Biscayne Trust Co. v. Commissioner

*1016 The two proceedings have been consolidated for hearing and decision and the deficiencies in income taxes as proposed by respondent are*2543 as follows:

Petitioner assigns the following errors in respondent's final determination:

(1) The inclusion in income for 1921 of the amount of $7,700 as profit realized upon an exchange for real estate in 1921;

(2) The inclusion in income for 1923 of the amounts of $16,950 and $8,850 as profits realized upon two exchanges of real estate in that year and also the amount of $22,500 as profit realized upon an exchange of a lease for certain unimproved lots;

(3) The disallowance of deductions in the amounts of $1,372.62 for 1921, $980.71 for 1922, and $919.61 for 1923, which was the cost in each of those years of maintenance are care of certain property known as "Whispering Pines," held as an investment; and

(4) The disallowance of deductions in the amounts of $200 for $1921; $200 for 1922, and $138.33 for 1923, as depreciation sustained upon the caretaker's house on the Whispering Pines property.

The entire deficiency is not in dispute and no issues have been raised relative to the year 1920.

FINDINGS OF FACT.

The petitioner*2544 is a Florida corporation with its principal office at Miami. As executor of the estate of Phillip Ullendorff, deceased, the petitioner seeks a redetermination of Ullendorff's income taxes for the years here involved.

Phillip Ullendorff conducted a retail and wholesale meat market in Miami for several years prior to 1913, at which time he discontinued the retail meat business. In 1918 he sold his wholesale meat business to Armour & Co. because his health was failing. In about 1911 or 1912 Ullendorff began investing his earnings in real estate. From that time until his death in September, 1923, he purchased and exchanged various pieces of real estate as investments, either for rentals or for future enhancement in value.

Ullendorff and W. H. Nichols, also an investor in Miami real estate, organized, in 1920, the Nichols-Ullendorff Realty Co., a Florida corporation. Each owned 50 per cent of the authorized capital stock of $100,000 par value, and Ullendorff was president of the corporation *1017 until his death. The corporation owned certain properties for investment purposes only and did not buy and sell for any one. Neither the corporation nor Ullendorff obtained the*2545 necessary state, city and county licenses required for doing business as real estate dealers or brokers. In December, 1922, A. D. Calkins was employed by the corporation to keep its books, collect rents and look after its property. Ullendorff also employed Calkins to keep his individual books, collect the rents on his property, and take care of his property as to repairs, etc. One office was occupied by the corporation, Nichols and Ullendorff, but neither of the latter two went to the office very often. Calkins' services were necessary because of Ullendorff's poor health.

From 1921 until his death, Ullendorff was in very bad health. He spent the winters in Miami, but spent his summers in sanitariums or hospitals. From 1918 until his death, Ullendorff engaged in no business except looking after his real estate investments and making occasional purchases and exchange of real estate for investment. He kept posted as to real estate values in Miami and during the years in question made several exchanges of property, some for the purpose of relieving himself of the necessity of paying off or refinancing a mortgage becoming due and some with the hope that the property acquired in*2546 the exchange would prove to be a better investment in respect to future enhancement in value.

On March 17, 1913, Ullendorff purchased lots 5 and 6, block 98, Lawrence Estate, for $800. On March 31, 1917, he purchased lots 11-12-13-14, block 91, Lawrence Estate, for $2,000. On March 23, 1921, he exchanged those six lots for lot 15, block 98 N., and assumed a mortgage in the amount of $27,500 upon the latter property, on which a 10 or 12-room house was situated. Lot 15 had been listed for sale with Walter L. Harris, a realtor, for a year prior to the exchange which was negotiated by Harris. In making the exchange no particiular value was placed upon the six lots which were exchanged for whatever equity the owner had in lot 15 and the house thereon. On the date of the exchange in March, 1921, lot 15 and the improvements thereon had a fair value of $30,000 and a readily realizable market value of less than that amount. On the same date the six lots had a value not in excess of $7,750, the aggregate amount for which they sold within the following year. Respondent determined that the six lots had an aggregate value of $10,500 on the date of the exchange; that lot 15 had a value*2547 of that amount in excess of the $27,500 mortgage; and that Ullendorff realized a profit of $7,700, the difference between $2,800, the cost, and $10,500.

The real estate market in Miami was very dull during 1921 and 1922 and began to improve a little in the fall of 1923. The Miami boom started in April, 1924, and reached its peak in July, 1925. *1018 During the taxable years in question the prevailing interest rate on money was 8 per cent and brokerage fees ranged from 8 to 12 per cent. Discount rates on first mortgages ranged from 10 per cent up, depending upon the ratio of the value of the property to the amount of the mortgage.

