Baertschi v. Commissioner

*289 Respondent determined deficiencies in petitioners' Federal income taxes *2 for the calendar years 1962 and 1963 in the amounts of $ 4,736.68 and $ 13,046.88, respectively.

The sole issue for determination is whether petitioners are entitled to utilize the nonrecognition provisions of section 1034 of the Internal Revenue Code of 1954 with respect to the sale of their old residence.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.

*290 E. F. Baertschi and Alma M. Baertschi, husband and wife, had their legal residence in Toledo, Ohio, at the time the petition herein was filed. They filed joint Federal income tax returns for the years 1962 and 1963 with the district director of internal revenue at Cleveland, Ohio.

On October 15, 1962, petitioners entered into an agreement which was captioned as a "Land Contract" with Irving Stollman (hereinafter referred to as Stollman) and Herman Ross (hereinafter referred to as Ross), two real estate promoters who were contemplating the construction of a shopping center. The agreement provided, in pertinent part, as follows:

FIRST. The said parties of the second part, for themselves and their*3 heirs, assigns, executors and administrators, promise, covenant and agree to purchase from the parties of the first part, ¹ the following described property, * * * [the property described will hereinafter be referred to as the old residence] and to pay therefor to the said parties of the first part their heirs, and assigns, at such place as may be designated by said parties of the first part the sum of One Hundred Ninety Two Thousand Dollars ($ 192,000.00), ² in the manner following, to-wit: Eleven Thousand Dollars ($ 11,000.00) cash, the receipt whereof is hereby acknowledged, and Forty Six Thousand Dollars ($ 46,000.00), on or before the 30th day of November, A.D. 1962, and One Hundred Thirty-Five Thousand Dollars ($ 135,000.00) on or before the 31st day of May, A.D. 1963, said balance of $ 135,000.00 shall bear interest from the date hereof at the rate of six per cent per annum.

SECOND. In consideration of the above and the fulfillment of all and singular the covenants contained in this agreement to be performed and kept, and upon the fulfillment of each and every one of them by the said parties of the second part, in the manner and at the time herein specified, the said*4 parties of the first part agree to sell and convey the above described premises by good and sufficient deed of general warranty unto the said parties of the second part, their heirs and assigns, and free and clear from all encumbrances, whatsoever except as stated herein and existing easements and restrictions of record, ordinances and zoning. Said parties of the first part further agree to give immediate possession of said premises to the parties of the second part, except that said parties of the first part shall have the right to remain in occupancy of and living at their residence on said premises until December 15, 1962 without interference from parties of the second part and the building located on said premises shall not be razed or removed at any time prior to December 15, 1962 without written consent of parties of the first part, and excavations, footings and the like shall not be commenced by parties of the second part until the payment of the $ 46,000.00 as required aforesaid has been made.

THIRD. It is understood and agreed by the parties hereto that the said parties of the second part shall pay all taxes and assessments on said described real estate, which may be*5 assessed or become payable on same from and after this date and shall not fail to discharge the same before the accruing of any penalty incurred by delay in the payment thereof, and shall keep said premises fully insured in favor of the said parties of the first part, their heirs or assigns in companies to be approved by the parties of the first part. If the parties of the *291 second part shall fail to make payments of said taxes, assessments or insurance premiums within twenty (20) days after said payments fall due, the same may be paid by the parties of the first part, and thereupon be charged against and become immediately due from the parties of the second part, and any amount paid by the parties of the second part may be applied or reapplied in satisfaction of the claim of the parties of the first part against the parties of the second part for taxes, assessments, or insurance premium paid by the parties of the first part. All payments to be made by the parties of the second part to the parties of the first part if not paid when due shall bear interest at the rate of eight per cent per annum, payable semi-annually.

FOURTH. If the parties of the second part, their*6 heirs, executors, administrators or assigns, shall fail to make any of the payments pursuant to this agreement, either of principal or interest, or in payment of taxes or insurance premiums, and be so in default for 20 days after registered mail notice of said default has been given by parties of the second part as hereinafter provided or in any other manner break the conditions of this contract, then and in that event, parties of the first part are hereby given an option either to declare the entire balance of the purchase price due and payable, and enforce their vendor's lien for payment thereof, or to rescind this contract to sell and convey said property, and take possession thereof; and in event of the exercise of the option to rescind this contract, any and all payments theretofore made by parties of the second part, and all improvements made on said premises shall be taken and retained by parties of the first part as and for liquidated damages for the non-performance of this contract, and parties of the first part, their heirs, executors, administrators or assigns, shall be entitled to the possession of the premises aforesaid, and of all the improvements thereon, and parties*7 of the second part covenant and agree that they and all persons holding under them shall and will surrender possession thereof, with the improvements, to parties of the first part, their heirs, executors, administrators or assigns. Failure or delay to exercise said option at the time of any default shall not be, or operate as, a waiver of the right to exercise such option at any time thereafter. * * * The remedy of recourse of said parties of the first part for the non-performance of any obligation of the parties of the second part hereunder shall be limited solely to the moneys paid hereunder, and to the herein described property, and said parties of the second part shall not be liable for any deficiency arising from the sale of said property in any way, capacity or manner whatsoever, nor shall said parties of the first part have the right to, nor seek, a deficiency or other money judgment against said parties of the second part. ³

And it is Further Agreed, that no sale, transfer, assignment or pledge of this contract shall be in any manner binding upon the said parties of the first part, unless the parties of the first part first consent in writing hereon to such sale, transfer, *8 assignment or pledge.

