions presented are:

(1) Is petitioner required to include in its gross income for the taxable years rents received by it during those years from the Penn Athletic Club Building?

(2) If it is held that the rent from the building is includible in petitioner's gross income:

(a) Is petitioner entitled to any deduction because it applied income received during the taxable years to the payment of a loan, the proceeds of which were used to pay real estate taxes which had accrued prior to the time petitioner acquired title to the building and constituted a tax lien thereon?

(b) Is petitioner entitled to deductions for depreciation, and, if so, the amounts of such deductions?

(c) Is petitioner entitled to deductions for trustee's commission and attorneys' fees, which were authorized to be paid out of capital and were so paid in 1942, in computing its net income for that year?

FINDINGS OF FACT.

Petitioner, trustee for the first mortgage bondholders of the Penn Athletic Club Building, is a bank and trust company organized and existing under the laws of the Commonwealth of Pennsylvania, with its principal place of business at Broad and Chestnut Streets, Philadelphia, Pennsylvania. Its returns for the taxable years were filed with the collector of internal revenue for the first district of Pennsylvania.

On October 31, 1922, the Penn Athletic Club of Philadelphia (hereinafter referred to as the club) was organized under the laws of the Commonwealth of Pennsylvania.

On or about September 15, 1924, the club purchased the site at the northeast corner of 18th and Locust Streets, Philadelphia, Pennsylvania, for the purpose of having erected thereon a clubhouse in which to carry on its activities.

About the same time, the club organized, under the law of Pennsylvania, the Rittenhouse Square Corporation for the purpose of holding title to the site on which the proposed clubhouse was to be erected. All of its stock was owned by the club.

On September 15, 1924, the real estate in question was conveyed by the club to C. Benton Cooper, a "straw man," who in turn, on September 15, 1924, executed to the petitioner, as trustee, a mortgage to secure an authorized issue of $ 3,000,000 first mortgage bonds. The club guaranteed in writing the payment of principal and interest on the first mortgage bonds. The mortgage, among remedies of the trustee and the bondholders, provided, inter alia, that the mortgagor should have possession prior to default; also that the trustee, in case of default, could enter upon the property, lease it, and, after deducting expenses paid, including taxes, apply the moneys to the payment of interest and principal of the outstanding bonds, and, after payment thereof in full, pay any balance to the mortgagor for his own use and benefit; also (art. VI, sec. 4) that the trustee could sell at public sale, and in case of foreclosure sale moneys raised should be appropriated to payment of principal and interest, cost, charges, and expenses, any balance to be paid to the mortgagor for his sole use and benefit.

The mortgage, article VI, sections 1 and 2, provided for service of written notice upon the mortgagor of any default and that the debt was considered due and payable and might be proceeded upon; and for foreclosure.

On September 25, 1924, C. Benton Cooper conveyed the premises, under and subject to the aforesaid first mortgage, to the Rittenhouse Square Corporation. Thereafter, the Rittenhouse Square Corporation, using the proceeds realized from the sale of the first mortgage bonds of C. Benton Cooper and the proceeds from the sale of its own bonds, proceeded to erect upon the premises, and to furnish and equip, the clubhouse later occupied by the club. On September 25, 1924, the Rittenhouse Square Corporation leased the premises to the club for the term of twenty-five years from March 1, 1926.

C. Benton Cooper, in executing the first mortgage to the petitioner, as indenture trustee, acted as "straw man" for the Rittenhouse Square Corporation for the purpose of facilitating the financing of the construction of the clubhouse.

Interest was regularly paid on the mortgage up to and including March 15, 1932. Thereafter default occurred in the payment of the first mortgage interest and petitioner, as indenture trustee, made several requests for payment. No payment was made pursuant to these requests.

On September 1, 1932, a deposit agreement was entered into, by virtue of which a committee was formed to protect the interests of the first mortgage bondholders.

On December 1, 1936, the club, as debtor, and the Rittenhouse Square Corporation, as subsidiary debtor, filed their petitions under section 77-B of the Federal Bankruptcy Act, in the District Court of the United States for the Eastern District of Pennsylvania, averring that they were unable to meet their debts as they matured and that it was desired by both to file a consolidated plan of reorganization, and requesting that in the meantime they be allowed to remain in possession of and to continue to conduct and operate the premises.

On December 1, 1936, the District Court allowed the petitions, enjoined the petitioner, as indenture trustee, from exercising any of its rights as indenture trustee (including its right to enter and take possession of the mortgaged premises and collect and receive the rents therefrom and apply them to the payment of the mortgage debt) and on the same day referred the petition to a special master, for his consideration and report.

Following the submission of plans by the club and the Rittenhouse Square Corporation as the debtor and the subsidiary debtor, respectively, reports thereon by the special master and exceptions filed thereto, the debtor and subsidiary debtor on January 11, 1939, filed a "New or Superseding Plan of Reorganization," which, after approval by more than 79 per cent of the bondholders, was thereupon referred to the special master for consideration. On April 10, 1939, the special master filed his "Special Master's Report No. 3," in which he recommended that the plan of reorganization be confirmed.

Shortly thereafter the plan was modified in certain minor respects and, as so modified, was approved and ordered effective by the Federal District Court by its decree dated January 30, 1940.

The plan of reorganization approved by the court provided, inter alia, that Rittenhouse Square Corporation should execute and deliver to the club its deed for the mortgaged premises, together with all other assets owned by it, and should thereupon be dissolved, and that the debt of C. Benton Cooper or Rittenhouse Square Corporation and all bank debts and unsecured claims should be canceled.

It further provided that the petitioner, as trustee under the first mortgage indenture, execute an agreement with the club as debtor, extending and modifying the first mortgage and the bonds issued thereunder by making provision, inter alia, that all interest and sinking fund payments accrued to January 1, 1939, be waived and canceled; that the principal sum of the first mortgage be reduced to $ 2,580,000 to conform to the amount of bonds then outstanding; that the club assume direct obligation as debtor to pay principal, interest, and sinking fund charges, as provided in the agreement, and to fulfill and carry out all covenants and conditions of the first mortgage indenture as modified and extended by the agreement; that all outstanding bonds be registered as to principal and interest; that the maturity of the first mortgage be extended to December 31, 1951; that all equipment, furniture, and furnishings then owned or thereafter acquired by the debtor be subject to the lien of the mortgage and held as additional security for first mortgage bondholders; that interest commence January 1, 1939, and be at the rate of 5 per cent per annum for 1939 and 4 per cent per annum thereafter, the amount payable currently to be at rates ranging from 1 per cent to 4 per cent and additional amounts payable currently within the maximum of 4 per cent per annum, depending upon cash receipts and earnings (as more fully set forth in the plan); that provision be made for a replacement and permanent improvement fund in the amount of $ 13,500 per annum reserved out of profits, subject to certain further conditions as set forth in the plan, and that:

* * * The agreement shall further provide, in a manner acceptable to counsel for the Girard Trust Company, Trustee, for a transfer and conveyance of the property by deed to the Trustee or its nominee, for the benefit of the registered bondholders in the event of default in any of the provisions of the Mortgage or any covenants of the Debtor described above for a continuous period of one year.

The plan further provided that upon execution of the plan the debtor pay to the Girard Trust Co., trustee, the sum of $ 25,800 for the payment by the latter of the sum of $ 10 per $ 1,000 and $ 5 per $ 500 of first mortgage bonds to the registered owners upon the delivery of the bonds, application and registration thereof pursuant to the plan, and as consideration for the waiver and cancellation by the trustee of any claim for use and occupation of the property under the proceedings. The plan further provided that the club would, in case of any default, include in its board of governors two persons selected by the bondholders. Two men were so selected and represented the bondholders on the board until after the transfer of the property to the trustee on January 21, 1942.

Under the order of the Federal District Court dated January 30, 1940, approving and effectuating the plan of reorganization, the bondholders were given five years from the date of the entry of the final decree to send their bonds for registration and modification in accordance with the terms of the plan as approved in order to participate in any distribution provided for in the plan; and it was ordered that any moneys unclaimed after five years in the possession of the trustee should become the property of the debtor.

In compliance with the plan as approved by the Federal District Court, the Rittenhouse Square Corporation conveyed the mortgaged premises to the club under and subject to the lien of the mortgage, and was thereupon dissolved.

Further, pursuant to the terms of the plan, the club, therein referred to as debtor, and the petitioner, as trustee for the benefit of the bondholders under the first mortgage indenture, entered into a supplemental mortgage agreement dated January 30, 1940, for the purpose of carrying out and effectuating the terms and provisions of the plan.

The supplemental mortgage agreement incorporates in general the conditions, provisions, and requirements of the plan as above set forth; and further provides that, except as so modified, the original mortgage is to remain unimpaired and unchanged.

