Leslie v. Commissioner

Warren Leslie, Sr., and Estate of May K. Leslie, Deceased, Warren Leslie, Sr., Executor, Petitioners, v. Commissioner of Internal Revenue, Respondent

Leslie v. Commissioner

Docket No. 4619

United States Tax Court

6 T.C. 488; 1946 U.S. Tax Ct. LEXIS 262;

March 15, 1946, Promulgated

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Decision will be entered under Rule 50.

1. Deduction -- Loss -- Transfer Entered into for Profit -- Residence. -- A residence of the petitioner was damaged by a hurricane in 1938 and was never thereafter occupied. A real estate agent was allowed to try to find a purchaser after the hurricane, but never succeeded. The property was transferred to the mortgagee in 1940. Held, the loss, if any, was not from a transaction entered into for profit within section 23 (e) (2).

2. Deduction -- Nonbusiness Expenses. -- Expenses of a caretaker for the property after the hurricane were not deductible under section 23 (a) (2) as ordinary and necessary expenses of conserving property held for the production of income.

3. Deduction -- Nonbusiness Expenses. -- Premiums paid by a wife on life insurance policies on her husband's life owned by her and put up as part of the collateral for a loan made by a bank to the husband upon which income-producing securities had also been pledged, was not an ordinary and necessary expense deductible under section 23 (a) (2).

Warren Leslie, Jr., Esq., for the petitioners.

J. Richard Riggles, Jr., Esq., for the respondent.

Murdock, Judge. Disney, J., dissenting. Leech, J., agrees with this dissent.

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MURDOCK

The Commissioner determined a deficiency of $ 7,903.35 in the income tax of the petitioners for the calendar year 1940. The petitioners assign error on the part of the Commissioner in disallowing deductions of:

(a) $ 26,181.77 representing a loss on the transfer of real estate to the the mortgagee;

(b) $ 1,046.08 representing caretaker expenses on the property from January 1, 1940, to the date of the transfer;

(c) $ 938.88 representing a bad debt;

(d) $ 15,893.80 representing life insurance premiums paid by May K. Leslie during 1940 on policies owned by her upon the life of her husband and pledged as collateral, with other assets owned by her, upon a debt of her husband.

FINDINGS OF FACT.

Warren Leslie, Sr., and May K. Leslie were husband and wife. They were the original petitioners herein and will be referred to as the petitioners. May K. Leslie is now deceased. The petitioners resided on 94th Street, New York, New York. Their joint return for 1940 was filed upon a cash basis with the collector of internal revenue for the third district of New York.

May K. Leslie, a number of years ago, acquired a property at Center Moriches, Long Island. She and her husband had occupied this property as a residence for a number of years prior to 1938. The property had 7 1/2 acres of land which fronted on the ocean. It was improved with a large frame house. The house was so badly damaged by the hurricane of September 21, 1938, that it could not be occupied thereafter without extensive repairs. The petitioners decided not to occupy it again. The repairs were never made and the property was never occupied by the petitioners after the hurricane. They made no attempt to rent the property or any part of it.

A real estate agent, shortly after the hurricane, asked Warren Leslie, Sr., for the right to try to sell the property. They agreed that the agent was to try to get an offer on the property for submission to Leslie. No price was ever agreed upon or even mentioned by Leslie. The agent never obtained any offer, although he showed the property to several people. No other efforts were ever made to sell the property.

The petitioners continued to pay the taxes on the property after the hurricane. The assessed valuation of the property was $ 40,000 for the 1938-1939 tax period, but was reduced to $ 30,000 for the 1939-1940 tax period.

The petitioners, on their return for 1938, claimed a loss on the property from the hurricane of $ 43,632.94 which they explained as follows on a schedule attached to that return:

Buildings	$ 49,156.05
Contents and personal effects	13,271.48
	62,427.53
Less estimated recovery	20,000.00
Balance	42,427.53
Emergency carpenter work and straightening up of trees and
shrubbery	1,205.41
Total loss	43,632.94

The petitioners recovered insurance in the amount of $ 27,000 after the hurricane. The record does not show the action of the Commissioner in regard to the loss claimed for 1938.