On October 15, 1962, upon the signing of the agreement, petitioners received the sum of $ 11,000 from Stollmen and Ross. The payment due on November 30, 1962, was not timely received. On December 12, 1962, petitioners' attorney gave written notice of default to Stollman and Ross. On December 14, 1962, petitioners received the overdue payment in the amount of $ 46,000, plus interest.

Also in December 1962, petitioners vacated their old residence, after which they lived temporarily in a house located on Bancroft Street, Toledo, Ohio, while looking for a satisfactory permanent residence.

*292 On May 31, 1963, petitioners timely received the final payment of $ 135,000, plus interest as specified in the agreement and at*9 that time they executed and delivered the required deed to Stollman and Ross. At the date of this final payment, the old residence was still intact.

On November 20, 1963, petitioners purchased a lot on Farmington Road, Toledo, Ohio, and later, on December 9, 1963, commenced construction of a new residence. The construction was completed at a total cost of $ 103,860.72 and on September 16, 1964, petitioners took up residence therein.

On their joint Federal income tax returns for the years 1962 and 1963, petitioners reported the sale of their residence as being subject to the nonrecognition provisions of section 1034.

Respondent, in his statutory notice of deficiency, determined that the transaction did not qualify for the relief provisions of section 1034 and that, therefore, the entire gain on the sale was taxable to the petitioners in 1962 and 1963.

OPINION

The issue for determination is whether petitioners are entitled to utilize the nonrecognition provisions of section 1034, with respect to the sale of their old residence. Section 1034 provides, in part, as follows:

SEC. 1034. SALE OR EXCHANGE OF RESIDENCE.

(a) Nonrecognition of Gain -- If property (in this section called *10 "old residence") used by the taxpayer as his principal residence is sold by him after December 31, 1953, and, within a period beginning 1 year before the date of such sale and ending 1 year after such date, property (in this section called "new residence") is purchased and used by the taxpayer as his principal residence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer's adjusted sales price (as defined in subsection (b)) of the old residence exceeds the taxpayer's cost of purchasing the new residence.

* * * *

(c) Rules for Application of Section. -- For purposes of this section:

* * * *

(5) In the case of a new residence the construction of which was commenced by the taxpayer before the expiration of one year after the date of the sale of the old residence, the period specified in subsection (a), and the 1 year referred to in paragraph (4) of this subsection, shall be treated as including a period of 18 months beginning with the date of the sale of the old residence.

In order to qualify for nonrecognition treatment, therefore, petitioners must show (1) that construction of the new residence was commenced before the expiration of 1 year after*11 the date of sale of the old residence and (2) that the newly constructed residence was used by them as their principal residence within 18 months after the date of sale.

*293 The facts of this case are (1) that construction of the new residence began on December 9, 1963, and (2) that use of the new residence began on September 16, 1964. The parties are in dispute as to the date on which the sale took place. Petitioners contend that the sale occurred on May 31, 1963, the date of the final payment and the execution and transfer of legal title. Respondent contends that the date of sale is either the date of the agreement, October 15, 1962, or sometime during December of 1962 when Stollman and Ross, having made the second payment called for by the agreement, had the right to begin operations on the land.

When the sale took place is a question to be determined from a consideration of all the relevant circumstances. The material facts, however, are not in dispute and the crux of the problem presented is the effect of the agreement of the parties dated October 15, 1962.

The agreement, set forth in detail in our findings, provided in general that petitioners were bound to sell to*12 Stollman and Ross on full payment of the purchase price. Petitioners, however, did not have the enforceable right to receive the full purchase price. In the event of nonpayment, petitioners had the option either to declare the entire balance due and payable and enforce their vendor's lien for payment thereof or to rescind the contract and retain all payments and improvements made on the land as liquidated damages. Both alternatives, however, were subject to the condition that any recovery was limited solely to the moneys paid and the value of the property and that petitioners possessed no right against Stollman and Ross in excess of that limit.

We are of the opinion that this agreement did not constitute a sale of the property on October 15, 1962.

The words "sale" or "exchange" as used in the Internal Revenue Code must be given their ordinary meanings. * * * "'A sale, in the ordinary sense of the word is a transfer of property for a fixed price in money or its equivalent.' * * *" [Ralph A. Boatman, 32 T.C. 1188, 1191-1192 (1959)]

In Commissioner v. Union Pac. R. Co., 86 F. 2d 637, 639 (C.A. 2, 1936), affirming*13 32 B.T.A. 383 (1935), the Court of Appeals summarized the applicable rule as follows:

A closed transaction for tax purposes results from a contract of sale which is absolute and unconditional on the part of the seller to deliver to the buyer a deed upon payment of the consideration and by which the purchaser secures immediate possession and exercises all the rights of ownership. The delivery of the deed may be postponed and payment of part of the purchase price may be deferred by installment payments; but for taxing purposes it is enough if the vendor obtains under the contract the unqualified right to recover the consideration. * * * [Emphasis supplied.]