Ullendorff sold 25 feet of lot 15 for 4,250 prior to 1923, and when the mortgage became due and he could not pay it he effected an exchange on February 13, 1923, of the remainder of lot 15 for lots 54, 55, 56, 57, and 58 in Tatum's Ocean Beach Park. That subdivision is a strip of low and between Biscayne Bay and the ocean. The bay front is a mangrove swamp extending back 150 to 200 feet. The ocean front is higher and covered with a thick growth of palmettos. The only improvement on the property in 1923 and, also, at the present time, was*2548 a road constructed by the county. The subdivision is five miles from the nearest residential property and about 15 miles from Miami. The lots consisted of strips of land 100 feet in width and extending between the bay and the ocean and were so poorly staked off that the location of them was very difficult. At that time the owner of that subdivision was carrying on an unsuccessful campaign for the sale of the lots at a price of $3,500. The lots had a value not in excess of $2,500 and they had no readily realizable market value, that is, those lots could not be readily sold for cash or the equivalent thereof equal to the fair value. Ullendorff acquired them as an investment for the prospective future enhancement in value and still held them for that purpose at the time of his death. The respondent determined that the purpose at the time lot 15 and the improvements was $38,000, that is, the $27,500 mortgage assumed plus $10,500. He deducted from $38,000 the amount of $700 as depreciation sustained on the house and $4,250 received for 25 feet of lot 15 which was sold, and determined a net cost of $33,050 to Ullendorff for the remainder of lot 15 exchange for the said lots 54 to*2549 58, inclusive. Respondent determined a value of $50,000 for the said lots 54 to 58, inclusive, and a realized profit of $16,950 upon the exchange made.

On April 30, 1921, Ullendorff acquired as an investment lots 2 and 3, block 12, South, Miami, for the consideration of $36,150. Those lots on Flagler Street between 4th and 5th, were about five blocks and across the railroad tracks and the river from the main business corner of Miami. In 1921 that location was outside of the business district. There were a few houses in that location and Ullendorff derived rentals from a small two-story frame building situated on one of the said lots.

On January 2, 1923, Ullendorff exchanged lots 2 and 3, block 12, for property known as Gautier Villa and he assumed mortgages thereon amounting to $55,000. Gautier Villa was a 10-room coccina *1019 rock dwelling situated on a lot 70 by 100 feet at the corner of Second Street and Second Avenue, Miami. The house needed a new roof and was in such a state of disrepair that Ullendorff could not rent the place after he acquired it. Walter L. Harris, realtor, had the property listed for sale for almost a year prior to the time he effected*2550 the said exchange in January, 1923. The value of Gautier Villa was $75,000 on that date, but its readily realizable market value was between $55,000 and $60,000. Ullendorff still held that property as an investment at the time of his death. Judge Gautier, the owner of the property, placed an exchange value of $100,000 on the property and on that basis the respondent determined that Ullendorff acquired an equity of $45,000 in exchange for his lots which had cost $36,150 and that he realized a profit of $8,850 on the exchange.

On April 1, 1919, Ullendorff acquired a lease known as the Dill lease. No consideration was paid therefor other than the regular rental. On February 21, 1923, Ullendorff exchanged that lease for lots 47, 48, and 49 in Tatum's Ocean Bay Park. Those lots were held as an investment at the time of Ullendorff's death. All the lots in that subdivision were of the same relative value, which was $2,500, as stated above. Those lots had no readily realizable market value. Respondent placed a value of $22,500 on the three lots and determined that Ullendorff realized a profit in that amount.

During 1920 Ullendorff acquired, as an investment, a piece of property*2551 known as Whispering Pines. The property was about one quarter of a mile outside of the limits of the City of Miami and was located in a subdivision of large estates. At the time it was acquired by Ullendorff it was planted with trees and shrubbery which required constant attention and care. Ullendorff erected a caretaker's house, which was completed in December, 1921, at a cost of $4,419.55. There was expended by Ullendorff for upkeep, maintenance and care of Whispering Pines during the years 1921, 1922, and 1923, the amounts of $1,372.62, $980.71, and $919.61, respectively. Those amounts were not expended for improvements, but solely for the purpose of maintenance.

The caretaker's house was the customary type of frame bungalow erected in the vicinity of Miami. There was no basement but the foundation was of concrete blocks, the lumber was pine and the roof was composition. The air at Miami is heavily laden with salt, which atmospheric condition cuts off the paint and causes what is called dry rot in the timbers of frame houses. It is necessary to paint frame houses every year or two to give them a life of from 15 to 25 years. The useful life of the bungalow on Whispering*2552 Pines was 20 years.

*1020 Ullendorff deducted on his returns the amounts above stated as expenditures on the maintenance of Whispering Pines and he also deducted as depreciation sustained on the caretaker's bungalow the amounts of $200 for 1921, $200 for 1922, and $138.33 for 1923. Respondent disallowed all of those claimed deductions on the ground that Whispering Pines was purchased for the purpose of erecting a residence for his own use and that the expenses were personal expenditures and not deductible.

OPINION.

TRUSSELL: Petitioner contends that Ullendorff derived no taxable gain from the several exchanges of property as set forth in the findings of fact and relies upon the provisions of section 202(c) of the Revenue Act of 1921 and articles 1564 and 1566 of Regulations 62.

Section 202(c)(1) of the Revenue Act of 1921, provides:

(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*2553 shall be recognized -

(1) When any such property held for investment, or for productive use in trade or business (not including stock-in-trade or other property held primarily for sale), is exchanged for property of a like kind or use; * * * (Italics ours.)

