Tennessee Carolina Transp., Inc. v. Commissioner

OPINION

Issue 1

The liquidation of Service was a complete liquidation of a subsidiary within the meaning of sections 332 and 334(b)(2).² Therefore petitioner’s basis in the various assets which it received must be determined by allocating petitioner’s adjusted basis in its Service stock among them in proportion to .their relative fair market values on the date of distribution, March 1, 1967. Sec. 1.334-l(c)(4)(viii), Income Tax Regs.

For the purpose of applying section 1.334-l(c)(4)(viii), supra, petitioner valued the terminal at $150,000. Respondent determined that on the date it was distributed to petitioner the fair market value of the terminal was less than $100,000. The burden of proving respondent’s determination incorrect is on petitioner. Welch v. Helvering, 290 U.S. 111 (1933).

After, the terminal was vacated by Service on January 22, 1967, it was of no further usefulness to petitioner. Petitioner’s objective was therefore to sell the terminal as quickly as possible. With this objective in mind, petitioner’s real estate agent recommended that the property be listed for sale at $150,000. Shortly after the terminal was listed, it was seriously damaged by trespassers. Windows were broken; plumbing and electric wiring were disarranged; and fire extinguishers were sprayed throughout the premises. These wanton acts discouraged prospective purchasers from becoming interested in the property, and during the 7 months in which the terminal remained listed for sale at $150,000, not a single offer of purchase was forthcoming.

As time passed, the need to sell the property became more urgent. Petitioner was in need of the cash that a sale would provide and could ill afford to bear the expense of maintaining so useless an asset as the terminal. Therefore when petitioner was offered $100,000 for the terminal by an unrelated party, an agreement was concluded on the basis of that offer.

Ordinarily, the price at which property is sold in an arm’s-length transaction is the best evidence of its fair market value at the time of the sale. T. H. Symington & Son, Inc., 35 B.T.A. 711, 756 (1937). Petitioner, however, contends that in this instance the sale of the property was dictated by economic necessity and that, consequently, there was inadequate opportunity to negotiate a fair price. Under such circumstances, the price agreed upon might not have been respresentative of the fair market value of the property. See Bell’s Booteries, Inc. v. United States, 91 F. Supp. 155 (M.D. Tenn. 1948).

In the 7 months during which the property was available for sale at $150,000, it was inspected by five or six prospective purchasers. In its damaged condition the property was of interest to none of them at that price. Certainly this indicates that the asking price was well in excess of the fair market value of the property in its damaged condition. Furthermore, when the offer of $100,000 was made, petitioner’s real estate agent deemed it well worth accepting. Given these facts, we are satisfied that the value of the selling price as evidence of the fair market value of the terminal has not been impugned because petitioner may have felt compelled by a need for cash to accept the offer of $100,000.

Some incidents of vandalism occurred before the terminal was distributed to petitioner in liquidation; others occurred thereafter. The initial acts of vandalism which occurred before the distribution must have had' an adverse effect upon the fair market value of the terminal because of the alterations which they effected in the appearance of the property. Not to be gainsaid, however, is the effect of the damage which was wrought upon the terminal after it was distributed to petitioner. Therefore in determining the fair market value of the property as of the date of distribution, respondent ought not to have presupposed that when the terminal was sold on August 31,1967, it was worth no less than it had been on the date of distribution 6 months before.

The extent to which the terminal was damaged after it was distributed was not precisely established at trial. We have therefore to approximate as best we can the extent to which the fair market value of the terminal declined between the date of distribution and the date of sale. Upon due consideration of all the pertinent facts we estimate the amount of the decline to have been $25,000. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). Accordingly, we hold that on March 1, 1967, the fair market value of the terminal was $125,000.

When Service purchased tires and tubes to be mounted on equipment used in its operations, it expensed the cost of procuring them when they were placed in service. The cost of tires and tubes purchased on new equipment was expensed at the time of the purchase. These costs were charged to expense rather than capitalized on the assumption that the average useful life of the tires and tubes was 1 year or less.

When Service was liquidated, it distributed to petitioner 1,638 tires and tubes, the cost of which it had previously expensed. For the purpose of applying section 1.334-l(c)(4)(viii), supra, petitioner valued these tires and tubes at $94,940.