The prevailing practice as to leases by mortgagees in possession was that the Court of Common Pleas of Philadelphia and the United States District Court would not approve such a lease for a period of more than one year. The attorneys for the trustee had had such difficulty, and suggested to the club that the plan have incorporated in it an additional remedy, that the trustee could after default for one year request conveyance of the property to the trustee in the mortgage indenture. This was incorporated in the plan, and paragraphs 14, 17, and 19 of the supplemental mortgage agreement provide as follows:

14. Debtor covenants and agrees that in the event that there shall be default in the performance of any of the covenants, conditions or provisions of said mortgage, as herein modified and extended, or in the performance of any of the covenants or agreements of the Debtor contained in this agreement, for the continuous period of one year from the date of such default, then and in that event, upon the written request of the Trustee, Debtor will transfer and convey the mortgaged premises to the Trustee or its nominee for the benefit of the bondholders, such transfer and conveyance to be made in a manner and form acceptable to counsel for the Trustee.

The Trustee may upon its own initiative or upon the written request of the holders of twenty-five per cent. (25%) in amount of the bonds then unpaid and outstanding, make such written request that the Debtor transfer and convey the mortgaged premises as aforesaid, and upon receipt of such transfer and conveyance, enter into or upon all and singular the land, buildings and premises mortgaged or intended so to be, and each and every part thereof, and have, hold, lease and use the same, operating by its superintendents, managers, receivers, or servants, or other attorney or agent the said mortgaged premises and the building or buildings thereon erected, and make from time to time all repairs and replacements thereto as may seem to it to be judicious, and collect and receive all rents, issues and profits of the same and every part thereof, and after deducting the expenses of operating the said building or buildings, and all of said repairs, replacements, alterations, additions and improvements, and all payments, which may be made for water rents, taxes, assessments, charges, liens or insurance prior to or subsequent to the time of these presents, upon all the said land, buildings, and premises, or any part thereof, apply the moneys arising as aforesaid, as provided in Article VI, Section 4 of said mortgage.

Or the Trustee, either with or without entry, as aforesaid, may, and it shall and may be lawful for it, upon the written request of the holders of a like amount of bonds, as aforesaid, and it is hereby authorized and empowered to sell the estate, real and personal, and premises mortgaged, or agreed and intended so to be, to the highest and best bidder at public sale in the City of Philadelphia, first giving at least one month's notice of such intended sale, by publication to be made at least once in each week in two daily newspapers published in the City of Philadelphia, Pennsylvania, and in two daily newspapers published in the City of New York, and the said property may be sold as an entirety or in parcels, as may be deemed most expedient, and it is hereby authorized to grant and convey the said land, buildings and premises to the purchaser or purchasers freed from all and every the trusts created by said mortgage and this Agreement, the purchase money (after deducting the costs and expenses of the trust, including a reasonable allowance for the Trustee's services and a reasonable attorney's commission), to be applied in accordance with Article VI., Section 4 of said mortgage. The transfer and conveyance of the mortgaged premises as above provided to the Trustee and its nominee for the benefit of the bondholders shall not result in a merger of said mortgage except as the Trustee shall in its sole discretion elect. This remedy in event of default shall be in addition to all other remedies granted under the provisions of said mortgage and this Agreement, and any of said remedies may be pursued single or concurrently.

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17. Debtor covenants and agrees that the said outstanding bonds, as herein modified and extended, shall constitute valid, legal and binding obligations of the Debtor for the payment and full performance of the covenants, conditions and provisions of which the Debtor hereby assumes direct and primary liability, and the Debtor further covenants and agrees to fulfill, observe and perform all of the covenants, agreements, conditions and provisions contained in this Agreement and in said Mortgage, as the same is herein modified and extended.

19. Debtor covenants and agrees to take such corporate action and execute such further papers and documents as shall be requisite and necessary, in the judgment of the Trustee, to effectuate the provisions and fulfill the covenants of this Agreement and of the said plan, as modified, in pursuance of which this Agreement has been entered into.

After the execution of the supplemental mortgage agreement the Penn Athletic Club continued in possession of the premises. Late in 1941 it was learned that the Federal Securities and Exchange Commission was interested in leasing the premises for its use. By this time, default under the supplemental mortgage agreement had occurred and continued for more than one year.

Petitioner and representatives of the bondholders felt that the club would never be able to pay the minimum interest payments under the mortgage and delinquent real estate taxes for the years 1939, 1940, and 1941. The Securities and Exchange Commission desired immediate possession of the premises and a lease from petitioner as owner for a period of seven years, subject to termination by it after three years. The Government estimated its expenditures required on the building would be $ 600,000 to $ 750,000. Counsel for the Securities and Exchange Commission were informed by counsel for the trustee as to the practice in the courts. After counsel had together examined the original and supplemental mortgages, Government counsel stated that it seemed to them that if the trustee could request conveyance to the trustee, under the terms of the additional remedies provided for in the supplemental mortgage, that the Girard Trust Co., as trustee, could make the lease for seven years. The lease was thereafter executed as hereinbelow set forth, in accordance with that arrangement with Government counsel.

On January 13, 1942, petitioner wrote to the board of governors of the club, as follows:

Gentlemen:

The undersigned, Trustee under Mortgage Indenture of September 15, 1924, recorded * * *, and Supplemental Mortgage Agreement, dated January 30, 1940, recorded * * *, requests that in accordance with the terms of paragraph 14 of said Supplemental Mortgage Agreement you transfer and convey to the undersigned the mortgaged premises, equipment, furniture and furnishings, etc. subject to the lien of said mortgage.

This request is made because of defaults in the performance of the covenants and provisions of said mortgage as modified for a continuous period of over one year.

The club called a meeting of its board of governors for January 19, 1942. Some of the members of the club were bondholders. At that meeting, at which the trustee's attorney was present, after discussion and agreement that the club could select and retain $ 25,000 worth of furniture and have 72 hours to move out of the property, the attorney representing the trustee was asked by the attorney who had been appointed by the board to draw a resolution (and before its adoption) was asked whether, if the club would make an absolute conveyance in fee simple, the Girard Trust Co. would accept it in complete satisfaction. The trustee's attorney answered that if such a proposal was made it would be accepted, but that in that event no furniture or furnishings would be released, and possession would have to be given immediately; and that no such proposition had come from the club. The attorney for the club replied that that was correct, that "We are not prepared to make that because we believe the property under expert testimony is worth $ 3,000,000." That proposal was not made. The following resolution was adopted by the directors of the club and ratified and approved by its members at the meeting on January 19, 1942:

Resolved that the proper Officers of the Club be authorized and empowered to at once convey and transfer to the Girard Trust Company, Trustee under the indenture of mortgage of September 15, 1924, recorded in the Office for recording of Deeds in Philadelphia County in Mortgage Book JMH #3660, page 427, and supplemental mortgage agreement dated January 30th, 1940, recorded in the same office in Deed Book DWH #926, page 361, all property subject to lien of said mortgage, including all real estate, buildings, machinery, furniture and furnishings, and the delivery of possession thereof by January 21, 1942, upon the said Trustee executing a release in proper form of all indebtedness due by the Club under said mortgage including tax liability and the delivery to it of such furniture, furnishings, and equipment excluding floor coverings, Venetian blinds, draperies and curtains, as may be found necessary to equip a new athletic club building or part thereof which it may lease, not to exceed in appraised market value in the appraisement about to be made in the sum of $ 25,000.00, it being understood and agreed that unsatisfied current indebtedness now due by the Club to other creditors be satisfied so far as may be found necessary out of proceeds of the rest of the furniture and equipment after all other assets including collectible receivables of this date, except those herein mentioned, have been used for such purposes, the Club agreeing to select and remove the furniture, furnishings and equipment on 72 hours notice.

It being also agreed that the trophies and books of the Library are not covered by the Mortgage Lien and remain the property of the Club, to be removed on 72 hours notice.

On January 21, 1942, pursuant to the resolution of January 19, 1942, the club executed and delivered a bill of sale to petitioner as trustee under the original and supplemental mortgage agreements, covering all furnishings and equipment except certain furnishings selected by the club having a value of $ 25,000, which it was permitted to retain. The instrument also recited that current indebtedness of the club should be paid from sale of other furniture and furnishings, to any extent cash assets and proceeds of other property not subject to the mortgage should be insufficient. On the same date the club executed a "Piece-deed-grant" covering the premises to petitioner. The deed designated the grantee as:

Girard Trust Company, of Philadelphia, Pennsylvania, a corporation organized and existing by virtue of the laws of the Commonwealth of Pennsylvania, Trustee under Indenture of Mortgage dated September 15, 1924, recorded on October 2, 1924, in the office for the Recording of Deeds in and for Philadelphia County, in Mortgage Book J. M. H. No. 3660, p. 427, as modified by Supplemental Mortgage Agreement dated January 30, 1940, recorded on March 8, 1940, in said Office for the Recording of Deeds in Deed Book D. W. H. No. 926, page 361, Grantee, of the second part.

