Cohen v. Commissioner

Morris Cohen, et al., ^{Cohen v. Commissioner}

Docket Nos. 87709, 88251 -- 88264

United States Tax Court

39 T.C. 886; 1963 U.S. Tax Ct. LEXIS 182;

March 15, 1963, Filed

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Decisions will be entered under Rule 50.

1. Capital Gain or Ordinary Income From Single Sale of Acreage. -- Farmland bought and later sold as one piece was not held primarily for sale to customers in the ordinary course of any trade or business of the owner despite the fact that it was suitable for subdivision.

2. Collapsible Corporation -- Sec. 341. -- Farmland acquired by a corporation was not held primarily for sale to customers in the ordinary course of any trade or business of the corporation nor was the corporation formed or availed of primarily for the construction of property within the meaning of sec. 341, at times material hereto.

Abe L. Hoffman, Esq., and Gilbert Goldstein, Esq., for the petitioners.

William J. McNamara, Esq., for the respondent.

Murdock, Judge.

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MURDOCK

The Commissioner determined deficiencies and additions to the tax as follows:

Docket				Addition
No.	Petitioner	Year	Tax	to tax
				sec. 6654
87709	Morris Cohen	1957	$ 4,544.69
88251	Paul and Zelda Goldstein	1956	89.81
		1957	2,078.14
88252	Sam and Tillie Goldstein	1956	105.27
		1957	2,309.68
88253	Abe H. and Yetta Goldstein	1956	86.38
		1957	2,331.11
88254	William J. and Elizabeth Goldstein	1956	91.55
		1957	2,117.00
88255	David and Sylvia Goldstein	1956	112.27
		1957	2,328.82
88256	Stanley L. Cohen	1956	39.93
		1957	618.90
88257	Lewis and Charlene Sachter	1956	68.97
		1957	1,108.37
88258	Arnold and Julie Cook	1956	321,25
		1957	4,792.75	$ 25.75
88259	Abe L. and Florence Hoffman	1956	367.87
		1957	1,529.27
88260	J. Glenn and Frances E. Donaldson	1956	123.42
		1957	1,672.11
88261	Louis Cook	1956	348.05	16.50
		1957	9,572.32	15.02
88262	Gilbert and Miriam Goldstein	1956	108.90
		1957	1,592.40
88263	Edward W. and Esther Linkow	1956	109.13
		1957	371.40
88264	Harold and Leanor Cook	1956	321.26	19.98
		1957	4,792.75	26.18

The additions to tax are not contested and two other items are stipulated. Issues for decision are whether land owned by Sarkisian Joint Land Venture was held primarily for sale to customers in the ordinary course of its trade or business; whether D.O.M., Inc. (hereafter called DOM), was a "collapsible corporation" within the meaning of section 341, I.R.C. 1954, while its stock was owned by the petitioners; how advances made by certain stockholders to DOM and how sewer construction costs should be treated; and whether Abe L. Hoffman realized deductible loss from a nonbusiness bad debt.

FINDINGS OF FACT.

The petitioners in each of Docket Nos. 88251-88255, 88257-88260, and 88262-88264 are husband and wife and they filed their joint returns for the 2 tax years with the director of internal revenue for the district of Colorado. The other petitioners filed separate returns with the same director. All returns were for calendar years.

J. G. Donaldson, Abe L. Hoffman, and Gilbert Goldstein were partners in a law firm. Investment opportunities were frequently called to the attention of this firm and considered by it for clients or for the firm. An opportunity to buy an 80-acre tract of farm land in the Denver metropolitan area was brought, unsolicited, to the firm by a real estate agent. The property had been the Sarakisian homestead. It was bounded on the south by West Sixth Street, a main highway, and was across a street from the Denver Federal Center where over 7,000 people were employed. Gilbert Goldstein believed that the city of Denver was developing toward this land, such development would substantially increase the value of this land within the next 5 to 7 years and it would be a good investment to hold for a while.

Gilbert consulted several clients who were looking for an investment, they investigated the property, and a group decided to buy the property as an investment. David Goldstein contracted on March 16, 1955, to buy the 80 acres for $ 160,000 on behalf of a joint venture known as "Sarkisian Land Joint Venture" (hereafter called Sarkisian). The participants in Sarkisian were the law partnership ^*186

There were two houses and some farm buildings on the 80 acres. The houses were rented, share crops were being raised, and horses were being grazed on the land. These uses continued while Sarkisian owned the land. The income thus derived was less than $ 2,000 per annum. The land was zoned "agricultural." There was sewer service to the houses. The property was in a water and sewer sanitation district when purchased but later a tentative commitment for water was received from what was thought to be a more promising source.

