Paladino v. Commissioner

Memorandum Findings of Fact and Opinion

Respondent determined a deficiency of $6,391.50 in petitioner's gift tax liability for the calendar year 1944, the deficiency resulting from respondent's valuation of the gifts, 8 per cent debenture bonds, at their face value rather than at 80 per cent of their face value, the figure which petitioner claims more accurately reflects their fair market value at date of valuation.

Findings of Fact

Petitioner is an individual residing at 589 Minneford Avenue, New York, New York. *160 Her gift tax return for the period here involved was filed with the collector of internal revenue for the third district of New York. On November 1, 1944, petitioner made a gift of $149,500 face amount of 20-year 8 per cent debenture bonds of Gerosa Paladino Holding Corporation to the following donees in the following face amounts:

The Gerosa Paladino Holding Corporation, a New York corporation, was organized in 1926 to buy, sell, and manage real estate. Its capital structure consisted of 6,000 shares of $100 par value common stock issued and outstanding. The stock was held by the following members of the Gerosa and Paladino families in the following amounts:

The balance sheet of the company at April 30, 1944, showed the following

There was no substantial change in the company's assets and liabilities between April 1, 1944, and November 1, 1944. The total income of the company from rents for its fiscal year ended April 30, 1944, was $161,061.93 and the income from interest on mortgages was $11,702.68. Its total profit for said fiscal year before paying interest on its bonds, officers' salaries, corporation taxes, and before charging depreciation, amounted to $118,473.74. After the above deductions the company showed a net loss for the fiscal year 1944*163 of $10,368.12.

The following real estate properties were owned by the company as of November 1, 1944, and comprised the $1,290,584.40 figure attributed on its balance sheet to land and buildings:

*165 The fair market value of the above properties as of November 1, 1944, was substantially less than their book value.

Petitioner on her gift tax return for the calendar year 1944 reported gifts of the above-described debenture bonds in the face amount of $149,500 and valued such gifts at 80 per cent of the face amount on the ground of (1) non-marketability and (2) improbability that the company would have sufficient funds to pay the bonds at maturity. Respondent determined that said bonds were worth their face value on the basis valuation date and computed a deficiency accordingly.

The bonds given by petitioner to the above-described donees on November 1, 1944, had a fair market value on that date of $119,600.

Opinion

ARUNDELL, Judge: Petitioner asks us to find a valuation of 80 per cent of face value for the bonds which comprised her gifts in the year involved instead of the valuation of 100 per cent of face value determined by the respondent.

To ascertain the fair market value of the bonds, absent market quotations or other evidence of sales, we must project ourselves into the position of a hypothetical purchaser under no compulsion to buy. Regulations 108, section 86.19. *166 ¹ The facts that would influence such a purchaser on the basic valuation date are properly determinative here. Among them, we count the priority of lien, the nature and extent of underlying assets, the effective interest yield, the maturity date, the past record of interest payments, the provisions for redemption, the provisions for acceleration in default of interest payments, and the relation of current earnings to the annual interest payable.

*167 Giving the proper weight to each of the above relevant factors, we conclude that there is ample justification for petitioner's valuation of the bonds at 80 per cent of their face value and we have found as a fact that the bonds possessed a fair market value of $119,600 at the date of the gift. We are brought to this conclusion primarily by the security which underlies these bonds. As we have set forth in our Findings of Fact, the bonds are not secured by any mortgage or deed of trust. No sinking fund has been provided. The bondholders can look only to the general assets of the corporation in case of default and must come in along with other general creditors in the event of the corporation's insolvency. While it is true that the corporation's assets at the valuation date appear by their book value to be more than sufficient to discharge the bonds in full, it should be noted that there is nothing to prevent the corporation from giving a first mortgage on such assets or from pledging them as security in any speculative type of venture on which it might subsequently embark. Furthermore, the book value of these assets does not reflect their realizable value if liquidation should become*168 necessary. An officer of the corporation who had been engaged in the real estate business for a number of years testified that these assets were not worth more than 50 per cent of their book value at the valuation date. While his testimony may have been slightly colored by family interest, the facts which were brought out concerning the poor physical nature of the industrial properties and their lack of ready marketability strongly indicate that they were worth considerably less than their stated book value.

The interest rate of 8 per cent on the bonds might appear at first glance to be comparatively high. However, petitioner introduced an expert witness, employed by one of the leading New York brokerage houses specializing in real estate bonds, who testified that the real estate bond market at this time was depressed and that many high-grade real estate bonds, adequately secured by mortgages or deeds of trust, were selling at a discount sufficient to give them effective current yields of from 8 to 12 per cent. In the light of this general market condition and the unsecured nature of petitioner's bonds, the effective yield based on the interest rate here is not particularly high.

*169 Other factors which would tend to make a prospective purchaser require a substantial discount before purchasing these bonds are the losses incurred by the corporation in the years immediately prior to the valuation date. These losses had already impaired the capital of the corporation. Such a downward trend of earnings would cause the purchaser to suspect the corporation's ability to meet the interest payments on its bonds in the future, especially in view of its past record of interest payments. Even though the defaults had been cured prior to the valuation date, interest payments had been in default during the period between 1932 and 1942.

We think it also probable that one who would consider purchasing the bonds of such a closely held corporation would demand a discount if he should acquire, as here, only a fractional part of the total bonds outstanding. Cf. . If the bonds were readily salable, it is true that such a fractional interest might have little or no effect on the market price. Where, however, the logical purchasers of the bonds would be members of the two families who control the corporation, the problem of*170 fractional interest becomes important price-wise.

The only witnesses at the hearing who testified as to the value of the bonds were the two expert witnesses who testified in petitioner's behalf. After a careful consideration of their testimony and all other relevant factors gleaned from the entire record, we have reached the conclusion that the fair market value of the bonds at the valuation date was $119,600.

Decision will be entered for the petitioner.