The record does not show what basis for gain or loss the land and building had in the hands of May K. Leslie in 1940.

The Riverhead Savings Bank held a mortgage on the property. The property was conveyed to the bank in the summer of 1940 to save the bank the expenses of foreclosing the mortgage. The amount due on the mortgage at that time was $ 11,800.

The record does not show that there was any change in the value of the property from a time immediately after the hurricane to the date of the transfer of the property to the mortgagee.

May K. Leslie did not sustain any loss on the Center Moriches property in 1940.

The petitioners, on their return for 1940, claimed a deduction of $ 33,003.09 under item 16, "Losses from fire, storm, shipwreck, or other casualty, or theft." They attached to their return a schedule explaining this deduction, which schedule was as follows:

Loss from Hurricane $ 33,003.09:
In 1938 the taxpayers property located at Center Moriches was
damaged by storm. The cost of the property per the taxpayers
record was		$ 93,959.14
Insurance recovered was	$ 27,000.00
Amount allowed as a loss in 1938 not compensated for
by insurance was	27,000.00
Remainder	54,000.00
Of the above amount the part considered as applicable
to furniture, shrubbery and personal effects was	4,843.95
Amount applicable to real estate		$ 49,156.05
Amount not recovered either by insurance or allowance as a
deduction in 1938		44,803.09
Less -- Mortgage		11,800.00
Value abandoned in 1940		33,003.09

After the hurricane the taxpayer obtained estimates for the restoration of the property, and for the reason that the cost of such restoration represented a substantial amount he did not go ahead with the work. During the year 1939 the taxpayer continued to pay the taxes and mortgage interest on the property. In 1940 the taxpayer came to the decision that the damage caused by the storm was so great that it would be better to abandon the property than expend the amount necessary to restore it. On July 16, 1940 the property was deeded by the taxpayer, without consideration to the Riverhead Savings Bank which institution held a mortgage on the premises for $ 11,800.00. The abandonment in 1940 was the direct result of the damage to the property in the 1938 hurricane.

The Commissioner, in determining the deficiency, disallowed in its entirety the loss of $ 33,003.09 and gave the following explanation:

The deduction of $ 33,003.09 claimed in your return as representing the loss, due directly to damage by a hurricane in the year 1938, of the remaining value of your residence at Center Moriches, Long Island, New York, when the property was voluntarily deeded in July 1940 to the mortgagee, has been disallowed. The loss resulting from the hurricane was allowed in the year 1938 in accordance with Section 23 (e) (3) of the Revenue Act of 1938 and the loss, if any, sustained in the year 1940 resulted from the disposition of residential property which is not an allowable deduction under the provisions of Section 23 (e) (2) of the Internal Revenue Code.

The petitioners employed a caretaker for the property at Center Moriches. They paid him wages of $ 552.50 during the first seven months of 1940. They also paid, during that period, $ 182.55 for 14 1/2 tons of coal, $ 2.25 for a plumber, $ 4.24 to the light company and $ 54.54 for insurance in connection with the care and protection of the property. They also paid an architect $ 250 on August 12, 1940, for services in looking over the property in connection with the question of the possible cost of repairs. No deduction was claimed on their 1940 return for any of the above items and the Commissioner did not allow any of them or refer to them in his notice of deficiency.

Warren Leslie, Sr., in 1928 personally guaranteed a loan made by the Empire Trust Co. to Frank McEneny. The petitioner paid $ 1,000 on the loan prior to 1940 and in 1940 he paid $ 938.88, the balance due on the loan at that time. He received in 1940 a mortgage which the bank had held as collateral on the loan. That mortgage was on some property owned by McEneny. It was worthless. The petitioner could not locate McEneny in 1940 or later.

The petitioners claimed a deduction of $ 938.88 on their 1940 return representing the amount paid on the McEneny note in 1940. The Commissioner, in determining the deficiency, disallowed the deduction for lack of information.

