Scruggs v. Commissioner

*1175 In Docket Nos. 33610 and 38711 the petitioners, Gross R. Scruggs and his wife, Marian P. Scruggs, respectively, seek redetermination of deficiencies against each of them for $1,293.17 for the year 1922 and in Docket No. 46270 the petitioner, Scruggs Investment Company, seeks redetermination of deficiencies of $290.70 for 1924 and of $20,107.67 for 1927, and redetermination of net losses for 1925 and 1926 for purposes of deduction in computing net income for 1927.

In the first two proceedings, the petitioners aver that the respondent erred in disallowing certain bad debts as deductions, and in his determination of depreciation allowable to each petitioner. Petitioners*1528 allege that respondent, in arriving at his depreciation allowance, erred in his valuation of certain property belonging to petitioners, as of March 1, 1913. In Docket No. 46270, the Scruggs Investment Company avers that the respondent erred in his determination of profit on the sale in 1927 of property previously acquired by the corporation from petitioners, Gross R. Scruggs and Marian P. Scruggs, and in his determination of the amount of depreciation which petitioner, Scruggs Investment Company, was entitled to deduct in computing its net income for each of the taxable years involved in this proceeding.

In the deficiencies determined against Gross R. Scruggs and wife, Marian P. Scruggs, respondent determined a March 1, 1913, fair market value of land and building involved in this proceeding to be, land, $32,500; building, $152,500, making a total of $185,000, while in the case of the Scruggs Investment Company he determined the value of the same property as of March 1, 1913, to be, land, $75,000; building, $110,000, making a total of $185,000.

At the hearing, respondent amended his answer in Docket Nos. 33610 and 38711, and alleged that his determination of the March 1, 1913, value*1529 of the land at $32,500 and the building at $152,500 was erroneous and that the correct value of said property as of March 1, 1913, was as follows: land, $75,000; building, $110,000. Respondent alleged that this change in valuation would result in a smaller depreciation allowance to petitioners, Gross R. Scruggs and Marian P. Scruggs, than he had allowed in computing the deficiencies asserted against each of them for 1922, and he asked that the deficiencies asserted against each of said petitioners be accordingly increased.

All three petitioners claim that the March 1, 1913, fair market value of said property was, land, $90,000; building, $185,000; total, $275,000. The petitioners further claim that the correct cost of additions made to the building in 1915 was $51,365.56, and not $50,000, as determined by the respondent. Both parties are agreed as to the cost of additions made in 1920. Both parties are also agreed that the transfer of the land and building from petitioners, *1176 Gross R. Scruggs and wife, Marian P. Scruggs, to the petitioner, Scruggs Investment Company, in 1922, for which they took in payment the entire capital stock of the corporation, was a nontaxable*1530 transaction and that in the subsequent sale by the Scruggs Investment Company, the basis for computation of profit, if any, was the March 1, 1913, fair market value of the property, that being admittedly greater than cost. To this March 1, 1913, value is to be added cost of subsequent improvements.

The cases were ordered consolidated for hearing.

FINDINGS OF FACT.

The petitioners, Gross R. Scruggs and Marian P. Scruggs, were during the taxable years and now are husband and wife, residing in Dallas, Tex.

The property in question was community property and all their income for the taxable year was community income. They filed separate income-tax returns for the year 1922, on a community-property property basis.

Petitioners were the owners and operators of a large general and local fire insurance agency in Dallas, Tex., and had in their employ R. P. Caruth and O. F. Rawls. It was petitioners' custom and business policy to pay their employees a fixed monthly salary, plus a commission on business secured by them, payable at the end of the year. R. P. Caruth was petitioners' son-in-law and had been in the employ of the insurance agency for a number of years prior to 1922*1531 as manager of the local city business in Dallas, at a salary of $500 per month and a commission.

Advancements were made to Caruth from time to time by petitioners, upon Caruth's express promise to repay them, and a number of such advances were repaid by Caruth. Caruth was trading in farm lands upon slender capital and also operating a farm, and the advancements were used mainly as payments on lands which he had purchased or in farming operations. Caruth and his wife were divorced November 21, 1921, but he remained in the employ of petitioners' insurance agency for three or four months thereafter and left in 1922, owing the agency operated by petitioners, Gross R. Scruggs and Marian P. Scruggs, the sum of $7,147.55. Some of the items of the account represented advancements which petitioners had made for the direct benefit of their daughter, Caruth's wife, and these items petitioners forgave and no longer claim as indebtedness against Caruth. The amount of the account against Caruth, after the forgiveness of these certain items, was $5,447.65. Both Gross R. Scruggs and the manager of the insurance agency, R. S. Graham, made frequent efforts to get Caruth to pay his indebtedness, *1532 but *1177 without success. They learned that his real estate was mortgaged to full value, that he was insolvent, and that a judgment against him would be uncollectible. The account was ascertained to be worthless and charged off by petitioners in 1922. The account was worthless in 1922 and petitioners have never collected anything therefrom.

