Rhodes v. Commissioner

HERMAN M. RHODES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Rhodes v. Commissioner

Docket No. 54899.

United States Board of Tax Appeals

34 B.T.A. 212; 1936 BTA LEXIS 733;

March 25, 1936, Promulgated

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1. During the taxable year petitioner, the president and principal stockholder of a corporation, made certain withdrawals of money from it which were treated by him and the corporation as loans and were subsequently repaid in full. Held, that such withdrawals constituted loans to petitioner and not the payment of dividends.

2. In September 1927 petitioner decided that a certain contract to purchase Florida real estate was worthless and charged off as a loss the amounts previously paid, amounting to $15,762.50. In the spring of 1928 he sold his interest under the contract for $1,000 to $1,100. Held, that the contract was not shown to have been worthless in 1927 and petitioner is not entitled to a loss deduction in that year of the amounts paid under the contract.

3. In 1927 Florida real estate to which the petitioner had taken title was sold for taxes. In the same year the petitioner decided to abandon the property as worthless and charged off as a loss the amount of his investment in it. Held, that the deduction claimed is not allowable. Frederick Krauss,30 B.T.A. 62">30 B.T.A. 62, followed.

F. E. Hagler, Esq., for the petitioner.

Frank B. Schlosser, Esq., for the respondent.

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TURNER

This proceeding is for the redetermination of a deficiency in income tax of $9,314.53 for 1927. The matters presented for determination are the correctness of the respondent's action (1) in determining that certain withdrawals made by petitioner during the taxable year from a corporation of which he was president and principal stockholder constituted dividends, and (2) in disallowing deductions taken by petitioner as losses sustained during the year with respect to certain parcels of Florida real estate.

FINDINGS OF FACT.

Petitioner is an individual residing at Memphis, Tennessee. In 1924 he organized a corporation known as the Rhodes-Jennings Furniture Co., with a capital stock of $200,000 divided into 2,000 shares. He acquired 1,005 shares of the stock and his wife acquired the remaining 995 shares. Petitioner was president of the corporation and managed its affairs. In addition to his activities in connection with the corporation, he owned and operated a farm known as the Bass Plantation and conducted as a sole proprietorship a business known as the Rhodes Furniture Co.

Prior to and during 1927 petitioner made withdrawals of money from the corporation. Some of the withdrawals were charged on the books of the corporation to his personal account, while others were charged to the accounts designated as Bass Plantation and Rhodes Furniture Co. In making these withdrawals petitioner considered them as loans, intended to repay them, and instructed the corporation's bookkeeper to treat them as loans. The withdrawals were carried as accounts receivable on the books of the corporation and were shown as such in its balance sheets, which were furnished to credit agencies and to the bank with which it did business. The withdrawals were not in proportion to petitioner's holdings of stock in the corporation.

From time to time petitioner made payments on the accounts by way of credits of his salary from the corporation, by turning over corporate securities, and by the payment of money. The following is a statement of the unpaid balances of the accounts at January 1, 1927, the withdrawals made during 1927 and charged to the respective accounts, the payments made during the year and credited to the accounts, and the unpaid balances of the accounts at December 31, 1927:

	Balance January 1, 1927	Withdrawals	Payments	Balance December 31, 1927
H. M. Rhodes, personal	$15,000.00	$56,795.83	$97,855.39	(Credit) $26,059.56
Rhodes Furniture Co	17,951.29	21,653.00	5,129.41	(Debit) 34,474.88
Bass Plantation	19,010.25	17,974.49		(Debit) 36,984.74
Total	51,961.54	96,423.32	102,984.80	45,400.06

All withdrawals by petitioner were repaid either in the years made or in years subsequent to 1927.

On January 1, 1927, petitioner executed a note to the corporation as security for the unpaid balances. On December 31, 1927, the account "H. M. Rhodes, Personal," was charged with $3,000 representing interest at 6 percent on the note. This amount is included in the amount shown above as withdrawals during 1927 and was reported by the corporation in its Federal income tax return for that year and in the income tax return filed by it with the State of Tennessee.

At the time petitioner was making withdrawals from the corporation, he was also borrowing money from other sources. He was solvent and able to repay the amounts withdrawn upon demand.

No dividends were declared by the corporation prior to or during 1927, but since 1927 dividends have been declared. The surplus of the corporation at the beginning of 1927 was $79,183.27 and at the end of 1927 was $65,294.87.

On August 10, 1925, petitioner entered into a contract to purchase, for $20,000, lot 4, block 18, La Gorce Subdivision, in the city of Miami Beach, Dade County, Florida, hereinafter designated as the Davis property. The terms of purchase were $13,250 cash within 30 days, a mortgage for $1,500 payable $500 annually for three years, and the assumption of a then existing contract on the property for $5,250. A down payment of $1,000 was credited to the cash payment required. Petitioner entered into the contract for the purpose of reselling the property at a profit. He made payments pursuant to the contract in a total amount of $15,762.50 and on April 29, 1927, paid state and county taxes on the property for the year 1926. He never obtained a deed to the property.

In September 1926 a hurricane struck the section in which the property was located. In 1927 petitioner made several trips to Florida to look after his real estate interests and while there in September of that year another hurricane struck the section. At that time he concluded that there was no chance for the property to return to near its former value and, being of the opinion that the property was not worth what was due on his contract, he decided the contract was worthless and that he would make no further payments.

In the spring of 1928 petitioner received an offer of $1,000 or $1,100 for his interest under the contract, which he accepted. Since that transaction he has had nothing further to do with the property.

In determining the deficiency the respondent denied a deduction taken by petitioner as a loss sustained on the transaction involving the Davis property.