A preliminary plat to show how the 80 acres might be subdivided had been contracted for by a person not a venturer before Sarkisian acquired the property but was delivered later to and paid for by Sarkisian. The latter had a boundary survey of the property made but had no intention of subdividing the property for sale, never made any effort of any kind to sell the property, never changed or added to the improvements, and never made any physical change in the property except to repair the sewer line to the rented houses. It spent a little time trying to assure itself that sewer service would be available to the whole property when needed but did not secure any definite commitment while it owned the property. It did not succeed in having the property rezoned.

The same agent who in early 1955 brought the property to the attention of Gilbert Goldstein, came to him again, unsolicited, with an offer to buy the property from a purchaser who desired to develop it. Gilbert believed that the amount offered for the property was in excess of its market value and the offer was accepted. A contract was executed on July 10, 1957, and modified on July 19. Title was conveyed on August 10, 1957. The sale price was $ 340,000.

Sarkisian Land Joint Venture did not hold the 80 acres primarily for sale to customers in the ordinary course of any trade or business carried on by it. The profit from the sale of the property was a long-term capital gain to the participants in the joint venture.

A real estate agent showed Gilbert Goldstein some unimproved land south of Denver in February 1955. Later Gilbert and some clients investigated the property as a possible long-term investment and decided to acquire it. They thought it would increase in value within 5 to 10 years and could be sold at a profit for development. They organized a Colorado corporation, DOM, to take title and limit their personal liability.

DOM entered into a contract on September 27, 1955, to purchase about 277 acres of this land and agreed to pay $ 10,000 down, $ 65,000 on or before December 1, 1955, $ 98,000 on December 1 in each year 1956 through 1961, and two deeds of trust in the total amount of about $ 229,000 then on the property.

DOM entered into another agreement on the same day under which it acquired an option to purchase about 57 additional acres of the land for $ 139,200. The option was to be exercised during September 1956.

DOM purchased in January 1956 less than 2 adjoining acres for $ 4,000.

All of the aforesaid land was in Arapahoe County, Colo.

The certificate of incorporation of DOM was filed on September 28, 1955. The purposes and powers of DOM stated in its certificate of incorporation were broad with regard to real estate. It was capitalized at $ 500 and issued 1,000 shares of stock. Louis Cook, Morris Cohen, and David Goldstein each subscribed for 250 shares on behalf of himself and members of his family. The law firm and Lee Yonkers, a real estate agent, subscribed for the remaining 250 shares on behalf of themselves and their wives. *190 Englewood had passed a resolution approving such service for the area on July 11, 1955. These efforts were continued, as the water and sewer plans for the area developed, by representatives of DOM not only while its stock was owned by the petitioners but also later while that stock was held by the purchasers from the petitioners.

A contour map of the property was made by a surveyor, a preliminary plat to show what could be done to develop the property was obtained by DOM, in the first part of 1956, and a first filing plat was obtained by DOM after May 16, 1956. A petition was filed during this period to have the property rezoned as residential. This was a protective measure at least in part. The Board of County Commissioners of Arapahoe County ordered the property rezoned as residential after May 16, 1956.

A newspaper announcement that a firm would build a large plant employing several thousand within a mile of the DOM property appeared in March 1956 and such a plant was later built. Another large manufacturing company announced about April 1956 that it would build a large plant at a location within 5 miles of the DOM property. These announcements had beneficial effects upon the value of the DOM property.

Persons representing South Range Development Co. came, unsolicited, to DOM in May 1956 and asked whether they could buy either the DOM land or the DOM stock. The DOM stockholders decided to sell their stock to this company. A contract of sale of the stock was executed on May 16, 1956.

The contract was in part as follows:

2. Sellers agree to bring a sewer main of sufficient capacity to the North property line of the hereinbefore described property on Clarkson Street, and agree that said main will be available so that the Buyer may make necessary connection to said sewer main in the development of the project.

Water and sewer were to be made available between July 1 and September 30, 1956. A water main was brought to the property at no cost to buyer or seller.

The purchase price stated in the contract was $ 1,282,344. The parties subsequently agreed that it would be more desirable for the purchaser to put in the connecting sewer and it did so at a cost of approximately $ 74,220.26, which amount it deducted from the amounts it owed for the stock. This arrangement was a modification of the contract which in effect reduced the purchase price.

DOM, while its stock was owned by the petitioners, did not hold the property here involved primarily for sale to customers in the ordinary course of its trade or business and was not formed or availed of principally for the manufacture, construction, or production of property, or for the purchase of property described in paragraph (3) of section 341(b). It was not a collapsible corporation within the meaning of section 341 of the Internal Revenue Code of 1954.

