Fell v. Commissioner

*81 The Commissioner determined a deficiency in income taxes for the calendar year 1919 amounting to $1,882.71. The petitioner abandoned assignments of error in respect to an additional assessment for the year 1920.

The petitioner contains the following*2130 assignments of error in respect to the year remaining in controversy: (a) Disallowance in 1919 of a deduction from gross income of $7,000, representing a bad debt or loss resulting from a loan of $20,000 to the McKnight Realty Co.; (b) increasing taxable net income for 1919 by $10,115 *82 on account of an alleged gain from the sale of certain securities acquired in 1914.

FINDINGS OF FACT.

The petitioner is an individual residing at New York City.

In 1911 he entered into negotiations with the McKnight Realty Co. for the sale for them of preferred stock and mortgage bonds. Pursuant to such negotiation, the petitioner sold certain of the securities and in compensation for his services he received certain preferred stock and mortgage bonds of the McKnight Realty Co. In 1913 the petitioner returned from London where he had been staying for some time and found that the company had been borrowing money and obtaining the loans by paying a 10 per cent bonus in addition to 6 per cent interest. In order to relieve the company of the necessity of paying a bonus he agreed to lend it money at 6 per cent.

The company accepted such offer and thereafter the petitioner loaned it*2131 $20,000, which was evidenced by a note. The note was dated November 10, 1913, payable 10 days after demand and specified certain securities which were pledged as collateral. In March, 1914, there was a change made in the collateral and after such change the collateral held was as follows:

30 shares of the capital stock of First National Bank of Seabright.

3 shares Little Farms Associates.

3 shares Flushing Terrace Realty Co.

170 shares of Steinway Park Realty Co.

$20,000 par value first mortgage bonds of the McKnight Realty Co.

On March 31, 1914, the petitioner demanded payment of the note. Payment not being made, on July 25, 1914, all the collateral securities then held by the petitioner under such collateral note, were offered for sale at public auction. The petitioner, the only bidder, bid $10 and secured all of the stocks and bonds at that bid. The bid was made by the petitioner in this small amount because the auctioneer's commission was based on the amount of the sale. The fair market value on July 25, 1914, of these securities was greatly in excess of $10. The petitioner believed they were worth $20,000 at the time. His valuation was based on the fact*2132 that he thought the bonds were worth their face value, and in the event that they were not worth their face value the other collateral would make up the deficiency. None of the securities was quoted on an exchange.

On November 18, 1916, judgment of foreclosure and sale was entered against the McKnight Realty Co. and others, in an action brought to foreclose the mortgage given to secure the bonds of the company. Pursuant to such judgment, the property was sold and bought in on behalf of one of the bondholders for an amount insufficient *83 to pay the debts of the mortgagor. The petitioner obtained his share of the amount realized. At the time of the sale the petitioner was a director and vice president of the McKnight Realty Co. and was familiar with its affairs. He had been actively connected with the company since January, 1912. The real estate market had been depressed since 1910 and endured a depression lasting over a long period of years. After the foreclosure sale the petitioner looked solely to the securities which he had purchased as the possible source from which to realize the amount of the $20,000 note.

On May 7, 1917, the petitioner sold the stock of*2133 the First National Bank of Seabright for $2,999.40. He had always considered this stock to be worth par.

On June 15, 1917, he received from the trustee the sum of $8,100 as a single and final payment on the principal and interest of the McKnight bonds.

On October 14, 1919, he sold the Steinway stock for $2,125.

On October 18, 1921, the petitioner received $450 as a liquidating dividend on the Flushing Terrace Realty Co. stock. He had never known the value of this stock. On January 9, 1928, he received a final dividend in liquidation of the company amounting to $91.78.

He still held the Little Farms Associates stock on October 22, 1928. He never thought it had any value.

In making out his 1919 return, although the petitioner had never placed the note of the McKnight Realty Co. on his books and, therefore, had never charged off the amount of such note, he deducted a loss of $7,000 on account of the unpaid amount of the note. The Commissioner disallowed this loss and increased taxable income for 19 9 in the amount of $10,115, which represented the total amount realized from the McKnight Realty Co. bonds and Steinway Park Realty Co. stock less the auction-bid price*2134 of $10 for the securities in 1914.

OPINION.