The debt due to the petitioner from McEneny, as a result of the payment of the note by the petitioner, was worthless when the $ 938.88 was paid.

Warren Leslie, Sr., was indebted to the Empire Trust Co. in 1940 in the amount of $ 498,050.54. The liabilities of Warren exceeded his assets in 1940. The collateral pledged to secure this indebtedness included securities owned by Warren worth about $ 23,000 and many shares of dividend-paying stock owned by his children and his wife May, and seven policies of insurance in the total amount of $ 325,000 upon Warren's life, owned completely by May. The policies were given as collateral in 1939 at a time when other income-producing securities belonging to May were released by the bank. There was no agreement as to the order in which the collateral was to be used in case of default on the indebtedness. The shares of stock had a value far in excess of the debt. The cash surrender value of the insurance policies was about $ 82,000. The bank had authority to use the dividends on the stock held as collateral to pay the premiums on the life insurance if May did not pay them.

May paid premiums of $ 15,893.80 on the insurance policies during 1940.

May K. Leslie, in August 1940, assigned all of her interest in the seven policies above mentioned to her children and had them named as beneficiaries.

No deduction was claimed on the petitioners' return for 1940 in connection with the premiums paid by May on the seven policies of insurance and the Commissioner, in determining the deficiency, did not allow any deduction in that connection.

OPINION.

The petitioners, on their return for 1940, claimed a deduction of $ 33,003.09 as a loss from storm. They had been allowed a deduction for the hurricane loss in 1938. They now have discarded that theory of the 1940 deduction and claim a deduction of $ 26,181.77 under section 23 (e) (2) of the Internal Revenue Code as a loss from a transaction entered into for profit not connected with their business. They claim that the property was converted to an income-producing purpose immediately after the hurricane when it was placed in the hands of an agent for sale; its fair market value at that time was not less than $ 39,640.18; a loss of the difference between that value and $ 11,800, the amount of the mortgage, was sustained when the property was transferred to the mortgagee. The record does not show that May sustained or incurred any loss in regard to this property in a transaction entered into for profit.

Loss on a personal residence is not deductible for obvious reasons. However, a residence may be abandoned as such and converted to a profit-inspired use from which a deductible loss may be incurred. Joseph F. Cullman, Jr., 16 B. T. A. 991. It must appear that the loss was sustained in the new transaction and was not a carry-over in whole or in part of a loss already incurred in the personal residence use of the property. Cf. Herbert L. May, 19 B. T. A. 229.The personal residence use must be terminated, the loss from that use must be fixed in some way, a new basis for gain or loss must be established, and a profit-inspired transaction must be entered into. There must be a showing that the loss was sustained as a result of the new profit-inspired transaction or use. A decline in value during a period while the owner is merely trying to enter into a profit-inspired transaction with the property is regarded as a part of the loss incidental to the personal use, without which the loss would not have occurred. Frances G. Smith, 23 B. T. A. 1134. Merely permitting the property to be offered for sale after deciding not to occupy it further is not sufficient to terminate the loss from residential use and initiate a new transaction for profit within the meaning of section 23 (e) (2). Rumsey v. Commissioner, 82 Fed. (2d) 158; certiorari denied, 299 U.S. 552">299 U.S. 552; Morgan v. Commissioner, 76 Fed. (2d) 390; certiorari denied, 296 U.S. 601">296 U.S. 601; Gevirtz v. Commissioner, 123 Fed. (2d) 707;Phipps v. Helvering, 124 Fed. (2d) 292; W. H. Moses, 21 B. T. A. 226; Frances G. Smith, supra.

Here, if the above obstacle were not present, there is still an inadequate showing as to the basis of the property in the alleged new use. Value at the date of conversion would fix the amount of the personal use loss and give a basis for gain or loss in the new use. Joseph F. Cullman, Jr., supra. The petitioners say that the value was $ 39,640.18 after the hurricane, but they fail to prove it. They rely upon two tax receipts which merely show that in 1939 the assessed value was reduced from $ 40,000 to $ 30,000. Was the actual value more or less? A witness for the respondent said it never exceeded the amount of the mortgage after the hurricane. A witness for the petitioner introduced some figures on costs and his unsupported notion of some adjustments thereto after a fire in 1930 and the hurricane in 1938. He did not profess to know anything about the value of the property. The building was old and cost figures are not very helpful. The petitioners suffer as a consequence of the inadequate proof.