In the case at bar, the vendors did not receive an unqualified right to recover the consideration. The contract in the fourth paragraph specifically provided that in the event of the buyers' default the sellers' *294 recourse was limited solely to the moneys paid and the property itself. Applying the facts of this case to the rule set forth above, we are convinced that no sale took place at the date the agreement was signed. ⁴

*14 On brief, respondent argues that the limitation on the sellers' rights in the event of a breach by the buyers is contradictory to the contract provision which entitled the sellers to declare the balance of the purchase price due and payable and enforce their vendor's lien for the payment thereof and, therefore, the limitation should be ignored. We cannot agree. This right and the limitation thereon are both contained in the fourth paragraph of the contract and the latter in our opinion is merely explanatory of the former. They are not provisions which require the acceptance of the one and the rejection of the other as suggested by the respondent. We also disagree with respondent's further argument which relies on this premise, namely, that under Ohio law the seller would be entitled to specific performance as against the buyer and that, therefore, we should treat the transaction as closed. Cf. Commissioner v. Stuart, 300 F. 2d 872 (C.A. 3, 1962). We note that the contract herein was made at arm's length and the limitation provision was a matter of specific negotiation between the parties. In fact, the provision was included at the insistence*15 of the buyers and over the objection of the sellers. To state that such a provision is null and void and to allow the seller to succeed in an action for the full purchase price is to do violence to the intent of the parties and in effect to rewrite their agreement. This we cannot do and we are not persuaded that under State law such a specific intention, manifested by the parties, would be ignored. In short, we are of the opinion that the parties intended that no sale would occur until full payment was made by the buyer. See Smith v. Loewenstein, 50 Ohio St. 346, 34 N.E. 159, 161 (1923), in which the court stated that --

To what extent a conversion takes place * * * must be determined by looking to the contract or instrument as indicating the intention of parties. * * *

Respondent next argues that the sale occurred no later than December 31, 1962, since by that date the purchasers had the right to begin excavating and to begin construction of the shopping center. They also had the right to raze the house though they did not, in fact, do so prior to the date of final payment. They also had the duty to insure the property and to*16 pay the realty taxes. He concludes that they therefore had assumed the benefits and burdens of ownership of the property at least by that date. He concludes that the sale therefore occurred at that time, relying on Commissioner v. Union Pac. R. Co., supra; Elsinore Cattle Co., a Memorandum Opinion of this Court dated Feb. 21, 1950, *295 and Ted F. Merrill, 40 T.C. 66 (1963), affirmed per curiam 336 F. 2d 771 (C.A. 9, 1964). Respondent in so arguing misinterprets the benefits-and-burdens test. In each of the above cases the respective courts dealt with a "closed transaction," that is, one in which, inter alia, the seller's right to the purchase price is unconditional. We do not believe that these cases are applicable to a situation like the one before us in which the seller has no such unconditional right.

We therefore hold that the sale occurred on May 31, 1963, the date of the final payment and that, therefore, on the facts of this case petitioners are entitled to utilize the nonrecognition provisions of section 1034 with respect to the sale.

Decision will be entered under*17 Rule 50.

Drennen, J., dissenting: I cannot agree that solely because petitioner may not have had the unqualified right to recover the entire balance of the cash consideration to be paid for the property that this transaction did not become a sale of the old residence for purposes of section 1034 until the balance of the cash consideration was actually paid. Section 1034 is a relief provision which permits a taxpayer to postpone recognition of gain on the sale of property used by him as his principal residence if he reinvests the proceeds from the sale of the old residence in a new residence within the time specified. It should be applied with the congressional purpose in mind.

It seems clear to me that not later than December 31, 1962, petitioners had given up the use and possession of their old residence, the purchasers had acquired possession of the property with the right to raze or remove the house and had assumed all of the benefits and burdens of ownership, and that the parties intended ownership of the property to pass prior to that date. See Ted F. Merrill, 40 T.C. 66. Petitioners were by that time unconditionally bound to deliver*18 a deed to the purchasers upon payment of the purchase price. Delivery of the deed and payment of all installments of the purchase price did not defer consummation of the transaction. I disagree with the majority's emphasis on the absence of personal liability on the part of the purchaser. Sales often occur where, in the event of default, the seller's recourse is limited to the property itself. I think that for purposes of section 1034 the sale of the old residence occurred not later than December 31, 1962, and consequently petitioners are not entitled to the nonrecognition benefits provided in that section.

If the rationale of the majority opinion is to be applied in all instances, a taxpayer, by selling his residence under a contract of sale containing the same recourse provision as the contract here involved, *296 but with the consideration to be paid in installments over an extended period of time, could extend the period within which he could reinvest the proceeds of sale and defer recognition of gain on the sale far beyond the period contemplated in the statute and make the statute meaningless.