The habendum clause twice refers to the Girard Trust Co. as "trustee as aforesaid" and the text of the deed provides:

Under and Subject, nevertheless, to the lien of the aforesaid mortgage debt or principal sum of Two Million Five Hundred Eighty Thousand Dollars ($ 2,580,000.), together with interest accrued and to accrue thereon.

And it is expressly stipulated that it is not intended hereby to merge the interests of Girard Trust Company, as Trustee, in the said premises as mortgagee of the aforesaid mortgage, and as owner in fee of the said premises, but that the said mortgage shall be, remain and continue in full force and effect for all purposes as though the present conveyance had not been made.

Also Under and Subject to the lien of all real estate taxes accrued and to accrue thereon.

The granting clause states: "has granted, bargained, sold, aliened, enfeoffed, released and confirmed and by these presents does grant, bargain, sell, alien, enfeoff, release and confirm unto the said grantee * * *." The deed was executed pursuant to the request and demand in the letter of January 13, 1942.

Attached to the deed is a certificate as follows: "It is hereby certified that the actual consideration is less than $ 100. Claude C. Smith." There is also attached to the deed a "Philadelphia Documentary Stamp Tax Certificate" executed on January 26, 1942, by Claude C. Smith, stating in pertinent part that he is attorney for the trustee, that the premises are worth less than the mortgage, and, therefore, there is no equity over mortgage indebtedness; that the conveyance is made pursuant to a decree entered March 7, 1941, by the District Court of the United States for the Eastern District of Pennsylvania in the bankruptcy of Penn Athletic Club, approving the new or superseding modified plan of reorganization filed therein which provided for said coveyance to be made to Girard Trust Co., trustee, under certain circumstances and conditions as therein set forth; that the conveyance is under and subject to the mortgage indebtedness and is not in lieu of foreclosure; that the transaction has an actual value of only $ 1; and that 5 cents in documentary stamps have been attached. Also attached to the deed is the following: "Received the day of the date of the above indenture, of the above named Girard Trust Company, Trustee, the full consideration within mentioned." (Signed for the club by Frank Smith, the president.) The deed was acknowledged by the secretary of the club on January 23, 1942. It was recorded on January 26, 1942. The deed includes "all the estate, right, title and interest, property claim and demand whatsoever of it, the said Grantor, as well at law as in equity, of, in and to the same and every part and parcel thereof."

On January 22, 1942, the petitioner executed a "Release from Mortgage and Tax Liability" which recites that the club owns and occupies "the Club property upon which Girard Trust Co." as trustee for bondholders has a mortgage of $ 2,580,000; also that the mortgage has been in default for one year and that in pursuance of its rights under said supplemental mortgage agreement the trustee has requested and the club has agreed, subject to the terms hereinafter referred to, immediately to convey the mortgaged premises "to the trustee for the benefit of said bondholders." After reciting the provisions of the resolution adopted by the directors and members of the club on January 19, 1942, the instrument further provides:

The foregoing action was taken by the said Directors and the said members to permit the Trustee to enter into immediate lease of the mortgaged premises or such part thereof as may be desired, with the Government of the United States for use by a designated agency (Securities and Exchange Commission), and to permit the Trustee to become the owner of said mortgaged premises and the equipment, furniture and furnishings thereof, for all purposes whatsoever, under and subject however to the lien of said above recited mortgage as modified, and also under and subject to all accrued and accruing real estate taxes, the interest of the Trustee as owner not to become merged, however, with its interest as mortgagee.

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Now, Therefore, Know All Men by These Presents, that Girard Trust Company, Trustee as aforesaid, does hereby remise, release and forever discharge Penn Athletic Club of Philadelphia, its successors and assigns, of and from all indebtedness due by the Club under said mortgage, together with all interest accrued or accruing thereon and all liability in connection with real estate taxes, past, present or future, assessed against the said premises. Nothing herein contained, however, shall be held to impair the lien of the aforesaid mortgage or the validity of said mortgage debt which may be asserted at any time against the original obligor, C. Benton Cooper, and against any other person or persons liable in connection therewith other than the Penn Athletic Club of Philadelphia.

On January 26, 1942, the "Girard Trust Company as Trustee, under mortgage indenture, supplemental mortgage agreement, and under deed of conveyance from Penn Athletic Club of Phila. covering premises n. e. cor. 18th and Locust Sts., Phila., Pa. known as Penn Athletic Club Bldg." executed a lease of the premises to the United States for use by the Securities and Exchange Commission, to start February 10, 1942, and to end February 9, 1950, subject to termination on six months notice at any time after February 9, 1945, for a rental of $ 18,750 per month for the first nine months and thereafter at the rate of $ 16,666.66 per month.

In due course petitioner sold the furnishings and equipment (except that leased to the Securities and Exchange Commission or surrendered to the club) at public sale, as provided by paragraph 14 of the supplemental mortgage, for a net consideration of $ 79,524.78. On May 22, 1942, petitioner rendered an accounting to the club as to certain items of receipts and disbursements growing out of the transfer of possession of the property, showing a balance of receipts in excess of disbursements for liabilities in the amount of $ 3,056.78 ($ 6,030.99 due the club less $ 2,974.21 credits), and upon payment of said balance to the club the parties executed a mutual release wherein they agreed, among other things, that neither had any property or assets of any kind belonging to the other, and that there was no further accounting which either was obligated to make to the other at that time or in the future. The release was intended to relate exclusively to the settlement of the accounts listed on the release, which covered adjustments and apportionment as of January 21, 1942, of rentals, wages, social security, taxes, electricity, water rents, and similar items in connection with operation of the premises.

It recited, inter alia, that "Whereas at the time that the Penn Athletic Club, in compliance with the request of the Girard Trust Company, Trustee * * * determined to convey and transfer to the Girard Trust Company as said trustee all real estate, * * * subject to the lien of said mortgage and deliver possession thereof as of January 21, 1942 * * *." It was signed by Frank Smith, president of the club, and G. H. Stuart, 3d, vice president of Girard Trust Co., trustee.

At the time of the conveyance to the petitioner, local real estate taxes owing to the city of Philadelphia for the years 1939 to 1942, inclusive, assessed against the club were unpaid, and they constituted a prior lien on the premises. In order to discharge these unpaid taxes, the Girard Trust Co., indenture trustee, borrowed $ 275,000 from the Pennsylvania Co. for Insurances on Lives and Granting Annuities, of Philadelphia, Pennsylvania, and used such proceeds as payment in part of the real estate taxes. The total real estate taxes paid by petitioner during 1942 for the years 1939 to 1942, inclusive, amounted to $ 317,869.28. Petitioner was advised by counsel that under the supplemental mortgage agreement it was necessary to pay all such taxes before any distributions could be made to bondholders. Partly to secure the Pennsylvania Co. for Insurances on Lives and Granting Annuities for the $ 275,000 advance made by it to discharge the delinquent taxes for the years 1939 to 1942, inclusive, the Girard Trust Co., indenture trustee, assigned to it all rentals due or to become due, and further agreed to subordinate the mortgage to the loan.

Petitioner maintains its books and records and files its fiduciary income tax returns on the cash receipts and disbursements basis, and reports on the basis of calendar years. Petitioner's gross income from rents for the taxable year 1942 was $ 178,509.37 and for the taxable year 1943 was $ 209,084.78.

On or about October 8, 1942, the petitioner, which prior to the conveyance had been advised by its attorney that, under the terms of the conveyance in accordance with written request, it was not absolute owner, but mortgagee in possession, required to account for any surplus above the debt, filed in Cause No. 1263 in the Court of Common Pleas No. 1 of Philadelphia County, its first account as trustee under the mortgages, accounting, among other items, for the $ 79,524.78 from furnishings and equipment and stating that it did not receive or disburse any income, that "all rental was collected as mortgagee in possession which is accounted for on the following pages" (after which the "mortgagee in possession Rent Account" is itemized). Petitioner petitioned the court to confirm its account, representing, so far as important here, that because of payment of real estate taxes no balance of income was available for distribution to the bondholders, but requesting the court to approve payment of expenses and attorneys' fees and trustee's commission to the extent of the principal collected and on hand, and to direct distribution of future available income under article VI, section 4, of the mortgage indenture as modified.

On November 13, 1942, the court, reciting due notice given to all parties, both by publication and by written notice duly mailed to all parties whose whereabouts were known, of the filing of the account and petition, and that no objection or exception had been filed, confirmed the principal and income accounts and the "mortgagee in possession rent account," allowed payment from principal of trustee's commissions of $ 5,000 to Girard Trust Co., as trustee, and attorneys' fees of $ 16,250, which had been paid out by petitioner, and ordered the accountant to distribute future principal, income, rents, and profits (after payment of expenses) "in accordance with the provisions of Section 4 of Article VI of said Mortgage indenture" as modified. The $ 5,000 and $ 16,250 are not reflected as deductions in the deficiency determined for 1942.

