Morrison v. Commissioner

Lucille L. Morrison, Petitioner, v. Commissioner of Internal Revenue, Respondent. Charles R. Morrison, Petitioner, v. Commissioner of Internal Revenue, Respondent

Morrison v. Commissioner

Docket Nos. 17366, 17367

United States Tax Court

12 T.C. 1178; 1949 U.S. Tax Ct. LEXIS 138;

June 30, 1949, Promulgated

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Decisions will be entered under Rule 50.

A taxpayer, having elected to report gains from sales of lots on the installment basis, repossessed certain lots after default by the purchaser. By the sale contract's terms the taxpayer retained title for delivery, when all price installments should be paid; default rendered the contract null and void, and released the purchaser from further liability for payment. The Commissioner's determination of a gain by regarding the taxpayer as exchanging the purchaser's installment obligations for the repossessed lot, held, warranted by section 44 (d), Internal Revenue Code, and section 29.44-3, Regulations 111.

Bleecker L. Morse, Esq., for the petitioners.

John P. Higgins, Esq., for the respondent.

Johnson, Judge.

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JOHNSON

The Commissioner determined the following deficiencies in petitioners' income taxes for the fiscal years ended November 30, 1944 and 1945:

	1944	1945
Lucille L. Morrison	$ 2,218.07	$ 450.44
Charles R. Morrison	2,202.78	450.44

The deficiencies resulted in part from his addition to community income of gains determined on the repossession of lots sold under contracts which became null and void after the purchaser's default in payment of a price installment. Petitioners reported profits on the installment basis, but argue that no gain is taxable on repossession after forfeiture because the purchaser was released thereby from further liability, and they consequently held no obligations which were exchanged for the lot.

FINDINGS OF FACT.

The proceeding was submitted upon a stipulation and exhibits, which we incorporate by reference as findings of fact, and from which it appears that:

Petitioners, husband and wife, are residents of Houston, Texas, and they filed separate income tax returns for the fiscal years ended November 30, 1944 and 1945, with the collector of internal revenue for the first district of Texas. During those years and prior thereto they were engaged in the subdivision and sale of various tracts of land which they owned, doing business as the Morrison Land Co. They offered lots for sale on an installment plan, and reported their income on the installment basis.

Under the plan a customer made a down payment for the lot desired and received from the Morrison Land Co. a "Contract for Deed" which recited receipt of the down payment and the customer's agreement to make a further designated payment each month until full payment of the specified price should be complete.

The Morrison Land Co. agreed to deliver to the customer upon completion of full payment an insured warranty deed to the lot, excepting certain oil and mineral rights. The customer under some contracts was to pay taxes on the lot from date of the contract; under others, the seller was to pay taxes until maturity. The customer was charged with 6 per cent interest only on payments in arrears. In case of a thirty-day default in the payment of an installment:

* * * then all previous payments shall be forfeited to The Morrison Land Company as rental charge for the possession of the above named property from date of this contract, and this contract shall be null and void thenceforth. The above named purchaser shall in that event be likewise relieved from all responsibility under this contract.

Upon default of a customer the Morrison Land Co. would send him a notice by registered mail, advising that unless he paid the amount in arrears by a specified time, his contract for deed would be canceled as of that date.

During the fiscal years ended November 30, 1944 and 1945, petitioners canceled 29 and 25 contracts for deed, respectively. They reported the amount collected in the taxable year under each defaulted contract, and, having computed the percentage of total prospective profit on the contract as if fully completed, they returned as taxable gain the same percentage of the amount collected, and also "gains on lapses," apparently representing that part of collections not reported as profits. In each of the taxable years the payment credits under five of the defaulted contracts for deed were, by the parties' agreement, not forfeited, but transferred to the credit of the defaulting payor as payment on other lots than those covered by the defaulted contract. The credits so transferred aggregated $ 530.50 in amount in the fiscal year 1944 and $ 795 in the fiscal year 1945.