DOM had very little cash capital while the petitioners owned its stock and David Goldstein, Louis Cook, and Morris Cohen agreed to lend it funds as needed to meet its obligations. The total amount thus advanced was about $ 90,000. The purchaser of the stock required that these loans be wiped out as obligations of DOM before the sale and the sellers agreed, among themselves, that this would be accomplished by cancellation of the debts and having the first payments from the purchaser go to the lenders until those payments equaled the amount loaned by each, and thereafter payments would be distributed to all stockholders in proportion to the stock owned by each. That agreement was carried out.

Louis A. Wick, a private first class in the Air Force stationed in Denver, married Hoffman's daughter. He was later transferred to a base near Columbus, Ohio, and while there he and his wife lived in an apartment until he was notified of his transfer to a base at Little Rock, Ark. He then telephoned Hoffman that he wanted to buy a house trailer but did not have sufficient funds to finance the purchase and would like to have a loan from Hoffman for this purpose.

Hoffman arranged for a bank in Columbus to finance the purchase. The cost was $ 2,676.25, plus $ 144.08 insurance, and Hoffman gave his promissory note for $ 2,668.80 to the bank. Title to the trailer was put in Hoffman's name. Wick agreed to make periodic payments to the bank. He and his wife took the trailer to Little Rock and lived in it until they separated in December 1955. Their marriage was later annulled. Wick had dropped behind in his payments to the bank and Hoffman tried unsuccessfully to have him continue them. Hoffman lost contact with Wick and never knew where he was after May 1956.

Hoffman had a dealer in Little Rock sell the trailer in March 1956 and pay the proceeds to the Columbus bank. Hoffman canceled the insurance, paid the balance due the bank, and sustained a loss of $ 960.64 which he deducted as a bad debt on his 1956 return. The Commissioner disallowed the deduction.

Wick was 18 to 19 years of age in 1955 and 1956. Hoffman had no practical way of collecting the $ 960.64 from Wick.

The petitioners reported their gains from the Sarkisian sale as long-term capital gains on the installment method but the Commissioner, in determining the deficiencies, held that ordinary income resulted from that sale.

The petitioners reported no gains from the sale of their DOM stock on their 1956 or 1957 returns but the Commissioner in determining the deficiencies, held that DOM was a collapsible corporation within section 341, I.R.C. 1954, and the gains were from the sale of property which was not a capital asset and consequently taxable as ordinary income on an installment method.

The Commissioner, in determining the deficiency against the Hoffmans, disallowed a claimed bad debt deduction of $ 960.64.

All stipulated facts are incorporated herein by this reference.

OPINION.

The Commissioner held and contends that both the Sarkisian property and the DOM properties were held primarily for sale to customers in the ordinary course of business of the holders. The evidence shows that there was no such business ever carried on either by Sarkisian or DOM (while its stock was owned by the petitioners) and that the petitioners never intended to subdivide the properties and sell them as lots or as improved properties. The petitioners anticipated that the properties would eventually be attractive for subdivision by possible purchasers, but the petitioners did not intend to change them into lots or to go into any business of selling the properties. The intention of the petitioners was to hold the properties as they were when purchased, until they could be sold in their entireties, hopefully, at a profit.

The Commissioner points to evidence which he says shows that the petitioners intended to subdivide the properties. This evidence relates to some efforts made to have the property rezoned from "agriculture" and to assure the availability of water and sewer services when subdivision of the land would eventually take place. Representations were made to the local water, sewer, and zoning authorities that the properties here involved would eventually be subdivided into lots and then would need water and sewer facilities. Some of these efforts were made by prior owners, some by the petitioners during their ownership, and some by subsequent owners. The water and sewer authorities were apparently interested in knowing what the future needs of the lands in their districts would be so that adequate plans could be made. The landowners were likewise interested in those plans and cooperated from time to time. Representatives of the petitioners spent a small amount of their time in such activities to protect their interests, as any landowner would and as other owners of land in the same area were doing. Whatever one accomplished affected the others as well. The petitioners took no such steps as were found in Jack Farber, 36 T.C. 1142">36 T.C. 1142, and cases cited therein, on which the Commissioner relies. There is evidence here that the early sale at a profit of the DOM stock was made possible by the selection of nearby land for the location of two large manufacturing plants, a fortunate circumstance not anticipated by the petitioners.

The very limited activities of representatives of Sarkisian or of DOM while the petitioners owned its stock did not put either in the real estate business, did not result in any physical change or improvement to the property of either and, in the case of DOM, did not constitute "construction" even within the broad meaning of that term as used in section 341(b). DOM was not a collapsible corporation while the petitioners held its stock.