The record shows that the house was terribly twisted and torn by the storm. It is reasonable to believe that it had little value thereafter. It does not appear that the value of the entire property after the hurricane exceeded $ 11,800, the amount of the mortgage. Perhaps an insufficient deduction was allowed for the storm loss in 1938, but the statute does not allow any deduction for that loss in 1940. The petitioners have failed to show that they sustained any loss in 1940 from a transaction entered into for profit.

The petitioners contend that the caretaker expenses are deductible under section 23 (a) (2) as nonbusiness expenses paid in the maintenance and conservation of property held for the production of income. They rely upon Mary Laughlin Robinson, 2 T. C. 305. The applicable regulation provides that ordinary and necessary expenses in connection with the conservation or maintenance of a residence are not deductible, even though efforts are being made to sell, prior to the time the property is rented or otherwise appropriated to income-producing purposes. Regulations 103, sec. 19.23 (a)-15 as amended by T. D. 5196. Here, as in the case of losses claimed on former residences, the necessity for administrative purposes of some unmistakable act of conversion or appropriation is obvious. The property in the Robinson case had been offered for rent and a part of it had been rented. Here the property was not offered for rent and no part of it had been rented. The efforts to sell did not appropriate it to income-producing purposes. It was still just an unoccupied residence. Cf. Eleanor Saltonstall, 2 T. C. 1099; reversed on another point, 148 Fed. (2d) 396. It was not being held for income-producing purposes and the caretaking expenses are not deductible.

The debt from McEneny was worthless when acquired by the petitioner as the result of his payment under his guaranty. It is deductible under section 23 (k).

The petitioners' argument in regard to the insurance premiums is too strained. They have found no case to support it. They contend that those premiums are deductible under section 23 (a) (2) as nonbusiness expenses paid to collect dividends which otherwise would be taken to pay the premiums and were paid to conserve stock held for the production of income, since the policies served to release income-producing stock which otherwise would have been required as collateral. This new provision of the code was not intended to make deductible expenditures which are not in their nature expenses. Don A. Davis, 4 T. C. 329, 334; affd., 151 Fed. (2d) 441; certiorari denied, Feb. 25, 1946. The insurance premiums were paid to keep the policies alive, not to collect income. They served to increase the value of the policies. They are a form of saving. They are not ordinary and necessary expenses under the circumstances of this case. They do not bear a sufficiently reasonable or proximate relation to the collection of the dividends on the stock of May held as collateral or to the conservation of other income-producing securities owned by her to make them deductible under section 23 (a) (2).

Decision will be entered under Rule 50.

DISNEY

Disney, J., dissenting: Prior to the amendment of section 23 (a) (2) of the Internal Revenue Code by section 121 of the Revenue Act of 1942, expenses of caring for property were deductible only if business property, for the simple reason that section 23 (a) (2) provided for the deduction only of expenses "paid or incurred in carrying on any trade or business" -- although section 23 (e) provided for deduction of losses incurred either in trade or business or in a transaction entered into for profit. This distinction led to such decisions as that in Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212. It is apparent from the history of section 121 of the Revenue Act of 1942 that Congress desired to broaden the concept of what expenses of carrying property should be deducted; for in the Committee Reports of the House of Representatives, 77th Congress, 1st sess., July 14, 1942 (21 C. B., part 2, p. 410), we find the following:

The existing law allows taxpayer to deduct expenses incurred in connection with a trade or business. Due partly to the inadequacy of the statute and partly to court decisions, nontrade or nonbusiness expenses are not deductible, although nontrade or nonbusiness income is fully subject to tax. The bill corrects this inequity by allowing all of the ordinary and necessary expenses paid or incurred for the production or collection of income or for the management, conservation, or maintenance of property held for the production of income. Thus, whether or not the expense is in connection with the taxpayer's trade or business, if it is expended in the pursuit of income or in connection with property held for the production of income, it is allowable. [Italics supplied.]