The Commissioner accepted petitioners' figures of cost, contract price and receipts, but, in addition to the installment gains reported on collections from the purchasers, he determined a profit on each of the forfeited contracts by subtracting from the fair market value of the repossessed lot the balance of the unpaid installment payments reduced by that part of them which would have been installment profits if collected. On all the lots repossessed during the fiscal year 1944 he thus determined aggregate gains of $ 13,146.76 and then reduced this figure by "Gain reported as forfeiture $ 1,423.08" and installment profits on resale of lots repossessed in 1943, $ 4,057.24, and on resale of lots repossessed in 1944, $ 2,119.72, to $ 5,546.72. This last amount he added to petitioners' community income. In like manner he determined gains of $ 11,474.82 on lots repossessed during the fiscal year 1945; reduced this figure by "Gain reported as forfeiture $ 1,535.76" and installment profits on the resale of repossessed lots in prior years, and added the resulting $ 1,600.49 to petitioners' community income for the fiscal year 1945.

OPINION.

Petitioners regularly reported on the installment basis profits from their contracts to sell lots, as they are permitted to do by section 44 (b), Internal Revenue Code, under regulations prescribed by the Commissioner with the approval of the Secretary of the Treasury. They returned as income in the taxable years:

* * * that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price. [Sec. 44 (a).]

But in respect of certain contracts the purchasers defaulted and, pursuant to the stipulated conditions, all previous payments were forfeited to petitioners, the contracts became null and void, and the purchasers were relieved from all further responsibility. Petitioners, having retained title, reacquired possession of the lots, and computed profit from such transactions by including the total profit percentage of the collection made under contract in the schedule of installment sale profits and then adding as "Gain on Lapses" an additional amount, which we infer represents the cost recovery attributable to collections and perhaps some adjustments. There is no break-down of the figure on the return and it is not described in the stipulation.

By section 29.44-3, Regulations 111, it is provided that if a vendor, returning income on the installment basis, reacquires the property after default by the purchaser, gain or loss is to be computed upon any installment obligations which are satisfied or discharged, regardless of whether or not title to the property had been retained by the vendor or transferred to the purchaser. Such gain or loss is to be measured by the difference between the fair market value of the reacquired property and the adjusted basis of the purchaser's obligations to the vendor. In effect, the vendor is treated as disposing of the purchaser's installment obligation in exchange for the repossessed property. Such a transaction is explicitly taxable under section 44 (d), which provides:

(d) Gain or Loss upon Disposition of Installment Obligations. -- If an installment obligation is satisfied at other than its face value * * * or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange -- the amount realized * * *.

The Commissioner has determined that upon repossession after default petitioners' gains are the difference between the fair market value of the lots repossessed -- an undisputed figure -- and the bases of the extinguished installment obligations, adjusted to eliminate amounts returnable as profits.

It has long been settled that section 44 (d) is applicable to a vendor's repossession of property subject to a sale contract under which there has been a default in the payment of required installments. Such was the holding of the Circuit Court of Appeals for the Third Circuit in Boca Ratone Co. v. Commissioner, 86 Fed. (2d) 9, wherein it appeared, as here, that the vendor had retained title to the property sold and that, after default by the vendee and repossession by the vendor, the vendee was released from any further obligation. In its holding the court reasoned that the installment obligations had been "satisfied" within the meaning of section 44 (d) by the repossession. This decision has been followed, Walker v. Thomas (C. C. A., 5th Cir.), 119 Fed. (2d) 58; T. Eugene Piper, 45 B. T. A. 280; and Eggerman Investment Co., 36 B. T. A. 1196, and, indeed, is reflected in the above described provisions of section 29.44-3, Regulations 111. See T. D. 4832, 1938-2 C. B. 155, approved July 19, 1938.