Article 1566 of Regulations 62 provides in part:

(a) * * * The words "like kind" are defined as having reference to the nature or character of the property and not its grade or quality. Therefore under this paragraph no gain or loss is realized by one other than a dealer from the exchange of real estate for real estate * * *. The fact that any real estate involved in an exchange is improved or unimproved makes no difference, for such facts relate only to grade or quality of the property and not to its kind or class. There is excluded from the provisions of this paragraph stock-in-trade or other property held primarily for sale. Unproductive real estate held by one other than a dealer, for future use or future realization of the increment in value, is held for investment and not primarily for sale.

Under the provisions of section 202(c)(1) of the Revenue Act of 1921 and the regulations applicable thereto, there*2554 is no question that each exchange set forth in the findings was an exchange of property for other like property, except for the exchange of the socalled Dill lease for unimproved real property. It is not necessary to determine whether the lease was exchanged for other for other like property and we do not pass on that question.

The record establishes that Phillip Ullendorff, now deceased, was never a real estate dealer or broker. He never secured the licenses *1021 which Florida real estate dealers are required to have. He engaged in the meat market business until 1918 when his health failed. From about 1911 or 1912 he had been investing in real estate and after he lost his health he engaged in no business except that of managing his own property and investments. From time to time he made deals in real estate purely as an investor with the hope of realizing future increment in value. During 1922 and 1923 Ullendorff was in such poor health that it was necessary for him to employ A. D. Calkins to keep accounts of rentals as well as collect them and to take care of repairs, etc., on property owned by him and held for investment.

During the years in question, as well*2555 as the preceding years, Ullendorff held his real estate for investment and certain properties, set out in detail in the findings of fact, were exchanged for other like property for investment. We are of the opinion that no gain or loss should be recognized upon those three exchanges of real estate. The respondent erred in including in Ullendorff's gross income the amount of $7,700 for 1921 and the amounts of $16,950 and $8,850 for 1923 as profits realized upon the respective exchanges made in those years. Cf. .

In 1919 Ullendorff acquired a lease known as Dill lease. No consideration was paid therefor other than the regular rentals. On February 21, 1923, he exchanged that lease for lots 47, 48, and 49 in Tatum's Ocean Bay Park. The uncontradicted testimony of a real estate dealer, well qualified to testify as to real estate values in and around Miami, establishes that lots in Tatum's Ocean Bay Park had no readily realizable market value. The individual lots could not be located because they were very poorly staked out, the land was low and swampy and there were no improvements such as streets, lights, gas, etc. The land was covered*2556 with a thick growth of mangrove and palmettos. The Miami boom did not start until April, 1924, and in February, 1923, when Ullendorff acquired the three lots they had no market value. We are of the opinion that Ullendorff realized no taxable gain upon the said exchange within the meaning of section 202(c) of the Revenue Act of 1921, above quoted, and article 1564, Regulations 62, which provides:

ART. 1564. Exchange of property. - Gain or loss arising from the acquisition and subsequent disposition of property is realized only when as the result of a transaction between the owner and another person the property is converted into other property (a) that is essentially different from the property disposed of, and (b) that has a readily realizable market value. Property has a readily realizable market value if it can be readily converted into an amount of cash or its equivalent substantially equal to the fair value of the property. In other words, the property received in exchange must be readily marketable at substantially its fair value in order that a gain or loss be recognized. Property which is regularly traded in in a public market has a readily realizable *1022 *2557 market value in the quantities regularly traded in. Property may be salable, as in the case of a forced sale or in exceptional quantities, without having a readily realizable market value. Stock in a close corporation may or may not have a readily realizable market value, depending upon all the facts in each particular case. The question whether property has a readily realizable market value, and if so the amount thereof, is one of fact to be determined in each case in the light of all the surrounding circumstances; and attention should be called in the return to each exchange effected during the taxable year about which there could be any doubt.

During 1920 Ullendorff acquired, as an investment, a piece of property known as Whispering Pines. To maintain the value of the property it was necessary for Ullendorff to expend $1,372.62 during 1921, $980.71 during 1922, and $919.61 during 1923, for its upkeep, care and maintenance. The trees and shrubbery planted on the property at the time he acquired it needed the constant care and attention of a caretaker. Those amounts were not expended for improvements on the property, nor were they personal expenses as determined by respondent. *2558 The said amounts expended in the said years were ordinary and necessary expenses incurred in a trade or business and as such are proper deductions from gross income in each of the respective years under section 214(a)(1) of the Revenue Act of 1921.

Whispering Pines was located in a subdivision of large estates and it was necessary for Ullendorff to erect on the property a house for the caretaker to live in so that he could give constant attention to the care and maintenance of the property. The construction of the caretaker's house was completed in December, 1921, at a cost of $4,419.55. We have found as a fact that the frame bungalow had a useful life of 20 years and accordingly a deduction for depreciation should be allowed at the rate of 5 per cent for each of the years 1922 and 1923, under section 214(a)(8) of the Revenue Act of 1921.

Judgment will be entered under Rule 50.