Labrot v. Commissioner

*332 These proceedings are for the redetermination of deficiencies in income tax asserted by the respondent for the year 1921 as follows: Sylvester W. Labrot, $12,569.23, and Elizabeth H. Labrot, $11,940.43. The petitioners allege that the respondent, in computing the net income of Labrot & Co., a partnership of which the petitioners were members, erred in disallowing a deduction of $128,561.11, taken on account of a loss claimed to have been sustained from the sale of certain real estate, thereby increasing the distributive shares of the petitioners.

FINDINGS OF FACT.

The petitioners, who are husband and wife, reside at Holly beach Farm, Anne Arundel County, Md. They are, and have been for more than twenty years, members of a partnership known as Labrot & Co., each of them owning a 50 per cent interest therein. The partnership was formed for the purpose of holding all of the property belonging to the petitioners.

About the*2079 year 1907 the partnership of Labrot & Co., began to acquire farm land near Annapolis, Md. Prior to March 1, 1913, ti *333 purchased for $64,806.81, a number of parcels or tracts of land ranging in size from 30 acres to 205 acres, which together formed a single tract of 550 acres, hereinafter called Holly Beach Farm. In the year 1911 the construction of a new residence on Holly Beach Farm was begun and it was completed in the fall of 1913 at a cost of $89,621.63. In the years 1913, 1914, and 1915, garden houses, greenhouses, fences, gates, silos, windmills, and an irrigation system were construced at a total cost of $14,919.74. In the latter part of the year 1920 and the early part of 1921, barns, garages, and a dairy were constructed at a cost of $26,095.20. The total cost of the farm and improvements to the partnership was $195,443.38.

In the year 1920 the partnership purchased a farm known as the Tryall Farm, for $65,098. This farm contained about 450 acres of land. It was contiguous to the Holly Beach Farm and together they comprised a single tract of about 1,000 acres. The two farms were operated by the partnership as a single farm, but for convenience were carried*2080 on the books as two separate units.

On July 8, 1921, a corporation, Labrot & Co., Inc., was organized by the petitioners under the laws of Maryland for the purpose of taking over and holding the real estate owned by the partnership of Labrot & Co. On July 20, 1921, subscriptions were received by the corporation for 500 shares of its capital stock at $500 per share, as follows:

On the same day the subscriptions were formally approved and accepted by the corporation, and the stock was formally issued to the subscribers and receipts given therefor. The partnership of Labrot & Co. was in fact the subscriber to and the owner of said shares of the capital stock of the corporation.

The subscriptions for said 500 shares of the capital stock of the corporation were entered on the capital stock account of the corporation as of July 26, 1921, and, as of the same day, the subscribers were charged with the amount of their subscriptions on their accounts on the corporation's books. On the same day the subscribers were credited on the*2081 books of the corporation with cash in the amount of $86,440.53, which represented a check for $80,000 payable to the corporation and drawn by the partnership on the National *334 City Bank of New York and a balance of $6,440.43 then standing to the credit of the partnership with the Riggs National Bank of Washington.

On July 26, 1921, the corporation received from the partnership an offer in writing to sell to the corporation the Holly Beach Farm for $75,000 and the Tryall Farm for $55,000, and on the same day the corporation by formal resolution accepted the offer. The corporation paid the partnership $75,000 for the Holly Beach Farm with a check for that amount apparently drawn on the Riggs National Bank of Washington. The corporation also paid to the partnership $5,000 on account of the Tryall Farm by check drawn on the Riggs National Bank of Washington, and the remainder of the purchase price of the Tryall Farm was credited on the indebtedness of the petitioners to the corporation, which indebtedness, as above set forth, was on account of the capital stock of the corporation issued to the petitioners.

The partnership of Labrot & Co., in computing its net income for*2082 1921, deducted the amount of $128,561.11 as a loss sustained on the sale of Holly Beach Farm and the Tryall Farm to Labrot & Co. The respondent disallowed the deduction and increased the petitioners' distributive shares of the partnership income accordingly, and determined deficiencies in tax as above set forth.

OPINION.

MARQUETTE: It is the contention of the petitioners that in 1921 the partnership of Labrot & Co. sold to Labrot & Co., Inc., a corporation, for $130,000, two farms which had a cost to the partnership, or a fair market value on March 1, 1913, of $258,561.11, and that the partnership thereby sustained a loss of $128,561.11, which should be deducted in computing its net income for 1921.

The respondent denies that the partnership sustained a deductible loss and urges (1) that the transaction was not bona fide, and (2) that if it was bona fide it was not a sale for cash but was an exchange of property for the capital stock of the corporation and did not give rise to gain or loss. The respondent also takes the position that under no circumstances can the partnership deduct any loss on account of the sale of the residence on Holly Beach Farm.

We do not deem it*2083 necessary in disposing of this case to discuss and decide all of the contentions made by the parties. We rest our decision on the single ground that under the Revenue Act of 1921 the transaction between the partnership and the corporation was one that could not result in either a taxable gain or a deductible loss. Section 202(c)(3) of that Act, provides:

*335 (c) For the purposes of this title, on an exchange of property, real, personal, or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized -

* * *

(3) When (A) a person transfers any property, real, personal, or mixed, to a corporation, and immediately after the transfer is in control of such corporation, or (B) two or more persons transfer any such property to a corporation, and immediately after the transfer are in control of such corporation, and the amounts of stock, securities, or both, received by such persons are in substantially the same proportion as their interests in the property before such*2084 transfer. For the purposes of this paragraph, a person is, or two or more persons are, "in control" of a corporation when owning at least 80 per centum of the voting stock and at least 80 per centrum of the total number of shares of all other classes of stock of the corporation.

The form of the transaction under consideration is that the partnership, desiring to have its real estate held and operated under corporate form, organized a corporation, subscribed for the capital stock to the extent of $250,000, and paid therefor cash to the extent of $86,640.53. The corporation on the same day purchased from the partnership two farms for $130,000 and paid to the partnership to the extent of $80,000, the same money that the partnership had paid to the corporation for stock. The balance of the $130,000 which the corporation agreed to pay the partnership for the farms was represented by a credit to the partnership on its outstanding indebtedness to the corporation on account of the capital stock for which it had subscribed. The substance of the transaction is that the partnership exchanged the farms for stock of the corporation, and that after the exchange the partnership was in control*2085 of the corporation, as the word control is used in the section of the statute just quoted. We are of opinion that the transaction is essentially one of the kind in which Congress did not intend for the purposes of taxation to recognize either gain or loss, and that we should be governed by its substance and not by its form. The individuals composing the partnership were, after the conveyance, in reality in no different position than they were before. The money that they had expended for the capital stock of the corporation was returned to them and the farms were still within their control, and they could reacquire them at any time by the simple method of dissolving the corporation and taking over its assets. We are constrained to hold that the partnership did not suffer any deductible loss.

Judgment will be entered for the respondent.