On August 13, 1925, petitioner, acting for himself and an associate, J. A. Carroll, purchased from one Spann and his wife lots 1 and 2 in block 13 of the Dixie Highway Tract, situated in Dade County, Florida, on the Dixie Highway about 16 miles north of Miami, and hereinafter referred to as the Spann property. The lots were small, vacant, and sandy, with palmetto brush on them, and of a type not suitable or valuable for farming purposes. There were no buildings near the lots. The lots were purchased solely for the purpose of speculation.

The purchase price was $60,000, payable $12,500 cash, assumption of a first mortgage for $5,500 and a second mortgage for $2,500, and the balance of $39,500 to be represented by four notes for $9,875 each, due in one, two, three, and four years and to be secured by a third mortgage on the property running to the sellers. While petitioner's interest in the property was three fourths, and Carroll's was one fourth, title to the property was taken in the name of petitioner only in order to facilitate its transfer in event of sale. The third mortgage and the notes for the balance of the purchase price likewise were executed only by petitioner. Carroll, however, bore his proportionate part of all payments made with respect to the property.

In 1926 and 1927 payments were made on the mortgage indebtedness assumed, but when the first of the notes given the Spanns became due in August 1926 it was not paid. As a result of the nonpayment they sued petitioner in December 1926 on all of the notes and obtained a judgment against him, which he paid.

On the occasion of his trip to Florida in September 1927, referred to above, petitioner and Carroll made an investigation as to the Spann property and concluded that it was worthless. The boom in Florida real estate had burst, a second hurricane had come, and things were on the decline. They did not see any prospect for real estate values to increase materially and decided that they would spend no more money on the property. Since then they have had nothing to do with it. In the latter part of December 1927 petitioner charged off as a loss the amount he had expended in connection with his interest in the property.

In 1927 the Spann property was sold for unpaid 1926 taxes due the city of Miami and tax certificates were issued on June 6, 1927. In the same year the property was also sold for unpaid state and county taxes due for 1926, and tax certificates were issued on August 1, 1927.

In determining the deficiency the respondent disallowed a deduction taken by petitioner as a loss sustained in respect of the Spann property.

OPINION.

TURNER: Petitioner contends that the respondent erred in determining that a portion of the withdrawals made by him during the taxable year from the Rhodes-Jennings Furniture Co. constituted dividends instead of loans. He urges that the circumstances under which the withdrawals were made and the manner in which they were treated by him and the corporation sustain his contention.

We think it is clear that both petitioner and the corporation regarded the withdrawals as loans. The corporation carried them as accounts receivable on its books and showed them as such in its balance sheet which it submitted to third parties for credit purposes. At the beginning of the taxable year petitioner gave to the corporation as collateral a note for approximately the amount of the unpaid withdrawals. During the year interest was paid on the note at the rate of 6 percent per annum. Withdrawals made during the taxable year amounted to $96,423.32, while repayments amounted to $102,984.80, or $6,561.48 in excess of the withdrawals. Petitioner was able financially to repay the amounts withdrawn. The evidence not only shows that the withdrawals were regarded as loans and were to be repaid, but that in a later year they were paid in full. On these facts we hold that the amounts in controversy constituted loans and not dividends. ; ; .

Petitioner contends that the contract to purchase the Davis property became worthless in 1927, resulting in a loss to him in that year of $15,762.50, which he is entitled to take as a deduction. The respondent contends that the contract did not become worthless in 1927 and that any loss sustained by petitioner was sustained in 1928 when petitioner sold his interest thereunder. There is no controversy as to the amount allowable in the event we hold that petitioner sustained a loss in 1927, the parties having stipulated the amount paid on the purchase price of the property.

As a result of his investigation in September 1927, petitioner decided that the property covered by the contract was not worth the balance owing thereon and that the contract therefore was worthless. In the spring of 1928, however, he sold his interest under the contract for $1,000 or $1,100. Petitioner stated that he was surprised when he received the offer, but there is nothing in the record to indicate that the value of the property or of other real estate in that vicinity had improved to any extent after September 1927. It would thus appear that the value of the property was as much in 1927 as in 1928 when petitioner disposed of his interest under the contract. This being true, we are unable to find that the contract became worthless in 1927 as petitioner contends. Cf. ; ; affd., .

Petitioner also contends that he sustained a deductible loss of $28,875 on the Spann property during the taxable year, and the parties have stipulated that the foregoing amount is correct if petitioner is entitled to a loss deduction in respect of the said property. Petitioner took title to the Spann property in 1925, assuming first and second mortgages, and gave the sellers a third mortgage thereon to secure payment of certain purchase price notes. Upon nonpayment of the notes, the sellers, without resorting to foreclosure of the mortgage, brought suit and obtained judgment on the notes. Petitioner subsequently paid the judgment. What action, if any, the holders of the two prior mortgages have taken is not disclosed by the record. The situation, therefore, is not one involving a loss resulting from the foreclosure of a mortgage.

Petitioner claims that the loss deductions should be allowed on the ground that he determined the property to be worthless and abandoned it during the taxable year, and for the further reason that the property was sold during that year for unpaid state, county, and city taxes. We have considered the claim of abandonment of real estate as the basis for a loss deduction in respect thereto in numerous cases and have decided the issue adversely to the claim of the petitioner herein. ; ; affd., ; . The question as to whether a sale of Florida real estate for taxes is such an event as to give rise to a deductible loss has also been carefully and fully considered in , and determined adversely to the petitioner. We accordingly hold that petitioner is not entitled to the loss deduction claimed in respect of the Spann property.

Decision will be entered under Rule 50.