Lexington Realty Co. v. Commissioner

LEXINGTON REALTY CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Lexington Realty Co. v. Commissioner

Docket No. 4639.

United States Board of Tax Appeals

12 B.T.A. 850; 1928 BTA LEXIS 3432;

June 27, 1928, Promulgated

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1. Where the petitioner in purchasing tangible property in January, 1917, paid certain cash and preferred stock to the owner thereof and certain common stock to a third party for an assignment of its option to purchase the property, and the actual cash value of the property is shown by the evidence to be in excess of the total amount of the cash and the par value of the preferred and common stock paid out by the petitioner, upon computation of the petitioner's invested capital for the years 1920 and 1921, the Commissioner was in error in holding that no tangible property or other thing of value was paid to the petitioner in exchange for its common stock.

2. The amount of depreciation allowed by the Commissioner approved, there being no evidence to show that his allowance was insufficient.

George L. Denny, Esq., and Milton W. Mangus, Esq., for the petitioner.

W. Frank Gibbs, Esq., for the respondent.

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MURDOCK

This is a proceeding for the redetermination of deficiencies in income and profits taxes for the calendar years 1920 and 1921, in the respective amounts of $716.43 and $328.64. In the amended petition it is alleged that the Commissioner erred "in disallowing as invested capital a common stock issue of $59,700 which was surrendered in the purchase of real estate." At the hearing the petitioner offered an amendment alleging that the basis of depreciation for the years 1920 and 1921, in the determination of the Commissioner was too low by $60,000.

FINDINGS OF FACT.

The petitioner was incorporated in December, 1916, and since January, 1917, has had as its sole business the ownership and operation of an apartment building located on Capitol Avenue in the City of Indianapolis, Ind., known as the Lexington Apartments. This building was constructed in 1901, and during the year 1916, and prior thereto, was owned by the Realty Investment Co. On December 21, 1916, Breed, Elliott & Harrison, a banking and brokerage concern of Indianapolis, submitted to the Realty Investment Co. an offer to purchase the Lexington Apartments which was accepted by the Realty Investment Co. on the same date. By this offer and acceptance the parties agreed that Breed, Elliott & Harrison would form a realty company under the laws of the State of Indiana, limited in its power to the ownership of the Lexington Apartments and in its life to a period of 16 years, and with an authorized capital stock of $170,000, consisting of $80,000 first preferred, $30,000 second preferred, and $60,000 common stock. The property was to be conveyed to the new realty company by the Realty Investment Co. in exchange for $75,000 in cash and $25,000 of second preferred stock and the latter company agreed to purchase at par from the new company the remaining $5,000 of its second preferred stock. The agreement also contained various provisions as to payment of dividends and redemption of the stock and payment of officers' salaries of the new realty company.

A portion of the minutes of a meeting of the board of directors of the petitioner held in the City of Indianapolis, on December 28, 1916, is as follows:

There was then submitted to the meeting the following proposition from Breed, Elliott & Harrison:

INDIANAPOLIS, INDIANA.

As the holders of a contract for the purchase thereof we agree to cause to be conveyed to you Lots 2 to 6 inclusive in Lilly et al's Subdivision of the east part of Block 8 in Drake's Addition to the City of Indianapolis, being the property known as the Lexington Apartments, and fronting 249.7 feet on Capitol Avenue and extending west to the alley, by warranty deed from The Realty Investment Company of Indianapolis, Indiana, owner thereof, together with all supplies on hand, in consideration of $75,000 in cash and $25,000 of the Second Preferred stock of your company. And we will also give you the benefit of the provisions of said contract whereby the present owner of the property will purchase the remaining $5,000 of Second Preferred stock at par on the terms set forth in said contract, a copy of which we hand you herewith; and we will also pay you $75,000 in money, all in consideration of your issuing to us or our order all the $80,000 First Preferred stock in your Company and $59,700 of the Common Stock, all to be fully paid up and nonassessable.

Respectfully,

BREED, ELLIOTT & HARRISON,

By GEORGE B. ELLIOTT, Vice-President.

The proposition as above set forth was on that date accepted by a unanimous vote of the board of directors.

The petitioner was incorporated in December, 1916, and in January, 1917, received title to the property. About the same time it issued all of its first preferred stock of $80,000 par value to Breed, Elliott & Harrison, who then as the agent of the petitioner turned over to the Realty Investment Co. $75,000 in cash. All the second preferred stock was issued to the Realty Investment Co., which paid cash for $5,000 par value thereof and received the remainder in pursuance of the offer of Breed, Elliott & Harrison, as noted in the corporate minutes. Of the $60,000 of common stock, one qualifying share of $100 was issued to each of the petitioner's three directors and the balance, or $59,700, to Breed, Elliott & Harrison. Since its organization the petitioner has used the same offices as Breed, Elliott & Harrison. The latter within a day or two after receipt of the common stock issued one-half thereof to John T. Martindale, the president and a director of the petitioner, as consideration for his agreement to personally supervise the remodeling and developing of the property.

Martindale who had been in the real estate business in Indianapolis for 20 years had had an extensive experience in the management of apartment houses. In December, 1916, he first considered the Lexington Apartments property as a possible investment. At his request a survey of the property was made on December 18, 1916, bythe J. S. Cruse Realty Co., a well-known real estate firm of Indianapolis, and shortly thereafter Martindale made a personal examination of the premises. On December 23, 1916, at Martindale's request, J. S. Cruse, president of the above realty company, and William A. Young, who at the time was in charge of the real estate department of the Fletcher Trust Co., made an examination and an appraisal of the property for Breed, Elliott & Harrison. In this appraisal the value of the ground was estimated at $37,437.50 and of the building at $125,000. At this time, due to the influx of colored families in the neighborhood, Capital Avenue was less desirable than formerly as a street for private residences. There was not a great demand for apartments in that section of the city at the time and only about one-half of the apartments on the property were occupied by tenants.