Some of the petitioners indicated on their returns for each taxable year that they elected to report long-term capital gains from the sale of the DOM stock on the installment method, although they stated they had not received any income from that sale during that tax year. The Commissioner agrees that all gains from the DOM stock sale may be reported under the installment method but he disagrees on the tax treatment of two items. First, he contends that amounts, which the petitioners regard as loans, were in fact contributions of capital. Second, the Commissioner contends that $ 74,220.26, paid by the buyer for a sewer connection, which under the contract the sellers were to provide at their own expense, was not a reduction of the purchase price but was a 1957 payment which included some installment income.

It makes no difference taxwise whether the advances were loans *893 they were a part of the basis of the stock of the contributor recovered through the sale and as such returned a part of his profit in the tax years under the installment method. If they were loans originally, as they pretty clearly were, the lenders and the other stockholders changed them into capital contributions by their agreement (to which the purchaser was not a party) whereby the lenders canceled their debts due from DOM and, to avoid any loss to them, were allowed by the other stockholders to receive an equivalent amount from the first cash payments of the purchase price of the stock. This arrangement increased for each lender the basis for gain on his stock by the amount of the loan he canceled and each payment from the purchaser received by him was in part a return of his basis and in part receipt of a part of his profit under the installment method which he elected to use. The stockholders other than the three lenders received no part of the purchase price and no profit until the buyer's payments exceeded the former loans.

The parties to the sale of the DOM stock stated in their contract that the purchase price would be $ 1,282,344, but one of the conditions was that the sellers would bring a sewer main to the property at their own expense. Later, the same parties agreed that the purchaser would bring the sewer line to the property and it is here stipulated that "The approximately $ 74,220.26 cost of said sewer lines was deducted from the amounts which South Range Development Company owed for the DOM, Inc., stock." A copy of an October 1, 1957, "settlement sheet," made a part of the stipulation, shows that the $ 74,220.26 was credited, with other items, to the purchaser against "due under contract $ 98,028.80" and other lesser items to which the sellers were entitled.

The petitioners argue from the above that the purchase price was reduced $ 74,220.26 by the above-described circumstances, while the Commissioner contends that the $ 74,220.26 represents a constructive payment by the purchaser of a part of the agreed purchase price in 1957 and represents in part taxable income in that year under the installment method of reporting the income from the sale. It seems obvious that the buyer would have insisted upon a corresponding reduction in the purchase price of the stock if the agreement had not required the sellers to pay for the connecting sewer main. The best solution of this problem would seem to be that the later agreement between the parties, shifting the sewer construction to the buyer, was a modification of the original contract under which the purchase price was reduced as the petitioners contend. It follows that the $ 74,220.26 should not be included in the sellers' bases and was not a constructive payment of purchase price in 1957.

The Hoffmans claim a nonbusiness bad debt on the loan to Wick. It is reasonably clear that no gift was intended and that Hoffman had no practical way in 1956 of requiring payment of any of the $ 960.40 due from Wick, then a minor in the Air Force, and his whereabouts unknown to Hoffman. Hoffman, a lawyer, testified that further efforts or expense on his part were not justified. The amount is deductible as a nonbusiness bad debt.

Decisions will be entered under Rule 50.

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Footnotes

• 1. Proceedings of the following petitioners are consolidated. Paul Goldstein and Zelda Goldstein, Docket No. 88251; Sam Goldstein and Tillie Goldstein, Docket No. 88252; Abe H. Goldstein and Yetta Goldstein, Docket No. 88253; William J. Goldstein and Elizabeth Goldstein, Docket No. 88254; David Goldstein and Sylvia Goldstein, Docket No. 88255; Stanley L. Cohen, Docket No. 88256; Lewis Sachter and Charlene Sachter, Docket No. 88257; Arnold Cook and Julie Cook, Docket No. 88258; Abe L. Hoffman and Florence Hoffman, Docket No. 88259; J. Glenn Donaldson and Frances E. Donaldson, Docket No. 88260; Louis Cook, Docket No. 88261; Gilbert Goldstein and Miriam Goldstein, Docket No. 88262; Edward W. Linkow and Esther Linkow, Docket No. 88263; and Harold Cook and Leanor Cook, Docket No. 88264.↩

• 2. The fiscal year of the law partnership ends in a calendar year not involved herein.↩

• 3. The stipulation shows how the stock was owned and the relationships among members of the group.↩

• 4. The Commissioner admitted in every one of his numerous answers in these cases that the advances were loans as alleged in the petitions.↩