All rentals received by petitioner during 1942 and 1943 were applied in payment of fees and other expenses and in payment of the loan from the Pennsylvania Co. The balance of the loan was paid off during 1944, and as of December 31, 1944, petitioner had on hand a balance of net rentals in the amount of $ 136,430.40, which it distributed to bondholders on March 2, 1945. In making this distribution petitioner advised each of the registered bondholders what portion thereof constituted payment on account of interest and what portion thereof constituted payment on account of principal of their bonds. This distribution amounted to $ 52.88 for each $ 1,000 bond, of which $ 10.58 was allocated to interest and $ 42.30 to principal. This allocation was in accordance with the provisions of article VI, section 4, of the original mortgage indenture, which provides that such distribution shall be pro rata, without preference as to interest or principal, and in accordance with the decree of the Common Pleas Court of Philadelphia County dated November 13, 1942, which directed all such distributions to bondholders to be made under article VI, section 4, of the mortgage.

About May 16, 1946, the petitioner filed a second account concerning the period from September 1, 1942, reporting inter alia, gross income "as mortgagee in possession" of $ 864,272.86 and disbursements of the same amount, including the distribution to the bondholders of $ 136,430.40 on March 2, 1945, and $ 141,538.80 on March 2, 1946, in accordance with the mortgage and supplement; and asked confirmation and approval of distribution of balance shown, after payment of expenses in accordance with section 4 of article VI of the mortgage and supplemental mortgage. Notice of filing of both accounts was given to the club "because of their interest in any surplus or balance that may remain after the bonds and interest are paid off." Notice of the distribution on March 2, 1946, was given the bondholders similar to that given on the distribution on March 2, 1945, and copies of both notices were given to the club.

By correspondence on April 29, May 2, and May 5, 1942, counsel for the petitioner and the club agreed that a perpetual insurance policy issued on the club building in 1926, and of a value of about $ 1,670, should be held by the trustee as additional security until the mortgage indebtedness was satisfied, under article IV, section 3 of the original mortgage, providing that insurance be carried and assigned to the mortgagee as additional security. ^{*213 The holders of bonds totaling $ 44,000 failed to present their bonds for registration within the five years set by the decree of March 7, 1941, by the United States District Court, and there remained in the hands of the trustee $ 440 out of the $ 25,800 deposited with the trustee by the club. The club filed a petition to reopen the bankruptcy proceeding, claiming the $ 440; to which the trustee answered claiming that the release executed May 22, 1942, precluded the return of the $ 440 to the club, and that it should be ordered distributed to the bondholders who did register their bonds. On July 16, 1946, in the bankruptcy proceeding the court, reciting in its opinion that the mortgage provided that if bonds are not registered any unclaimed moneys pertaining thereto "shall become the property of the debtor," held that the release of May 22, 1942, did not contemplate the fund in question, that the release "may not be construed to extend beyond the express consideration intended or contemplated by the parties," and that the trustee should pay the $ 440 to the club. *214 Under date of July 12, 1946, the petitioner, as trustee, after being approached by parties interested in purchasing the club property, and with the club's knowledge and consent, sent printed notices to various brokers, giving notice in substance that it held title as mortgagee in possession, that a private sale was considered more beneficial to the bondholders than a foreclosure or public sale under the mortgage, that bids would be received on September 18, 1946; that it was advised that the manner, terms, and conditions of the sale were subject to review and approval by the Court of Common Pleas, and that after the sale such approval would be sought and the sale, if not approved, would be canceled; also that Commonwealth Title Co. would insure title if sale were approved by the Court of Common Pleas. The property was not sold.}

The title company issued a title examination paper as to the club property, reciting in pertinent part that a petition to the Court of Common Pleas by the Girard Trust Co., as trustee under the mortgage, for leave to sell and decree authorizing sale, would be required.

Demand has never been made, under section VI of article 1 of the mortgage, for payment of the mortgage.

The mortgage has never been satisfied of record.

For the year 1942 petitioner filed a fiduciary income tax return, Form 1041, on May 13, 1943, and subsequently filed a blank amended return including therein only certain statements of receipts and disbursements. In its original return petitioner reported total income of $ 125,179.11, and deductions of $ 317,869.28 for taxes and $ 2,441.50 for interest, leaving a loss of $ 195,131.67. Explanation was added that petitioner was trustee under the mortgage indenture as modified, that the club premises had on January 21, 1942, been conveyed to it as trustee in response to its request in connection with remedies available to the mortgagee, for the benefit of bondholders, in which capacity it had leased to the United States. Line 17, "Amount distributable to beneficiaries" is filled in "None." The computation of the $ 125,179.11 (from the club building) makes no deduction for depreciation. There was attached a rider stating that the return was filed without prejudice and with no inference of liability for filing same, stating reliance on Regulations 103, section 19, as to receivers of rents on mortgaged property not needing to file. The same statement is attached to the blank amended return. In determining the deficiency the respondent made the following adjustments to the net income (loss) reported in the original return:

Net income as disclosed by return -- Loss			($ 195,131.67)
Unallowable deductions and additional income:
	(a) Real estate taxes	$ 317,869.28
	(b) Insurance premium paid in advance	4,501.49
	(c) Real estate expenses	22,569.03
			344,939.80
Total			$ 149,808.13
Nontaxable income and additional deductions:
	(d) Rents		$ 1,251.16
Net income adjusted			$ 148,556.97

For the year 1943 petitioner filed a blank fiduciary income and victory tax return on March 15, 1944, to which was attached a statement of receipts and disbursements, and a rider stating that the return was filed without prejudice, for the same reasons stated in the earlier returns, as to receiver of mortgaged property. In determining the deficiency the respondent made the following adjustments:

Net income as disclosed by return			0.00
Unallowable deductions and additional income:
	(a) Rents		$ 209,084.78
Total			$ 209,084.78
Nontaxable income and additional deductions:
	(b) Taxes	$ 64,464.72
	(c) Real estate expenses	10,540.82
	(d) Insurance and water rent	4,003.09
	(e) Interest	1,934.15
			80,942.78
Net income adjusted			$ 128,142.00

The fair market value of depreciable assets transferred by deed to petitioner on January 21, 1942, was $ 1,400,000 and these assets depreciated at the rate of 3 per cent per annum.

OPINION.

The primary issue relates to the rentals realized from the Penn Athletic Club Building during the taxable years. The respondent contends that as a result of the deed executed by the club on January 21, 1942, petitioner became the absolute owner in fee of the club building and should have included the rentals in its gross income; but the deficiency notice as to 1942 disallowed the deduction for taxes paid, taken in the first return filed. Petitioner contends that the rentals are not includible in its gross income because, under paragraph 14 of the supplemental mortgage agreement, it had only the right as a mortgagee in possession, to lease and operate, apply the rentals to taxes, expenses, and the mortgage debt, account for and pay to the club any balance remaining, and then retransfer the property itself to the club.

It is well settled that a mortgagee in possession is obligated to apply collected rents on the mortgage debt, and to account for the surplus. See 41 C. J. 630, citing a great number of cases. Therefore, the crucial question here is whether the petitioner was a mortgagee in possession, for if it was, the rents received were merely collections upon the debt and to tax them as income would be a tax upon capital being recovered. A mortgagee in possession has been defined as "one who has lawfully acquired actual possession of the premises mortgaged to him, standing upon his rights as mortgagee and not claiming under another title, for the purposes of enforcing his security upon such property or making its income help pay his debt. * * *" See 41 C. J. 612 and cases cited. One holding under an absolute deed given as security is a mortgagee in possession. Peugh v. Davis, 113 U.S. 542">113 U.S. 542; Mahoney v. Bostwick, 30 Pac. 1020; Jordan v. Warner's Estate, 83 N. W. 946; Wilmer v. Light Street Savings & Building Assn., 122 Atl. 129.

The evidence discloses that because of the prevailing court practice to restrict leases by mortgagees in possession to one year, an additional remedy had been placed in the supplemental mortgage, as paragraph 14, empowering the mortgagee, after default of one year, to demand a conveyance of the property and to lease or sell it and account to the mortgagor; and that on January 13, 1942, when the club had been in default for a continuous period of over one year, petitioner made a request in writing that the club transfer and convey to it the mortgaged premises, equipment, furniture and furnishings, etc., subject to the lien of the mortgage, in accordance with the terms of paragraph 14 of the supplemental mortgage agreement. Examination of the provisions of paragraph 14, and of the facts set forth in our findings, which need not here be restated, convinces us that the parties contemplated a transfer of title under the remedy provided in the mortgage and as additional security only, and that petitioner was a mortgagee in possession, and, as such, liable to account to the club for income realized from the mortgaged premises, after payment of the mortgage indebtedness and expenses. Paragraph 14 of the supplemental mortgage agreement refers to transfer of the property to the mortgagee as "This remedy," saying: "This remedy * * * shall be in addition to all other remedies granted under the provisions of said mortgage and this Agreement, and any of said remedies may be pursued singly or concurrently."