But petitioners argue that under their contracts no installment obligations of the purchaser existed because the purchaser was always free to default and nothing subjected him to liability for the unpaid balance if he did. If we were here dealing with the taxation of profit under the normal method of computation, this argument would be very cogent. But the installment basis of reporting gains is an optional method of convenience which a taxpayer is permitted to use under regulations prescribed by the Commissioner. Sec. 44 (b). Having elected to use it, petitioners are bound by the regulations and by their decision. Pacific Nat. Co. v. Welch, 304 U.S. 191">304 U.S. 191. The regulations have been held reasonable and the effects of the method in producing tax consequences at variance with those of normal accounting have been sustained. Commissioner v. South Texas Lumber Co., 333 U.S. 496">333 U.S. 496. Indeed, acceptance of petitioners' view that there were no installment obligations would seem to defeat their right to use an installment basis for reporting gain, for total profit and other factors of computation involve such obligations.

As shown by the holding in Boca Ratone Co. v. Commissioner, supra, and by the provisions of section 29.44-3 of Regulations 111, a uniform application of the installment basis is intended without distinctions on account of legal technicalities such as transfer of title at time of the sale contract or on completion of the contemplated payments. More recently, the Circuit Court of Appeals for the Sixth Circuit held, in United States v. Eversman, 133 Fed. (2d) 261, that gain or loss should be computed under section 44(b) by use of the fair market value of the repossessed land, even though the contract for its sale provided that the buyer could default, cancel the contract, and relieve himself of all obligation to make further installment payments by giving specified notice of his intent to do so. Such provisions are substantially the same as those on which petitioners here rely, but the court considered the seller as holding an installment obligation which was disposed of at other than its face value by virtue of the repossession of the land. Petitioners stress as to the contrary the court's statement that "Cancellation of a contract is certainly not the equivalent of payment of obligations under it." But this observation was made in holding that the initial payments during the year did not exceed the 40 per cent maximum requisite for use of the installment basis. The repossessed land was not deemed a payment under the contract, but consideration for disposition of the installment obligations.

In general support of their contention, petitioners assert that the Commissioner in effect has determined a gain on the acquisition of property, using fair market value as the measure of receipt, while tax is laid on profit from a disposition. But clearly the Commissioner has not done so. Under the governing regulations, which a taxpayer of necessity accepts in electing use of the installment basis, petitioners' lots are considered as sold when the contract is signed, regardless of contractual provisions which might technically postpone consummation of the sale. And, analogously, where the purchaser lost his rights under the contract by default and petitioners reacquired possession of the lot, they are deemed to have exchanged the purchaser's agreement to pay specified installments, receiving the lot in consideration therefor. The resulting gain is thus derived from a disposition of the customer's agreement to pay installments, and by the regulations its basis to petitioners is the excess of face value over the income returnable if the installments had been paid in full, while the amount received therefor is the fair market value of the lot.

Of course it can be objected that the purchaser's agreement to pay installments could not be enforced after forfeiture, but, as the cited decisions establish, the pattern of gain computation on the installment basis is designed for uniform application. Were this not so, petitioners never held any "obligations of the purchaser" and were not entitled to use the installment basis. But, by choosing it, they elected to consider the purchaser's agreement as an obligation, and, having enjoyed the benefits in returning profit on collections, they can not escape the temporary disadvantage of the consequences of forfeiture. The disadvantage, moreover, is nicely compensated by the increased basis of the repossessed lot, which, on a resale, will yield pro tanto less gain or more loss.

With regard to the forfeited payments which petitioners transferred -- voluntarily, it would seem -- to the credit of the defaulter for payment on another lot which he had contracted to purchase, petitioners agree that they are properly includible in income to the extent not previously reported, but charge that the Commissioner has determined gain on "the mere transfer of credit balances from one account to another." Such a transfer would not constitute income, but in the state of the record we are unable to find whether or not he did so, and an opportunity will be given the parties under Rule 50 to clarify and, if necessary, correct his action in this respect.

Decisions will be entered under Rule 50.