It seems clear from the above language that there was a feeling in Congress that if income from property was subject to tax, the expenses of carrying such property should be deducted, even though they were "nontrade or nonbusiness expenses." The statute, so far as here concerned, requires only that the expense be "for the management, conservation, or maintenance of property held for the production of income."

In accordance with such statute, the regulations were amended, and Regulations 103, section 19.23 (a)-15, amended by T. D. 5196, so far as pertinent here provides in substance, that "income" includes "gains from the disposition of property," that expenses of maintaining investment property (not primarily for hobby, sport, or recreation) are deductible, even though the property is merely held to minimize a loss, and that the question whether property is held for production of income rather than primarily as a sport, hobby, or recreation, is to be determined from all the circumstances. Then the regulation continues:

Ordinary and necessary expenses in connection with the management, conservation, or maintenance of property used as a residence by the taxpayer or acquired by him for such use are not deductible, even though the taxpayer makes efforts to sell the property at a profit or to convert it to income-producing purposes, and even though the property is not occupied by the taxpayer as a residence, unless prior to the time that such expenses are incurred the property has been rented or otherwise appropriated to income-producing purposes by some affirmative act and has not been reconverted. [Italics supplied.]

The regulation, except the paragraph last above quoted as to residence property, is in substance the same as the committee report of the House of Representatives (appearing on pages 420, 421, 21 C. B., part 2), and the Senate committee report is, though not to such length, in substance largely the same.

The paragraph above quoted from the regulations as to residence property is in effect added by the regulation to the House committee report. I find nothing tangible on the subject in the conference report.

In my view, a reading of the new statute, and the regulations and the committee reports thereon discloses an intent to distinguish on this question of deduction of expense of carrying property, primarily between property carried as "a sport, hobby, or recreation" on the one hand, and property held "for the production of income" on the other. In addition, of course, section 24 (a) (1), prohibiting deduction of "personal, living, or family expenses" requires consideration of a residence and the expenses of maintaining it. In other words, if property is not a sport, hobby, or recreation, expense of holding it, even to minimize a loss, should be allowed -- without application of any previous ideas of trade or business; but if the personal, living, or family expense of a residence is involved, it, under a separate statute, may not be deducted.

Section 121 of the Revenue Act of 1942 amended only section 23, and in nowise touched upon section 24 (a) (1). In short, Congress, for expense deduction purposes, merely divided property not devoted to business into two classes, hobby property and property held for production of income -- and did not legislate with reference to residences or personal expenses, leaving the rules as before on that matter.

The majority opinion discloses: That the property had been occupied by petitioner and her husband as a residence for a number of years prior to 1938; that it was "terribly twisted and torn by the storm. It is reasonable to believe that it had little value thereafter"; that it was so badly damaged by the hurricane that it could not be occupied without extensive repairs; that it was decided not to occupy it again, and the repairs were never made and it was never occupied by the petitioners again; but, after a real estate agent, upon their agreement, showed the property to several people without getting an offer for the property, it was conveyed to a mortgagee in the summer of 1940 -- less than two years after the hurricane -- to save the mortgagee the expenses of foreclosure on a mortgage of $ 11,800; and that the petitioners recovered $ 27,000 insurance after the hurricane. Surely all this is a complete showing that the property had ceased to be a residence, a personal, living, or family matter, so as to require cessation of denial under section 24 (a) (1) of carrying expenses because of such personal element. After passage of section 121, a showing of conversion to business property need not be made under section 23 (a) (1) (A), and the petitioner need only demonstrate that the property was held for production of income (even though only "gains from the disposition of property" and though "held merely to minimize a loss"), under section 23 (a) (2). Under the first part of the regulation above quoted, such showing required mere holding for sale. Under the latter part the residence situation is covered, and an affirmative act of appropriation to income-producing purposes is required as to a residence, even though it is not occupied as such. What, however, of a former residence, a property which is affirmatively shown to have lost that status? The whole history of this question convinces me that nothing need be shown except a change from a residence status to a nonresidence status, for the passage of the act in 1942 is proof enough that conversion to a business property is not requisite, and if so (and the property is not mere hobby, which is nowhere suggested in this case, but negatived by the former residence feature), then all that the residence idea adds is the provision of section 24 (a) (1). But since the application thereof disappears with the end of residence, and the house becomes mere property, logically the latter part of the regulation is seen as altogether inapplicable. In my view, if property is not hobby, only abandonment thereof as residence is required to be shown, for I think that the statute was definitely intended to allow carrying expenses as to nonhobby property, except when section 24 (a) (1) puts the personal element into the picture where the property is used as a home, entailing such personal element. That factor here affirmatively being shown to have ceased, other showing is outside the statute.