The respondent can not, and does not, deny that the demand for the conveyance, made on January 13, 1942, was under the mortgage; but, in effect, he contends that the conveyance dated January 21, 1942, was nevertheless not made under the mortgage, but was (despite the specific retention of mortgagee status by the petitioner, in the deed set forth) an absolute conveyance, rendering the petitioner liable for all income, yet depriving it, because of ownership, of the right to deduction for taxes paid by it, but assessed while the club held title. We are unable to find anything in the record to demonstrate that in a period of a few days the petitioner ceased to proceed under its mortgage remedies, under which it started on January 13; on the contrary, we think it clear that it did so proceed. It obtained a "conveyance" just as paragraph 14 of the supplemental mortgage agreement provided, by giving the notice there provided. The conveyance was carefully made subject to the mortgage lien, and to continue the mortgage "in full force and effect," also, "for all purposes as though the present conveyance had not been made." Could language be plainer that the petitioner expressly was "standing upon his rights as mortgagee and not claiming under another title," precisely within the above definition of mortgagee in possession? On the face of the writings alone, we find no sufficient reason to think that the position of mortgagor and mortgagee was abandoned, but conclude that, as the instruments indicate, the status was preserved. The mortgagee did take possession, and such taking of possession can not be attributed solely to those portions of the deed expressing the usual forms of absolute conveyance, but is seen to be based upon the whole contract expressed in the instrument (to say nothing just here of the agreement otherwise proven). It immediately leased the property -- as provided for by paragraph 14, after conveyance demanded and obtained. In leasing and accounting it is "operating" the property as by the mortgage specifically empowered. In our opinion the deed itself demonstrates that the petitioner did not become absolute owner, but was merely enforcing the mortgage, collecting rents, and paying back taxes for the benefit of the grantor and its bondholders, and it was in a position of accountability both to them and to the club if and when the indebtedness should be paid. It is to be noted that sections 1 and 2 of article VI of the mortgage require written notice of default, and to put the whole indebtedness in default for foreclosure. Such notice has never been given.

Essentially the respondent's position is that on January 21, 1942, the club waived its right of redemption and conveyed in lieu of foreclosure. The deed does not so state, as it could easily have done and, it would seem, logically would have recited, if such had been the intent. On the contrary, the mortgage is specially mentioned only to maintain it as before. Of course, the conveyance provided in paragraph 14 of the supplemental mortgage agreement could not mean an absolute conveyance, for, if so, it would have been altogether superfluous then to provide that the grantee could lease or sell. An absolute grantee need be given no such rights. It is to be noted that the respondent does not say that the deed intended by the mortgage was to be an absolute conveyance. Such a provision would be ineffective against the right of redemption, for a multitude of cases, including cases from Pennsylvania, hold that, under the maxim "Once a mortgage always a mortgage," a mortgagor can not in advance "by any device or contrivance" waive his right to redemption. See authorities cited, 42 C. J. 348, 356. "It is beyond the power of the parties." Peugh v. Davis, supra. Moreover, though of course it is recognized that it is possible for a mortgagor subsequently by deed to give up its equity of redemption to a mortgagee, it is hornbook law that if the original instrument was by way of security it should plainly appear that the later deed was intended as absolute and not by way of security. The transaction will be "closely scrutinized." Peugh v. Davis, 96 U.S. 332">96 U.S. 332, 337.

The presumption is that there is mere continuation of security. Guttenfelder v. Iebsen, 300 N. W. 299, citing, inter alia, the annotation in 129 A. L. R. 1435, which, on this point, says:

Generally, a conveyance of mortgaged premises by mortgagor to mortgagee operates as a bar to equity of redemption only when it clearly and unequivocally appears that both parties so intended that it should, and otherwise it will be regarded as a mere change in form of security operative as a mortgage.

* * * *

Where mortgagor of realty executes to his mortgagee a deed of the realty for a nominal consideration only, deed will be presumed to be a continuation of the security, and the right of redemption thereon is presumed to continue.

In 19 R. C. L. 387, we find:

* * * But any contract by which the mortgagor sells or releases his interest to the mortgagee is viewed suspiciously and carefully scrutinized in a court of equity. * * * However, it is the general rule that a conveyance of the mortgaged premises by the mortgagor to the mortgagee operates as a bar to the equity of redemption only when it clearly and unequivocally appears that both parties so intended that it should; otherwise, it will be regarded as a mere change in the form of security operative as a mortgage. * * *

Koob v. Zoller, 3 N. W. (2d) 130, requires careful scrutiny of a conveyance of mortgaged premises to a mortgagee, and says it will be upheld only if it "clearly appears that an absolute sale and not a transfer for security only was within the contemplation of the parties." Both the Guttenfelder and Koob cases stress that lack of cancellation and surrender of evidence of indebtedness and mortgage indicates that the conveyance is not absolute. Here, the mortgage was specially kept alive, the mortgage and bonds were never surrendered, and only personal liability was released. Under the above authorities, how can it be said that it "clearly, and unequivocally appears" that absolute conveyance was intended, contrary both to the evidence of the parties, their treatment (relied on in the Koob case), the presumption, and the continuation of the mortgage in the deed itself? In logic this principle is even more applicable here, where the mortgage itself provides a deed as a remedy, and one patently not absolute, since additional rights to lease or sell under it, are given. The "conveyance" provided here in case of default does not wipe out the mortgagor's equity of redemption, for, as above seen, that "right is inherent in, and essential to, every mortgage." 42 C. J. 343; Jones v. Gillett, 118 N. W. 314; 121 N. W. 5; Platt v. McClong, 49 Atl. 1125; and a power of sale in a deed of trust does not destroy the redeemable character of the instrument so long as the power remains unexecuted. Bell Silver & Copper Mining v. First Nat. Bank of Butte, 156 U.S. 470">156 U.S. 470. The petitioner has never sold the club building. The power of redemption remains, unless, for some reason which we are unable to discern, an absolute conveyance, wiping out equity of redemption, is demonstrated. We think that right is shown not to be destroyed.

In Peugh v. Davis, 96 U.S. 332">96 U.S. 332, the Court says:

* * * Without citing the authorities, it may be stated as conclusions from them, that a release to the mortgagee will not be inferred from equivocal circumstances and loose expressions. It must appear by a writing importing in terms a transfer of the mortgagor's interest, or such facts must be shown as will operate to estop him from asserting any interest in the premises. * * *

In that case the Court had under consideration an original deed, held by it to be security for a loan, and then another deed under seal, with general covenants of warranty, and a special covenant against any claim against the title. Accompanying the second deed, of the same date, was a receipt for $ 2,000 purporting to be in full payment for the purchase of the land. Yet the Court found that it was a mortgage. The deed here involved is obviously not so absolute in form as in that case, for on its face it (the deed here) not only refers to the mortgage, but preserves it intact.

In Wilmer v. Light Street Savings & Building Assn., supra, involving this question the Circuit Court said:

If the mortgage lien * * * was not extinguished by merger, in consequence of the conveyance from the mortgagor, * * * then the association must be treated, for the purposes of this case, as having held the properties in the character of mortgagee in possession after default. * * *

Merger here was specifically prohibited. The petitioner is therefore mortgagee in possession. In Caro v. Wollenberg, 163 Pac. (Ore.) 94, this question arose and the court said that a deed conveying a mortgagor's interest to the mortgagee must be "without any condition whatever permitting redemption." Yet in the instant case we find such retention of the redemption privilege -- simply because the "mortgage shall be, remain and continue in full force and effect for all purposes as though the present conveyance had not been made." If the mortgage was preserved, the right of redemption was preserved -- and petitioner is seen clearly as mortgagee in possession. Under general principles of public policy as to equity of redemption, almost any mention of existent mortgage is sufficient to defeat a claim of absolute deed; yet here we see the mortgage specifically kept alive.

The club kept that right, in precise language. Can it be doubted that in a contest it would maintain that right? Certainly its position is far stronger on the face of the instrument than in Peugh v. Davis, 96 U.S. 332">96 U.S. 332, where not only was there no hint of mortgage, but there were words of absolute conveyance, equally as categorical as here. We can not but conclude that the deed of January 21, 1942, is insufficient to translate the petitioner from the position of mortgagee to that of absolute owner.