O. F. Rawls was a bookkeeper in the local city department of petitioners' insurance agency. He received a salary plus commissions, to be paid or credited at the end of the year if his department showed a profit. A number of advances and loans were made to him by petitioner, Gross R. Scruggs, out of community funds, for the purpose of buying a home. Part of these were repaid, but when Rawls left the employ of the agency in 1920, the balance on the indebtedness was $1,900. Petitioners charged this off as a debt ascertained to be worthless December 30, 1922, and took same as a deduction from their 1922 gross income. However, the following year, 1923, collection of $955.43 was made on said account and petitioners in their amended petition, and at the hearing, claim only $900 as a deduction on account of this debt against Rawls. Petitioners*1533 made numerous efforts to collect this balance, but were unsuccessful. Rawls had no property subject to execution and a judgment against him would have been worthless. The amount of the debt which petitioners now claim against Rawls, to wit, $900, was worthless when charged off in 1922.

In 1910 petitioners, Gross R. Scruggs and wife, Marian P. Scruggs, purchased a lot of ground, 50 by 100 feet, at the corner of Jackson and Browder Streets in Dallas, Tex., for the sum of $32,500, and in that year constructed thereon a one-story and basement reenforced concrete and brick building. In 1912 four stories were added to this building of the same character of construction, and on March 1, 1913, it consisted of a basement and five stories of reenforced concrete and brick. The fair market value of the building on March 1, 1913, was $120,000, and of the land was $90,000, or a total fair market value of $210,000 for the land and building.

During the year 1915 petitioners, Gross R. Scruggs and wife, Marian P. Scruggs, added three stories to the building at a cost of $50,000, and in 1920 three more stories were added at a cost of $98,702.01. This building is known in Dallas as the "Insurance*1534 Building" and will hereafter be referred to by that name.

On December 1, 1922, petitioners, Gross R. Scruggs and wife, Marian P. Scruggs, conveyed the lot and building to the petitioner, Scruggs Investment Company, subject to a mortgage of $300,000, in consideration of $199,400 of the capital stock of the latter, which was its entire capital stock, except qualifying shares.

*1178 The property was sold by the petitioner, Scruggs Investment Company, to the Great States Insurance Company on May 15, 1927, for $425,000. It was stipulated at the hearing that a reasonable and proper rate of depreciation on said building and the additions thereto was 2 per cent per annum.

OPINION.

BLACK: The issues raised in these consolidated proceedings are entirely of fact and it is unnecessary to review or comment at length on the many authorities cited by counsel. There appears to be no issue of law between petitioners and respondent.

The claims for deduction of the debts of R. P. Caruth, $5,447.55, and O. F. Rawls, $900, are involved only in the cases of Gross R. Scruggs and Marian P. Scruggs, Docket Nos. 33610 and 38711. It appears that as to both debtors suits would have availed*1535 nothing. In that sort of a situation, in , the Board said:

With reference to the bad debt claims, it may be pointed out that in two of the cases the money loaned to the debtor was loaned in a generous effort on the part of the petitioner to help a person connected with him in business. The financial condition of such debtor was known by petitioner to be precarious at the time the loan was made and so remained at all times thereafter. Moreover, no suit was filed to collect these claims. However, the money was loaned under a promise to pay; it was not a gift. A suit would have been futile and, with an added outlay for expense. * * *

We believe that the evidence establishes the worthlessness of all those debts in the year in which the deductions were taken, and we therefore hold that for the year 1922 petitioner is entitled to deduct from gross income the following amounts * * *.

See also . We think that petitioners are entitled to the bad debt deductions claimed in their amended petitions, and respondent should allow such deductions in recomputing the deficiencies against petitioners, *1536 Gross R. Scruggs and Marian P. Scruggs.

The remaining issue to be discussed is the March 1, 1913, fair market value of the land and building known as the Insurance Building, located at Jackson and Browder Streets, Dallas, Tex., which was an office building of reenforced concrete and brick, 50 by 100 feet and having a basement and five stories.

As has already been stated in our findings of fact, we have found that the March 1, 1913, value of the land was $90,000. We believe this valuation is supported by the weight of the evidence. The evidence shows that beginning around July 1, 1912, two of the leading real estate firms in the city of Dallas began taking options on real estate in the vicinity of the Insurance Building. The purpose of *1179 securing these options was to secure land for the terminal of the Electric Railway Company, an extensive interurban system running into Dallas. Such purpose was not known to the public at that time, but became known prior to March 1, 1913, and there was great activity in the real estate market in that vicinity and all property located thereabout greatly increased in value. It was definitely known prior to March 1, 1913, that the*1537 interurban station and office building would be erected on land situated near the Insurance Building, and that Browder Street, adjoining the Insurance Building, would be opened through. All this added greatly to the value of the real estate in question and we think the valuation of $90,000 for the land as of March 1, 1913, as claimed by petitioners, is supported by the weight of the evidence.