The majority opinion, however, tends to go back to former criteria when it says:

* * * Here, as in the case of losses claimed on former residences, the necessity for administrative purposes of some unmistakable act of conversion or appropriation is obvious. * * *

Such necessity is not obvious to me, for I can not find it in the statute, by text or implication.

I think section 121 of the Revenue Act of 1942 was definitely intended to do away with any comparison with losses, and that we should view the matter only to inquire whether property is "held for the production of income," and not set up requirements based on losses, or the former statute, or analogy thereto. Conversion or appropriation, though necessary to change a residence to business property, is logically unnecessary to divest it of a personal character. If such test is still requisite, the statute seems to have accomplished little, if anything. "As a general rule an actual removal from, and cessation of use of, the premises may raise a presumption of abandonment * * *," 40 C. J. S. 671, Homesteads. Evans v. Evans, 210 N. W. 564 -- abandonment held from fact of family moving to town, after destruction of home by fire. No rule of law requires any "unmistakable act of conversion or appropriation" as proof of abandonment of homestead -- which per se in logic ends basis for denial of the personal family expense therewith connected. Whatever is convincing that residence in the property has stopped, is sufficient, both in law and logic.

However, even under the regulation any facts which show that property is, in the words thereof, "appropriated to the production of such income" are sufficient basis for the deduction; and I think such showing was here made, under any reasonable test.

We have here no mere moving out of a residence, with question as to state of mind of the owner and as to temporary or permanent nature of the moving, leaving in doubt whether the property has ceased to have a "personal, living, or family" residence status, but a case where an act of God, a hurricane, has so badly damaged the property that it could not be occupied thereafter without extensive repairs, where the petitioners decide not to occupy it again and never occupied it again, where they put the property up for sale with an agent who, though he never obtained an offer, showed the property to several people in an effort to do so. True, price was not set, but that is not infrequent in real estate negotiations until a prospect is found. It seems to me that if the true test, since section 121 of the Revenue Act of 1942, is whether property (not a hobby) is held for production of income, even though it be only upon "disposition of property," and if the only exception thereto is tied in with section 24 (a) (1), that is, personal, living, or family expenses, it is clear that the expense of carrying property damaged so badly that it could not be occupied without extensive repairs, and where decision was made not to occupy it again and it was not occupied, but attempts were made to sell it, that all reason for denying application of section 121, Revenue Act of 1942, disappears. Property so unfit for residential purposes might be held for years, and apparently here was held for about two years, in a vain effort to sell it "to minimize a loss with respect thereto," in the words of the regulation, and I would not make the allowance of deductions for carrying expense depend upon whether or not it was possible to find a purchaser or buyer. The very impossibility of obtaining an offer is some indication that the property was not fit for residence purposes. In my opinion such efforts to find a buyer for a property in the condition seen here is an appropriation to income-producing purposes, offering no difficulty in administration. Realistically viewed, this house appears fit only for holding -- for less than two years, when it was turned over to the mortgagee. To deny the deduction is, in my view, to go backward instead of with the new statute. I therefore respectfully dissent. I regret the length of this dissent, but I feel that this is a crucial stage in an important subject.