During 1966, the last full year of its operations, Service charged $53,918.03 (net) to expense in respect of tires and tubes. In view of this, respondent determined that the value assigned by petitioner to the 1,638 tires and tubes was excessive.

There is nothing in the record to indicate that the cost of tires and tubes increased significantly between the time when Service purchased the tires and tubes whose cost it charged to expense in 1966, and the date on which it was liquidated. On the date of Service’s liquidation, 67.5 percent of the useful life of the 1,638 tires and tubes remained. We would therefore be inclined to hold that on the liquidation of Service the fair market value of these tires and tubes was $36,394.67, Colonial Fabrics v. Commissioner, 202 F.2d 105 (2d Cir. 1953), affg. a Memorandum Opinion of this Court, cert, denied 346 U.S. 814 (1953), unless, as petitioner contends, the average useful life of the tires and tubes which it received was substantially in excess of 1 year when Service put them into use. This possibility is belied by the testimony of Service’s former tire serviceman to the effect that most tires and tubes have a useful life of approximately 1 year.

We therefore hold that on March 1, 1967, the fair market value of the tires and tubes in question was $36,394.67.³

Issue 2

If the useful life of items purchased for use in the production of income is sufficiently brief that the cost of procuring them may be.expensed,⁴ then ordinarily their cost is expensible in a taxable year to the extent the items are actually consumed in operations during that year. Spiegal, May, Stern Co. v. United States, 37 F.2d 988 (Ct. Cl. 1930). A taxpayer engaged in the motor freight transportation business may, however, expense, the cost of tires and tubes purchased for use in its operations before they are consumed, provided the average useful life of the tires and tubes is 1 year or less. See Rev. Rul. 59-249,1959-2 C.B. 55; Rev. Rul. 73:357,1973-2 C.B. 40.

Certain of the tires and tubes whose cost Service expensed were not fully consumed in its operations. Rather they were distributed by Service in liquidation when a substantial portion of' their useful life had not- been exhausted. We must decide if Service recognized income on the distribution of these tires and tubes under the tax benefit rule. We have not addressed ourselves to this issue previously. See Estate of David B. Munter, 63 T.C. 663, 677(1975). .

The tax benefit rule, provides that an item properly offset against gross income in determining. 1 year’s tax liability is in-cludable in gross income when it is recovered in a subsequent year. Alice Phelan Sullivan Corp. v. United States, 381 F.2d 399, 401-402 (Ct. Cl. 1967). Before proceeding to consider whether the rule is applicable in the case now before us we note that so far as can be ascertained from the record, the costs incurred by Service in procuring the tires and tubes which it distributed in liquidation were offset against Service’s gross income in determining its tax liability.⁵

Relying on Commissioner v. South Lake Farms, Inc., 324 F.2d 837, 839-840 (9th Cir. 1963), affg. 36 T.C. 1027 (1961), petitioner contends that Service made no recovery in respect of the tires and tubes which it distributed in liquidation because in actuality it neither received nor became entitled to receive money or property in exchange for them; and that therefore the tax benefit rule is inapplicable in this instance.⁶

In our opinion the understanding of “recovery” upon which the decision of the United States Court of Appeals for the Ninth Circuit in South Lake Farms, Inc., rests is unduly restrictive. It is well established, for example, that an item of expenditure that has been properly accrued but not paid is deemed to be recovered when liability for the item terminates. Bear Manufacturing Co. v. United States, 430 F.2d 152 (7th Cir. 1970), cert. denied 400 U.S. 1021 (1971); Mayfair Minerals, Inc., 56 T.C. 82 (1971), affd. per curiam 456 F.2d 622 (5th Cir. 1972). This leads us to conclude that for purposes of the tax benefit rule, a taxpayer may have recovered an item previously expensed although actually he has neither received nor become entitled to receive money or property. See Estate of William H. Block, 39 B.T.A. 338, 341 (1939), affd. sub nom. Union Trust Co. v. Commissioner, 111 F.2d 60 (7th Cir. 1940).

