Stewart v. Commissioner

*87 This proceeding involves a deficiency of $1,087.32 in income tax for the year 1934. It results entirely from respondent's determination that a loss sustained by the petitioner in the liquidation of a debt owing to him does not constitute a bad debt but rather a capital loss, limited by section 117, Revenue Act of 1934.

*88 FINDINGS OF FACT.

The facts are found as stipulated and will be summarized. In September 1928 a corporation of which petitioner owned substantially all of the stock sold under a land sale contract or "contract for deed" approximately 800 acres of*1074 land in Divide County, North Dakota, for $16,000, receiving $2,500 cash and agreeing to give a deed when $6,500 of the purchase price had been paid. In July 1929 petitioner acquired at a cost of $13,500 the interest of the corporation in that contract. At that time one $1,000 payment was overdue and a total of $12,500 was payable in installments on December 1, 1930, through December 1, 1934. No payments were made to petitioner up to 1934. In the spring of 1934 the purchaser applied for a loan to the Divide County National Farm Loan Association and was given a commitment for a loan of $8,800 to be procured through the Federal Land Bank and the Land Bank Commissioner. The commitment was subject to obtaining scale-downs of the purchaser's indebtedness, as stated in the following excerpts from a letter from the association to petitioner dated August 24, 1934:

Due to the requirements by the Federal Land Bank and the financial condition of the [sic] Mr. Stuart [the purchaser] it has taken considerable time and work to take up the necessary scale down matters with the various creditors. However, we have now at last obtained scale downs and we submit a statement of payments, *1075 debts, and scale downs as we have been able to get them to agree on at this time.

* * *

* * * But before we take it up with the Federal Land Bank we want to refer the matter to you to find out if you will be willing to deed the land over to Mr. Stuart and cancel your claim against him for the available proceeds which the work sheet shows will be approximately $1873.89.

At the bottom of the work sheet you will find a statement regarding the taxes. The County Commissioners have recommended a 10% cut in the taxes but 10% cut recommended by our County Commissioners has to be approved by the State Tax Commissioner and the recommendation by the County Commissioner has already gone to the State Tax Commissioner. Mr. Stuart owned [sic] personal property taxes from 1924 and his real estate taxes are due beginning with the year 1928 so unless the taxes are paid either by you or from the loan proceeds the County will soon take action to call for Tax Deed on the land.

As we presume you know that Mr. Stuart has no crop at all this year and his livestock which is so mortgaged to the limit will, that is most of them, have to be shipped out for lack of feed to carry them through*1076 the winter.

When you have digested the enclosed work sheet kindly then advise us whether you think you can accept the available proceeds and if so we can proceed and close the Stuart Federal Land Bank Loan matter.

The attached work sheet showed debts to others of $4,404.83 scaled down to $1,212.83, which would be paid from the proceeds of the *89 loan, in addition to the $1,873.89 which would be paid to petitioner. Personal and real estate taxes in the amount of $4,789.20 would be discharged. Debts of $2,731.82 would remain outstanding.

Petitioner replied by letter to the association on August 27, 1934, as follows:

I have your letter of the 24th in regard to Mr. Stuart's application for Federal Land Bank loan and have checked over the Company statement carefully.

The closing of the loan on this basis means a very substantial loss to me, but on account of Mr. Stuart's whole indebtedness and the condition of farm operations in that country, I have decided to accept the closing of the loan on a basis of the statement you have sent me.

I hope this loan can be closed in the very near future and that I will receive the proceeds for the balance of contract, approximately*1077 $1,874.00, in the very near future.

On October 31, 1934, the following notification was received by petitioner from the association:

We have now reached the closing stage in the T. S. Stuart Federal loan and we are in position to remit the full statement according to the set-up sent you some time ago, namely $1873.89.

* * *

For the $1873.89 we inclose orders for Shipment of Bonds, valued at $1824.89, and we inclose check for $49.00. * * *

In all cases where a deed is involved in a Federal loan, the Federal Land Bank required [sic] that a receipt for full payment be signed by the sellers of the land. We inclose this receipt and you and your wife sign same, have it dated, and witnessed and then return to us promptly with the enclosed bond orders.

On November 5, 1934, petitioner accepted the bonds. Until the letter of October 31, 1934, he thought he was going to receive cash rather than bonds in settlement of the indebtedness due him.

Petitioner ascertained the unpaid balance of the indebtedness, $11,626.11, to be worthless in the taxable year, and claimed it as a deduction on his income tax return. Respondent has filed no brief.

OPINION.

OPPER: The issue*1078 is whether the transaction by which petitioner canceled the land sale indebtedness, relinquished his interest in the property, and received Federal Farm Loan bonds in a lesser amount than the face value of the debt, was a sale or exchange of capital assets on the one hand or is to be treated as the payment of a partially worthless debt on the other. Respondent does not contend that the indebtedness was partially worthless when acquired by petitioner or that it became worthless prior to the taxable year, so that the only question is whether petitioner is entitled to a deduction for the full amount of *90 his loss as a bad debt or only to the limited deduction allowable if the transaction is a sale or exchange.