LITTLETON: When the petitioner made a loan of $20,000 to the McKnight Realty Co., he did not acquire the securities which were pledged as collateral; what he received was a promissory note of $20,000 and the securities remained the property of the corporation. The petitioner actually came into ownership of the securities in 1914 when there was a default on the note and the securities were bid in by the petitioner at an auction sale for an amount less than the face value of the note. Nor do we think that the auction price bid is representative of a cost of the securities which might be considered as a basis for gain or loss on their future disposition. Apparently, the corporation, and perhaps others, did not bid because they were aware of the amount of the loan for which the securities *84 were pledged as collateral and considered that the petitioner would protect himself on the loan to the extent of the market value of the securities. In this situation the petitioner bid only $10 and, there being no other bid, the auction sale was completed on this basis. The petitioner testified that he bid this small amount since the auctioneer's*2135 commission was based upon the amount of the sale. Apparently, the bid price was merely an amount to cover the auctioneer's commission and, in any event, so long as the bid price was less than the face amount of the note, there would be no occasion for the petitioner to make any new outlay of money on account of his bid other than expenses of the sale. Had there been competitive bidding and had the petitioner bid the property in for less than the face of the note, but for a substantial amount, we do not see that the situation would have been different from what we have here with only a nominal bid other than to the extent the bid price might fix the market value of the securities. Outside of a greater commission in the case of the greater bid price, the petitioner would have paid no more in one instance than in the other. Accordingly, we regard it as unsound to follow the Commissioner's contention that there was a closed transaction in 1914 in which the petitioner sustained a loss of $19,990 - $20,000, amount of note, less $10, auction price - and we are also of the opinion that the $10 is not a cost of the securities which would serve as a starting point for the computation or*2136 gain or loss on account of their future disposition.

We are of the opinion, however, that the market value of the securities when acquired in 1914 should be used as the starting point from which we would compute gain or loss on account of their future disposition. What that value was, we do not know, our only evidence being the statement of the petitioner that he considered them worth the face value of the note, and this we consider as insufficient, but from the fact that when the securities were put up at public auction no bids were received, other than the nominal bid of the petitioner, there is strong reason for considering that their market value was not in excess of the value of the note. And subsequent events as to their disposition tend to confirm such a conclusion. But whether there was a loss in 1914 and, if so, how much, we are not here called upon to determine, for the reason that 1914 is not before us in the consideration of a deficiency for such year. It may well be, as the petitioner points out, that this was not a closed transaction in 1914 in the sense that there was a loss of the difference between the amount loaned, $20,000, plus the amount actually paid to*2137 the auctioneer, and the market value of the securities received, for the reason that we have no evidence as to the cancellation of the note or whether the petitioner might not have recovered further *85 from the corporation on account of any deficiency which might then have existed, but we do not regard this as conclusive in deciding the question before us. What did happen, in so far as we are now concerned, is that in 1914 there was a realization by the petitioner on the note held by him to the extent of the securities then received. Title and unqualified ownership of the securities then came to him, property which he had not theretofore owned, and he got them not because he paid $20,000 therefor at the time, plus the auction-bid price, but because of the rights he then had under a note which he had received in exchange for $20,000 some time prior thereto. The fair market value of the securities in 1914 would not only be the basis upon which this factor would be taken into consideration in determining the extent of the loss then realized, if any, but also would serve as the starting point or cost upon which to compute gain or loss upon their subsequent disposition. Cf. *2138 .

It follows from what we have said that a loss claimed by the petitioner in 1919, on the basis of the difference between the amount of the loan and the amount realized in 1917 and 1919 upon the sale of the greater part of the securities, can not be allowed. The Commissioner not only denied the loss in 1919, but also increased income for such year in the amount of $10,115. The record shows that of the securities received in 1914, petitioner sold only the stock of the Steinway Park Realty Co. in 1919, receiving therefor $2,125, and that the realization on the bonds of the McKnight Realty Co., which the Commissioner included in taxable income for 1919, took place in 1917. The Commissioner admits error in this respect and concedes that the only amount to be taxed in 1919 on account of the sale of these securities is $2,115. Since we do not have evidence as to the fair market value in 1914 of the securities sold in 1919, we are unable to do other than affirm the Commissioner's action in this respect.

Reviewed by the Board.

Judgment will be entered under Rule 50.

ARUNDELL concurs in the result.

MURDOCK, dissenting: I dissent from that part of the opinion which sustains the action of the Commissioner in holding that the petitioner had a gain of $2,115. When all of the circumstances in this case are considered, it is quite apparent that the petitioner has not had any gain, but, on the contrary, has had a loss which he has reduced as far as possible by means of the collateral security which was in his hands.

TRUSSELL agrees with this dissent.