Service was permitted to expense the cost of the tires and tubes which it purchased, on the assumption that their useful life would be fully exhausted in its operations. Once Service had expensed their cost, the tires and tubes were therefore deemed to have been fully consumed in its operations for purposes of Federal income taxation whatever their fair market value may have been. If, having expensed the cost of the tires and tubes Service subsequently treated them as property having a fair market value in a transaction of consequence in the scheme of Federal income taxation, it would therefore necessarily be deemed to have received tires and tubes identical to them immediately prior to that transaction. Anders v. United States, 462 F.2d 1147, 1149 (Ct. Cl. 1972), cert. denied 409 U.S. 1064 (1972); Spitalny v. United States, 430 F.2d 195, 197-198 (9th Cir. 1970).

When Service was liquidated, among the property which it distributed to petitioner, its sole shareholder, were tires and tubes having a fair market value of $36,394.67. Service had previously expensed the cost of these items. It must therefore be deemed to have received immediately prior to its liquidation, tires and tubes equal in value to those which it distributed.

Service’s receipt of tires and tubes which is deemed to have occurred for purposes of Federal income taxation, was occasioned by its distribution of property in liquidation. Section 336 provides that a corporation shall not recognize gain or loss on the distribution of property in liquidation. The receipt of the tires and tubes, however, is an event of independent significance for purposes of Federal income taxation and is therefore not subject to section 336. Hempt Bros., Inc. v. United States, 490 F.2d 1172, 1180 (3d Cir. 1974).

We therefore hold that under the tax benefit rule Service had to include in gross income on its liquidation the lesser of the fair market value of the tires and tubes which it distributed or the portion of their cost attributable to their useful life remaining at the time of the distribution. Spitalny v. United States, supra at 198; Alice Phelan Sullivan Corp. v. United States, supra.

There is no indication in the record of significant fluctuation in the cost of tires and tubes. In this instance, therefore, the portion of the cost of the tires and tubes attributable to their remaining useful life is equal to their fair market value at the time of the distribution, $36,394.67, and it is that amount which Service had to include in gross income on its liquidation.⁷

At this juncture we would take note of the decision of the Supreme Court in Nash v. United States, 398 U.S. 1 (1970).

Petitioner contends that under Nash an accrual basis corporate taxpayer which provides for bad debt losses with respect to its accounts receivable by maintaining a reserve account would not be required under the tax benefit rule to include the reserve in gross income if it distributed the receivables in liquidation; and that by analogy we are precluded by Nash from applying the tax benefit rule in the case now before us.

In so contending petitioner fails to perceive that Nash presupposes that the fair market value of the receivables distributed equals their net worth, i.e., their face value less the amount in the reserve for bad debt; and that the case now before us is better analogized to the situation in which the fair market value of the receivables exceeds their net worth. Nash implies that in the latter case the reserve would be includable in the gross income of the liquidating corporation to the extent the fair market value of the receivables exceeded their net worth. See 398 U.S. at 4-5. See also Citizens’ Acceptance Corp. v. United States, 462 F.2d 751, 756-757 (3d Cir. 1972). Our holding in the case now before us is therefore wholly consistent with Nash.

Decision will be entered under Rule 155.

Reviewed by the Court.

2 All statutory references are to the Internal Revenue Code of 1954', as amended, unless otherwise indicated.

3 All outstanding issues of fair market value having been resolved, petitioner’s basis in the various assets which it received on the liquidation of Service may be computed under Rule 155, Tax Court Rules of Practice and Procedure.

Respondent concedes that, petitioner is entitled to deduct on the consolidated return filed for 1967 the basis allocated to the tires and tubes.

4 See sec. 1.446-l(a)(4)(ii), Income Tax Regs.

5 Certainly the burden of proving the contrary, would be upon petitioner. Welch v. Helvering, 290 U.S. 111 (1933).

6 In deciding South Lake Farms, Inc., 36 T.C. 1027 (1961), this Court did not address itself to the issue of whether there had been a recovery for purposes of the tax benefit rule. That issue was dealt with only by the United States Court of Appeals for the Ninth Circuit; and it is on the decision of that court that petitioner relies.

7 Our holding pertains solely to the distribution in liquidation of property whose cost has previously been expensed. We point this out to preclude inapposite analogies to the distribution in liquidation of fully depreciated property. Commissioner v. Anders, 414 F.2d 1283, 1288 (10th Cir. 1969), revg. 48 T.C. 815 (1967), cert. denied 396 U.S. 958 (1969). See also the concurring opinion of Judge Tannenwald in Estate of David B. Munter, 63 T.C. 663, 679-680 (1975).