Moreover, we think it clear from the evidence, outside of the deed itself, that the agreement was not one of absolute conveyance. With the deed containing both ordinary expressions indicative of absolute conveyance and those relative to nonmerger of interest and continuation of the mortgage, it is apparent that the instrument is not unambiguous. Obviously, evidence to explain is properly considered. A host of cases so state. The respondent so agrees, if there is ambiguity. This is not a matter of proving a deed to be a mortgage, but of clarification of the status of what had been a mortgage. Moreover, even without ambiguity in the instrument, it may be explained, in this case involving a third party. Commissioner v. Berkeley Hall School, 84 Fed. (2d) 539; Russell v. Southard, 53 U.S. 138">53 U.S. 138; Peugh v. Davis, 96 U.S. 332">96 U.S. 332; Indianapolis Glove Co. v. United States, 96 Fed. (2d) 816; Macon, Dublin & Savannah Railroad Co., 40 B. T. A. 1266, stating that we have uniformly denied application of the parol evidence rule where a third party is a litigant involved, and collecting cases. With the deed shortly following the demand for it under the mortgage, and specifically provided for in the mortgage, logic dictates that it was under such mortgage. What indicates otherwise?

The respondent's principal argument that the deed was absolute is, first, that the Government demanded or required that the petitioner become absolute owner of the property; and, second, that equitable powers must be exercised in order to find that the deed was not absolute.

Clearly, the argument fails in both respects. ^{contra. It is that counsel for the parties and for the United States Government, which was leasing, considered and examined the mortgage and supplement and the Government counsel suggested the request of conveyance under the additional remedies provided by the supplemental mortgage, and thought the lease could thus be made for the seven-year period desired. *939 neither demanded nor required by the Government; instead, it was fully aware that the lease rested on a conveyance under the mortgage remedies, and, considering the specific provision therein for conveyance and lease, was obviously justified in leasing from such a lessor.}

The respondent, however, as above noted, argues that equitable powers must be exercised or the deed accepted here as absolute. The idea is completely untenable. We need not exercise powers of equity in order to ascertain the facts as to liability for taxation. In Macon, Dublin & Savannah Railroad Co., supra., we said that extraneous evidence is admissible to inform us of the material facts and held that the transaction purporting to be an absolute sale was not such, but merely transfer to a nominee, and we collected cases where we had held instruments to be other than as appeared on the face, among them United National Corporation, 33 B. T. A. 790, where we held that a written agreement was not absolute sale as described, but security for a loan. The point is the same here. The leading case is Helvering v. Lazarus & Co., 308 U.S. 252">308 U.S. 252, affirming 32 B. T. A. 633, and holding that a deed in fee simple, with lease back, was in fact a mortgage and did not deprive the grantor of its right to deduct depreciation. The Court said:

* * * In the field of taxation, administrators of the laws, and the courts, are concerned with substance and realities, and formal written documents are not rigidly binding. Congress has specifically emphasized the equitable nature of proceedings before the Board of Tax Appeals by requiring the Board to act "in accordance with the rules of evidence applicable in courts of equity of the District of Columbia." * * *

Other cases to the same effect are: Tex-Penn Oil Co. v. Commissioner, 83 Fed. (2d) 518, holding in a tax case that face of contract does not govern, but real agreement may be shown by extraneous evidence; United States v. Board, 14 Fed. (2d) 459, a tax case, to the same effect; Park Chamberlain, 41 B. T. A. 10, a quitclaim deed held on the evidence not to prove a sale. The respondent's view, that the deed, being (allegedly) absolute in form, is not subject to explanation by evidence, is contrary to the body of the law on the subject.

Moreover, on the evidence, which is entirely consistent with the recitals in the deed as to the mortgage, a proposition of absolute conveyance was intentionally not made, not only because all furniture and furnishings would in that case have been required, instead of the club keeping $ 25,000 value thereof, but the attorney for the club expressly did not make such a proposition because he thought the property was worth more than the debt. Also, immediate possession in such case would be required. ^{*235 The Government representatives said they must know the next day. An absolute conveyance was negatived, moreover, by the understanding of the parties. Their treatment of the transaction is consistent with such understanding. They agreed that an insurance policy was retainable by the mortgagee for its security, under article IV, section 32, of the original mortgage, providing for its assignment as additional security, though obviously, had the conveyance been absolute, with no retention of mortgagee status, such insurance policy, of a value of about $ 1,670 would have been the property of the club, which had purchased it. Certainly, this is mutual recognition that the mortgage status had not changed. The statement attached to the recorded deed, recites that it is being made under the mortgage indebtedness "and is not in lieu of foreclosure * * *," indicating that at that time, and as now contended, it was the intent not to take an absolute conveyance or to obliterate the mortgage. The petitioner was advised by counsel prior to the conveyance that it would receive same under the mortgage indenture and be required to account. The release given and accepted, dated January 22, 1942, not only recites that the club "owns and occupies" the property (though the deed had been executed January 21, 1942), but also, reciting the history of the matter, and action of the club in approving the transfer, states that the foregoing action was taken by the said directors and members "to permit the Trustee to enter into immediate lease of the mortgaged premises. * * *" It is true that the quoted statement continues: "and to permit the Trustee to become the owner of said mortgaged premises and the equipment, furniture and furnishings thereof, for all purposes whatsoever, under and subject however to the lien of said above recited mortgage as modified * * *," but this language only emphasizes the fact that the petitioner was to "become the owner under * * * the mortgage" and subject to its lien -- which is nothing more than the supplemental mortgage remedy provided. That is not absolute ownership. The whole evidence and the necessity for prompt lease to the Government are convincing that, though in form the deed has some similarity to an absolute conveyance, it was qualified, both on its face and in fact, and was, under the mortgage remedies, so conveyed as to cause the Government to accept the lease, and an unqualified transfer was neither made nor intended. The lease was made "as trustee" and "under deed of conveyance" -- quite unnecessary if petitioner was absolute owner. Why, if it was the owner outright of the property, would the petitioner subordinate the mortgage to the loan of $ 275,000 from Pennsylvania Co. for Insurances on Lives and Granting Annuities? Why, if it was the absolute owner of the furniture and fixtures taken over, would it account for the $ 79,524.78 received from the sale thereof? The mutual release dated May 22, 1942, was intended to cover only settlement of accounts listed therewith (having to do with small items such as rents, inventories, wages, utility bills, etc., at the time of change of possession), and (in connection with the $ 440 matter arising from nonregistration of bonds) was found by the United States District Court to contemplate nothing further. *238 It specifically states that the list includes all "liabilities" of the Girard Trust Co., trustee, and all sums payable by it to the club, and all "liabilities" of the club and "all sums payable" by it to petitioner. It does not list the indebtedness under the mortgage. Obviously the remedy in rem against the property was not covered, either in text or intent.}

The instrument refers to the conveyance to petitioner as made in compliance with the request of Girard Trust Co., trustee. The mortgagee went into possession under the arrangement made. It used the rentals from the property to pay taxes previously accrued, for the protection both of bondholders and mortgagor. We see the petitioner, therefore, in the position of a mere manager of the property, a mortgagee in possession, through which the rentals passed for the benefit of others, and not taxable thereon.

A receiver of less than all of the property of a taxpayer is not required to file an income tax return. Sec. 142 (a), I. R. C.; Regulations 103, secs. 19.52-2, 19.142-4. The petitioner here was in an analogous position. It had, pursuant to mortgage remedies, taken possession of the property mortgaged and was operating it instead of the mortgagor and for its account. The taxes accrued upon the club property, payment of which in 1942 is here involved, were not petitioner's taxes (as respondent emphasized by denying deduction thereof), and petitioner was like a receiver, in the position of applying another's income upon another's taxes. In the absence of surrender of the club's equity of redemption, the petitioner acted for the mortgagor, getting the rents for the better security of the bondholders. The release of personal obligation in nowise released the mortgage, which as seen, was specifically preserved.

The taxes against the property paid during the years in question are approximately equal to the gross rents received by petitioner, so that it is apparent that, had the club remained in possession, its deductions for its taxes would have more than equalized its net income. The club would not under the above authorities, and on the facts here, be deprived of its right of redemption, and the same facts show that the petitioner paid the mortgagor's taxes with mortgagor's income, for which it is accountable under the mortgage. Entry to foreclose does not transfer title, but merely increases security; and accounting is necessary for rents and profits between mortgagor and mortgagee in possession. Hadley Falls Trust Co. v. United States, 110 Fed. (2d) 887. In the same case, in the District Court, 22 Fed. Supp. 346, it was held that a mortgagee in possession is not taxable upon rents received, which, the court says, go to a reduction of a debt. The point was not definitely touched upon by the Circuit Court in vacating and remanding for further proceedings, but its holding, above referred to, that accounting for rents is necessary, seems to approve the view of the lower court. That the mortgagee here felt additionally secure, when it acquired possession and rents of at least $ 18,750 (later $ 16,666) a month, can not be questioned.