The situation of the parties prior to the surrender of the claim and conveyance of the property by the petitioner seems to be comparable in all respects to the case of a sale of property for a consideration consisting of notes secured by a purchase money mortgage. Roby v. Bismarck National Bank,4 N.D. 156; *1079 59 N.W. 719, 720; Ferguson v. Blood,152 Fed. 98, 103. Petitioner's predecessor had made a contract to sell the property in consideration of the purchaser's agreement to pay the purchase price in installments. This resulted in the purchaser obtaining equitable title (Woodward v. McCollum,16 N.D. 42; 111 N.W. 623, 626; see Vail v. Evesmith (N.D., 1932), 241 N.W. 719, 721), being liable to the vendor on the contract, and leaving the vendor with legal title to the property or a vendor's lien thereon as security for payment. Johnston Land Co. v. Whipple (N.D. 1930), 234 N.W. 59; Comp. Laws N.D. 1913, §§ 6861, 6720, 6721. And petitioner's acquisition of the debt carried with it the vendor's title held as security. Roby v. Bismarck National Bank, supra.

Had the purchaser surrendered his interest in the land or reconveyed it to the vendor in exchange for a cancellation of the debt, the transaction would have been regarded as a sale or exchange of capital assets. *1080 Betty Rogers,37 B.T.A. 897; Harry Payne Bingham,38 B.T.A. 913. Here, however, the process was reversed. There was no reacquisition of the property by the vendor. Rather, he relinquished all of his claim to the property by conveying legal title to the purchaser, who already held equitable title. And he canceled part of the indebtedness in consideration of a payment of the remainder on behalf of the purchaser. From this standpoint it seems to us that the transaction was purely in the nature of a partial payment of an indebtedness. See Harold S. Denniston,37 B.T.A. 834, 837. The result was not the sale or exchange of the legal title for the partial payment. It was the mere release of the property as security for the obligation, as in the Denniston case, the mere completion of the conveyance which had been initiated by the contract. And the cancellation of the debt in return for a partial payment could not be said to be a sale or exchange since, to quote from Hale v. Helvering, 85 Fed.(2d) 819, affirming *1081 32 B.T.A. 356:

* * * Neither business men nor lawyers call the compromise of a note a sale to the maker. In point of law and in legal parlance property in the notes as capital assets was extinguished, not sold. In business parlance the transaction was a settlement and the notes were turned over to the maker, not sold to him. In John H. Watson, Jr., v. Commissioner of Internal Revenue,27 B.T.A. 463, overruling Henry P. Werner v. Commissioner of Internal Revenue,15 B.T.A. 482, *91 it was held that the payment at maturity, of the face amount of bonds purchased at a premium, was not a sale or exchange resulting in a capital loss. If the full satisfaction of an obligation does not constitute a sale or exchange, neither does partial satisfaction. * * *

Nor can we question that the canceled portion of the debt was worthless in view of the facts that the debtor had other obligations of a substantial character; that the real property was evidently worth considerably less than the amount of the claim; and particularly that to the extent the indebtedness was actually reduced it was a condition of the intervention of the*1082 Federal Land Bank, from which apparently the only assistance could be procured. Had a note been given for the unpaid balance, to be later written off as worthless, as in Harold S. Denniston, supra, that formality would but have detracted from the convincing proof of worthlessness in the present proceeding. This proof is reinforced by the fact that petitioner claimed his entire loss on his verified income tax return. See Harold S. Denniston, supra, p. 837; cf. Rufus H. Syfers,22 B.T.A. 736.

It is true that payment was made partly in the form of Federal Farm Mortgage Corporation bonds rather than cash. This seems to us under the present circumstances to be immaterial. It is evident from the statutory authorization and the practice of the Farm Credit Administration thereunder that it was an integral part of the program specified by Congress that payments on account of agricultural indebtedness of this character should be made to a considerable extent in the form of bonds. 12 U.S.C. 723(f), 772, 1016(g); 48 Stat. 346, 347. The choice did not lie with petitioner and it is difficult to see how his situation*1083 was aided or injured by the receipt of readily marketable securities in satisfaction of the debt. Josephine C. Bowen,37 B.T.A. 412, is not authority to the contrary. As we said of that decision in Harold S. Denniston, supra, p. 839, "It does not appear, either, that the taxpayer there claimed any bad debt loss in respect of the balance of the purchase money mortgage, nor was there any discussion of this question." Here, of course, petitioner expressly claims the right to such a deduction, and in fact that is the only issue.

Reviewed by the Board.

Decision will be entered for the petitioner.

LEECH concurs only in the result.