Relative to the fair market value of the building, there is a wide difference of opinion between the expert witnesses who testified, ranging from $120,000, as fixed by the expert witness who testified for respondent, to $185,000, as testified by the expert witnesses for petitioners. After carefully weighing all the evidence, we have found the March 1, 1913, value of the building to be $120,000.

On July 6, 1912, petitioners, Gross R. Scruggs and wife, Marian P. Scruggs, gave Murphy and Bolanz an option to sell the land and building for $185,000. On October 13, 1913, the petitioners executed a lease on said premises to Shuttle Bros. & Lewis, for a period of 25 years, at a gross rental of $1,200 per month or $14,400 per annum. The lease provided that the lessors, the said petitioners, were*1538 to bear the ordinary operating expenses of the building, such as taxes, insurance, etc. The lease contained a clause which reads:

Clause (5): In case of total destruction of the building on the leased premises by fire, or tornado, during the first twenty years of this lease, lessor shall forthwith rebuild at their own expense, constructing five or more stories and basement under this lease; but if a building is constructed costing more than the present building, lessees rent for the basement and first five floors shall be increased, but in proportion only to the difference between the cost of constructing the present building ($100,000.00) plus the present value of the land ($75,000.00) and the then cost of constructing a building of the same size as the present building of the material or construction actually used, plus the present value of the land.

Petitioners introduced several expert witnesses, who testified that the building had approximately 375,000 cubic feet of office space on March 1, 1913, and that the cost of similar construction as of that date was approximately 50 cents per cubic foot, and that, based on these figures, the value of the building on March 1, 1913, was*1539 $185,000. These witnesses also testified that the cost of construction of first-class office buildings in Dallas, Tex., at the time of the hearing in this proceeding, to wit, November 1, 1930, was between 50 and 60 cents per cubic foot, and was about the same as it was in 1913.

*1180 Respondent introduced evidence to show that in 1913 the cost of construction of office buildings such as the one in question was considerably less than it was at the time of the hearing, November 30, 1930, and that the value of the Insurance Building could not have been as high as that fixed by petitioner's witnesses. Respondent's evidence of value of the building appears to more nearly accord with the contemporaneous facts which took place around March 1, 1913, such as the execution by petitioners, on July 1, 1912, of an option to Murphy and Bolanz to sell the land and buildings for $185,000, and the statement in the lease to Shuttles Bros. & Lewis, dated October 13, 1913, that the cost of constructing the building was $100,000. Moreover, the gross rental agreed upon in the lease to Shuttle Bros. & Lewis, was $14,400, and this supports the view that the building did not have a greater value*1540 than $120,000 on March 1, 1913, and the land a value of $90,000. This $14,400 agreed upon in the lease to Shuttle Bros. & Lewis would be a gross return of approximaely 7 per cent on the total amount of the investment, if fixed at the figure of $210,000, whereas all of petitioners' expert witnesses testified that an office building of the kind in question would have to yield a gross return of between 8 and 10 per cent on the investment, in order to yield a fair net return on the owner's capital investment.

The evidence shows that during the year 1913, the year prior to the lease to Shuttle Bros. & Lewis, the gross rentals from the Insurance Building were $18,700. This would be a gross return of slightly less than 9 per cent on the total amount of $210,000, the value of the land and building as of March 1, 1913, which we have fixed from the evidence. So, taking all the evidence into consideration, and giving weight to all elements of value, such as type of building, cost of reproduction, gross return on investment, suitability to the neighborhood in which it is located, and other factors, we think the valuation we have fixed, $90,000 for the land and $120,000 for the building, *1541 is just and reasonable. Cf. , affirming .

The respondent fixed the cost of the addition made in 1915 at $50,000, which petitioners urge should be $51,365.56. Petitioners did not present any itemized or satisfactory account showing those costs. We do not think petitioners have sustained the burden of proof and shown error on respondent's part as to this item and his determination of $50,000 for the addition in 1915 is approved.

The cost of the addition made in 1920 was $98,720.01, as agreed by stipulation.

Depreciation on the building will be allowed to petitioners on the foregoing figures at 2 per cent per annum for each of the taxable *1181 years involved, and the profit of the Scruggs Investment Company resulting from the sale to the Great States Insurance Company in 1927 will be calculated according to the March 1, 1913, value, plus the cost of the two additions, all property depreciated to the date of sale.

Decision will be entered under Rule 50.