For each of the taxable years in question the Commissioner has allowed as a deduction for depreciation the amount of $3,714.38, which is the amount appearing upon the petitioner's books. The actual cash value of the Lexington Apartments property in January, 1917, amounted to $162,437.50, the value of the ground being $37,437.50 and of the building, $125,000.

OPINION.

MURDOCK: The petitioner has alleged that the Commissioner erred "in not allowing as invested capital a common stock issue of $59,700, which was surrendered in the purchase of real estate." It has evidently misunderstood the nature of invested capital as defined in the statutes (section 326(a) of the Revenue Acts of 1918 and 1921) and has meant to allege error on the part of the Commissioner in disallowing as part of the petitioner's invested capital the cash value of tangible property paid in for $59,700 par value of its common stock. We do not know what amounts the Commissioner has allowed the petitioner as invested capital during the two taxable years but in his answer to the amended petition the Commissioner admits that he has disallowed the petitioner's claim for an addition to its invested capital of the above amount of $59,700 on the ground that "no cash tangible property or other thing of value was paid to the company in exchange for the said common stock." Therefore, two questions have been raised - whether or not any tangible property was paid in to the petitioner in exchange for its common stock and if tangible property was paid in therefor, the actual cash value of such property.

We have set forth in the findings of fact the details of the transaction as it was finally carried out. It is seen that Breed, Elliott & Harrison, having an option to purchase the property in question, agreed to assign it to the petitioner for certain considerations. In its purchase of the property the petitioner transferred certain things. It issued $80,000 first preferred stock for $75,000 cash which Breed, Elliott & Harrison turned over to the Realty Investment Co. In addition the petitioner issued to the Realty Investment Co. its entire authorized second preferred stock of a par value of $30,000, $5,000 thereof for cash and the remainder as part of the purchase price, and finally it issued $59,700 par value of its common stock to Breed, Elliott & Harrison.

All the transfers occurred at the same time and as part of the same transaction and looking at the substance of the whole transaction it is apparent that in purchasing the property the petitioner turned over $75,000 in cash, $25,000 par value second preferred stock and $59,700 par value of common. In other words, regardless of the identity of the persons to whom the cash and the various kinds of stock were paid, the petitioner parted with cash and stock of the above amounts in return for which it received property having an actual cash value of $162,437.50. It therefore follows that tangible property having an actual cash value of at least $59,700 was received by the petitioner in return for its common stock having a par value of that amount. See .

We have found as a fact that the actual cash value of the property itself was $162,437.50, representing a value of the land of $37,437.50 and of the building of $125,000. It is true that the Realty Investment Co. agreed to sell the property for $75,000 cash and $25,000 par value second preferred stock, and that this was the total consideration it received. These facts without any further evidence would indicate that the owner's valuation of the property, namely $100,000, measured its cash value, but in our opinion the weight of the evidence points to the higher value. The petitioner has offered the opinion testimony of two witnesses, one of whom, Martindale, estimated the value of the property to be $165,000. He was in the real estate business at the time of the transfer and prior thereto, and had been engaged for some years in renting apartment houses. His idea as to value was based to a certain extent upon the opinion of others and as a stockholder of the petitioner he had some interest in this proceeding. However, the other witness, Cruse, had had an extensive experience in the appraisal of real estate in the city and had examined the property a month before the transfer. His opinion as to value is therefore entitled to serious consideration. He estimated the cash value of the property at the time of the transfer to be the same as that found by his appraisal, or $162,437.50, the land being valued at $37,437.50 and the building at $125,000. Upon cross-examination the respondent developed the fact that at the time the building was constructed in 1901, the district had been a desirable one for private residences, and that its character had changed at the time of the transfer. However, the witness has taken this fact into consideration in forming his opinion and there is no evidence to show either the original value of the building or that the value of the land had decreased between the date of construction and the date of transfer. The respondent has offered no evidence to contradict the opinion of the witness and we see no reason to doubt its reliability. In addition to the opinion testimony, the petitioner has offered the appraisal made at about the time of the transfer by Cruse and another experienced real estate man, in which the value of the property was estimated at $162,437.50. This appraisal was based on existing facts and is not open to many criticisms directed against a retrospective appraisal.

We find that the amount of $59,700, representing the cash value of tangible property paid in for $59,700 par value of its common stock should be considered in the calculation of its invested capital for the taxable years 1920 and 1921.

The petitioner has also alleged that the basis for depreciation for these years in the determination of the Commissioner was too low by $60,000. We are unable to determine that the Commissioner erred in respect to the amount of depreciation which he allowed. There is no evidence as to the cost used by the Commissioner in his computation of the deduction and the only stipulation of the parties is that the amount of depreciation allowed for each of these years was $3,714.38. The sole business of the petitioner was the operation of the Lexington Apartments. The building when acquired by the petitioner had a value of $125,000 and an expected life of thirty-four years. Using this value and basing the allowance on the number of years of expected life, we arrive at an amount for depreciation which is less than the amount allowed by the Commissioner. So far as we know the petitioner may or may not have had other depreciable assets on account of which the allowance should or should not be increased. Consequently, we will not disturb the Commissioner's determination on this point.

Judgment will be entered under Rule 50.