The club was released from the debt, but a personal release of a debtor does not extinguish a mortgage. The respondent does not so argue. On the contrary, he states that "The mortgage, however, remains in existence merely for the benefit of the mortgagee to preserve any remedy or remedies it may afford the creditor-mortgagee." He continues that the remedy to sue for a deficiency or other remedies was valueless, since the debtor had no assets except the building, and that all prior estates were under common law principles merged in the fee simple estate. No authorities are cited and the idea is obviously erroneous, since merger is a question of intent. Parks v. Welch, 199 Atl. 506; Felgner's Administrator v. Slingluff, 71 Atl. 987. The intent here is beyond doubt, and merger here is shown to be specifically prohibited. In Schexnailder v. Fontenot, 85 So. 207">85 So. 207, it was held that, even though a Louisiana statute provided that mortgages are extinguished by the extinguishment of the debt for which the mortgage was given, the personal release of the debtor would in no sense, from the creditor's standpoint, discharge or extinguish the debt; also that, though another statute required that there be a personal indebtedness or obligation to support the lien of a mortgage, this does not mean that there shall be a personal liability. After quoting the language of the statute, the court said:

In the larger sense, this language means that there must be a principal indebtedness or obligation to support the accessory stipulation or lien or the mortgage, but this does not mean that there shall be a personal liability. A mortgage, whether conventional or judicial, imposes a real right or obligation upon the property bound for its discharge. C. C. 2012 and 3282. There is nothing to prevent, and, in fact, it is not uncommon for a mortgage to be given with the stipulation that the mortgagor shall not be personally bound beyond the value of the property so mortgaged. * * *

In Barth v. Severson, 183 N.W. 617">183 N. W. 617, it was held that a release of personal liability on the judgment would have no effect on the legality of the foreclosure proceedings; the court stating that the release from personal liability "amounted to no more than an election on the part of the then holder of the note and mortgage to proceed strictly in rem and waive his right to a claim in personam." This he had a right to do without in any way affecting the validity of the foreclosure proceedings.

MacArthur v. Peppard Seed Co., 286 Pac. 955, collects cases and authorities to the effect that an agreement to relieve from personal liability does not satisfy or discharge the mortgage. 2 Jones on Mortgages (7th Ed.), sec. 871, and 41 C. J. 785, are cited.

41 C. J. 785, on this subject, states:

The debt and the mortgagor's liability for it are not the same thing in law. Hence the mortgage is not discharged if it is the intention of the parties merely to release the mortgagor's personal liability for it and not to extinguish the debt.

Is it not more than plain that the mortgage was not released here? It was, on the contrary, to "continue in full force and effect for all purposes as though the present conveyance had not been made." And absence of personal liability does not preclude the right to redeem. 42 C. J. 344; Russell v. Southard, supra;Conover v. Palmer, 108 N. Y. Supp. 480. That right the club never gave up. That right left the petitioner a mortgagee in possession, merely operating the property.

We have before us not only the above discussed transaction itself, but the fact that the petitioner, as trustee, twice accounted, as mortgagee in possession, to the Court of Common Pleas, and at least the first account was approved by that court. (No proof was made as to approval of the second, though petition for approval is shown.) Notice was given in both instances, to Penn Athletic Club, and the court recited in its order notice given to all parties. The petition for approval alleged petitioner's status as mortgagee in possession and that because of the taxes paid no balance of income remained for distribution, and it asked that the court direct distribution of future available income under the terms of the mortgage, and approval of use of principal collected in payment of expenses. The court approved and directed distribution of income in the future, "in accordance with the provisions of Section 4 of Article VI of said mortgage indenture." In this we find, without collusion suggested, an adjudication of the petitioner's status as mortgagee in possession, and the distributability of the income by a local court, controlling here; Freuler v. Helvering, 291 U.S. 35">291 U.S. 35; Letts v. Commissioner, 84 Fed. (2d) 760; Estate of Sallie Houston Henry, 47 B. T. A. 843 (holding the Pennsylvania Orphans' Court decree, on account filed, binding on question whether moneys were principal); Susan B. Armstrong, 38 B. T. A. 658 (holding binding the surrogate's decree on accounting that certain moneys were return of capital); and the decree plainly puts the petitioner in the position of acting and accounting under the mortgage, not as absolute owner.

We have here no case of afterthought, no contention devised later for tax purposes, but a legal position taken at the time of the transaction involved. When the deed was recorded on January 26, 1942, the petitioner was on record as considering the deed given under the mortgage and subject thereto and not in lieu of foreclosure and that there was no merger, as shown both by the release and the affidavit attached to the deed. By May 1942 it had claimed, and the club had agreed, that the insurance policy was being held as security under the mortgage. The agreement and release of May 22, 1942, recited that the conveyance had been subject to the mortgage lien and in compliance with the request therefor. On October 8, 1942, the petitioner filed its accounting on the theory of being mortgagee in possession, and on November 13, 1942, the decree of the Court of Common Pleas issued on the same basis. In addition, competent evidence, admissible and admitted, and only bearing out the recitations in the deed as to mortgage being preserved, explains the mutual intent of the parties that the deed was not to be absolute.

After considering the deed itself, the concurrent instruments executed, the understanding and intent of the parties, and their treatment of the matter, and the decree of the Court of Common Pleas, we conclude and hold that the petitioner was not taxable upon the income received in the taxable years. Having so concluded, we need not consider the ancillary questions, which depend upon the principal issue above determined.

Decision of no deficiency will be entered as to each taxable year.

HARLAN

Harlan, J., dissenting: In January of 1941 the petitioner, as mortgagee-trustee for the first mortgage bondholders of the Penn Athletic Club Building, was confronted with a problem. The mortgagor, the Penn Athletic Club, had been in default under the terms of the mortgage for a period in excess of a year, and it owed real estate taxes on the mortgaged premises for the years 1939, 1940, and 1941 in the amount of $ 317,869.28 and was unable to meet even the minimum interest requirements under the mortgage. The Securities and Exchange Commission wanted to make a long term lease of the club building and was insisting that it be given immediate possession and that any lease be executed by petitioner as lessor. Petitioner knew that in order to make such a lease it would have to acquire ownership of the premises, inasmuch as it was the practice of the Court of Common Pleas of Philadelphia and the United States District Court not to permit a mortgagee in possession to make a lease for a period in excess of one year. Foreclosure could not be resorted to because of the time element required to obtain title by proceedings in equity or scire facias. Petitioner was, therefore, faced with a choice of either abandoning its efforts to negotiate the lease with the Securities and Exchange Commission or of inducing representatives of the club to make a voluntary conveyance that would permit it to lease the building for a long term. While the petitioner wrote the club under date of January 13, 1942, requesting a conveyance pursuant to paragraph 14 of the supplemental mortgage agreement, the evidence indicates that thereafter it became necessary to enter into extended negotiations because a substantial number of the club's board of directors and members believed that the club was under "no legal compulsion" to remove itself and turn over the property to petitioner, and they felt "if it did so it would, for all practical purposes, result in the end of the Penn Athletic Club of Philadelphia as a needed and desirable Philadelphia institution," and, to avoid such a result, they "offered serious resistance to the demands of the petitioner and its counsel that the property be abandoned by the Club." During these negotiations the suggestion was made by the president of the club that conveyance of the property would be made and possession given at once if the petitioner, as trustee for the bondholders, would release the club from all indebtedness and allow it to retain certain personal property. "Being of the opinion that the only way in which immediate possession of, and a deed of conveyance of the mortgaged premises could be secured by it from the * * * Club * * * would be through compliance with these conditions insisted upon by the * * * Club," the petitioner, acting upon advice of counsel and with the approval of representatives of the bondholders, decided to agree to these conditions.

Agreement was finally reached between petitioner and the club on January 19, 1942, and it is apparent that the club demanded a high price for the conveyance to petitioner of "all property subject to lien of said mortgage, including all real estate, buildings, machinery, furniture and furnishings, and the delivery of possession thereof by January 21, 1942." In consideration therefor the petitioner released and forever discharged the club "of and from all indebtedness due by the club under said Mortgage" (the principal indebtedness amounted to $ 2,580,000), "together with all interest accrued or accruing thereon" (interest for 1939 and 1940 amounted to approximately $ 200,000), "and all liability in connection with real estate taxes, past, present, or future, assessed against the said premises" (taxes assessed and unpaid at time of transfer amounted to $ 317,869.28). As additional consideration the petitioner also agreed to deliver to the club furniture, fixtures, and equipment having a value of $ 25,000, which was necessary to equip a new athletic club building, and to pay unsatisfied current indebtedness due by the club to other creditors, so far as might be found necessary, out of proceeds of the rest of the furniture and equipment after all other assets, including collectible receivables as of the date of the transfer, had been used for such purposes.

The conveyance was made on January 21, 1942, by deed in fee simple form which contained all the wording which the Pennsylvania statutes prescribe as necessary to pass fee simple title and to convey the entire estate of the club, as grantor. Purdon's Penna. Stats. Ann., title 21, ch. 1, secs. 2-3. It included "all the estate, right, title and interest, property, claim and demand whatsoever of it, the said Grantor, as well at law as in equity, of, in and to the same and every part and parcel thereof." The release executed the following day stated that this action was taken to permit the trustee to become the owner of the mortgaged premises.

I shall make no attempt to discuss the principles involved in the many cases cited by the majority other than to point out that in none of those cases do we have a transaction, such as we have here, where a mortgagor transferred to a mortgagee-trustee for first mortgage bondholders all of its interest in the mortgaged premises for an adequate consideration, consisting in part of a complete release and discharge of all indebtedness under the mortgage. That the consideration was adequate and fair is shown by the statement attached to the deed "that the premises are worth less than the mortgage, and therefore there is no equity over mortgage indebtedness."

If the conveyance had been made to petitioner as provided in paragraph 14 of the supplemental mortgage agreement, I would have no hesitancy in agreeing with the majority view that petitioner became a mortgagee in possession and, as such, was liable to account to the club. That paragraph contemplates a conveyance merely so that the mortgagee may have possession after default as additional security. It does not contemplate and was never intended to embrace a purchase of the mortgaged premises by the mortgagee from the mortgagor for an adequate consideration, and the deed does not state that the conveyance was made pursuant to paragraph 14. It is true that petitioner requested such a conveyance, but after that request was made the club saw the opportunity to drive a hard bargain and took advantage of that opportunity. It sold its interest in all of the property subject to the lien of the mortgage, with the exception of the $ 25,000 in furnishings and equipment which it was permitted to retain. Under such circumstances the question of intention, which is so important where a mortgagor makes an absolute conveyance for no consideration or for a nominal or inadequate consideration, is not a decisive factor because, "even though his intention or interest is to keep alive the debt and its incidental lien, he cannot do so, it is evident, if the conveyance of the mortgaged premises to such holder of the mortgage debt was made and accepted as a payment of the debt. In such case the debt is discharged, not as having been merged but as having been paid." Tiffany, Real Property (3d Ed.), vol. 5, p. 486.

It is well settled that after the making of a mortgage the mortgagor and the mortgagee may deal with each other as other individuals, and the mortgagor may, for an adequate consideration, convey to the mortgagee his interest in the mortgaged premises. Tiffany, Real Property (3d Ed.), vol. 5, p. 358. That is what happened in this proceeding. When the transaction was consummated the relationship of debtor and creditor between the club and the petitioner, as trustee for the first mortgage bondholders, ceased to exist. Moreover, there was no other debtor, inasmuch as C. Benton Cooper and the Rittenhouse Square Corporation had been eliminated in section 7 (a) of the modified plan of reorganization approved by the Federal District Court on January 30, 1940, which provided that "All past, present and future indebtedness or obligations of C. Benton Cooper or of the Subsidiary Debtor [Rittenhouse Square Corporation] * * * of any kind or nature whatsoever, including Trustee's fees and commissions, under and by virtue of the terms of said First Mortgage, shall be waived and cancelled and said First Mortgage shall be satisfied of record." There being no debt existing to support the mortgage at the time of the conveyance to petitioner, it could not have been made as additional security. Swinson v. Sodaman, 20 N. E. (2d) 623, 626; 300 Ill. App. 31">300 Ill. App. 31; Holmburg v. Hardee, 90 Fla. 787">90 Fla. 787; 108 So. 211">108 So. 211, 220.Inasmuch as the conveyance was not made as additional security, there seems to be no possible escape from the conclusion that it vested in petitioner, as trustee for the first mortgage bondholders, the ownership of all the property which had theretofore been subject to the lien of the mortgage, including the club building and excepting the $ 25,000 of furnishings and equipment which the club was permitted to retain. As owner, it negotiated leases with the Securities and Exchange Commission and with occupants of stores on the ground floor of the building. The majority opinion would relieve it from tax on rental income which amounted to $ 178,509.37 in 1942 and $ 209,084.78 in 1943. I think the respondent correctly determined that this rental income should be included in the gross income of petitioner.

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Footnotes

• 1. The gist of the correspondence is a letter from Claude C. Smith, attorney for the Girard Trust Co., on April 29, 1942, to Frank Smith (president of Penn Athletic Club), stating that under article IV, section 3, of the mortgage the policy should be held and retained by petitioner as additional security; Frank Smith's reply, May 2, 1942, that he would bring the letter to the attention of the board with his conclusions that under article IV, section 1, of the mortgage the policy "shall be held by the Trustee until the mortgage indebtedness is satisfied and the principal and interest of the bonds are paid"; also Frank Smith's letter to Arthur Hinkel, chairman of the finance committee of the club, stating his opinion that the policy "belongs to the bondholders * * * until the bonds are paid off." He expresses the idea there is little likelihood thereof, and does not "believe that we have any equity in this policy of insurance."↩

• 2. The court said of the release: "According to its terms the release was executed to effect a settlement of accounts between the debtor and trustee arising out of the transfer of property to the trustee for the liquidation of the security of the mortgage as modified under the plan."↩

• 3. The respondent also suggests (without pleading estoppel) that the petitioner is estopped to deny against the Government that the deed to it, lessor to the Securities and Exchange Commission, was not absolute. If the principle were applicable, and we do not so consider it, the facts show clearly that the Government representatives were fully informed of all facts prior to the lease.↩

• 4. The only evidence on the point is that shown on pages 34, 35, and 36 of the transcript, as follows:

  "* * * It was at that stage of the proceeding that the question came up as to how the SEC could be given a lease, and the Penn Athletic Club go elsewhere and have sufficient or some necessary furniture and equipment to provide for it.

  "At that time, for the first, negotiations with Government counsel in Washington (naming the parties), were conducted as to our leasing with the consent of the Penn Athletic Club -- of the Girard Trust Company leasing to the SEC under its rights under the mortgage.

  "In those negotiations I was asked by Government counsel whether the Girard Trust Company could make the lease, assuming that the Penn Athletic Club would consent to it and give up possession for a long term, and the Government had estimated its expenditures required on the building would be $ 600,000 to $ 750,000.

  "I then informed Government counsel of the practice of our courts here in Philadelphia. We examined the supplemental mortgage together, and the original mortgage, and Government counsel then stated that it seemed to them if we could request the Penn Athletic Club under the terms of the additional remedies provided for in the supplemental mortgage indenture, to make the conveyance to us as trustees, that is to the Girard Trust Company as trustee, that then we could make the lease for the seven years: because the title, being in our name as trustee under the original indenture, would require that the Penn Athletic Club, if they undertook to lease or sell it, would have to have the Girard Trust Company consent to or join in it.

  "It was then decided at that time that the lease, if and when that could be worked out and we obtained possession -- I say 'we', I mean the Girard Trust Company obtained possession of the Penn Athletic Club -- that the lease would then be made between the Girard Trust Company as trustee under the mortgage indenture and the Girard Trust Company, trustee under this conveyance that had been made to it. And the lease was thereafter executed in accordance with arrangement made by Government counsel, between the Girard Trust Company as the trustee under the original indenture, and as trustee under the deed of conveyance."↩

• 5. At pages 41-42 of the transcript the evidence is:

  "At that meeting that night, the Board of Governors then appointed one of the members -- Judge Ladner -- who was on the Board, to draft the resolution in accordance with what I have stated * * *.

  "After the resolution had been drafted and submitted to the Board of Governors, and before it had been adopted, I was then representing the trustee at that meeting, and among other things I remember being asked by Mr. Ladner whether, if the Penn Athletic Club would make an absolute conveyance in fee simple to the Girard Trust Company, whether or not the Girard Trust Company would accept it in complete satisfaction. My answer to Mr. Ladner at the time was: If such a proposal were made by the Penn Athletic Club, the Girard Trust Company would accept it because they believe that the building in the future would be sufficient value to let them out; but they would not release and turn over in that event any furniture or furnishings; and would have to be on condition that possession was given immediately without that being done.

  "Well, Mr. Ladner also stated that he thought we would be willing to do that because expert testimony would show that the building was worth $ 3,000,000. That proposal was not made. Instead of that, the conveyance was made in answer to the request of the Girard Trust Company, trustee, for the conveyance to be made to it in accordance with the terms of the supplemental mortgage indenture; and the resolution was thereafter adopted as prepared by Mr. Ladner to that effect."

  Again, at pages 60-61 of the transcript the testimony is:

  "* * * At that meeting, prior to the adoption of that resolution, inquiry was made by Mr. Ladner, from me representing the Girard Trust Company, whether the Girard Trust Company would be willing to accept an absolute conveyance of the property in full satisfaction and release of everything. I said yes, it would if such proposition came from the club; but no proposition had come from the club. He said, yes, that is correct, 'We are not prepared to make that because we believe the property under expert testimony is worth $ 3,000,000.' * * *"↩

• 6. It is noteworthy that the court said that the release on its terms was executed to effect a settlement of accounts between the debtor and trustee "arising out of the transfer of property to the trustee for the liquidation of the security of the mortgage↩ as modified under the plan." (Italics ours.)