Burge v. Comm'r of Internal Revenue, Docket No. 53083.

• Decision Date: 30 April 1957
• Docket Number: Docket No. 53083.
• Parties: RAYMOND G. BURGE AND KATHLEEN E. BURGE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

28 T.C. 246

RAYMOND G. BURGE AND KATHLEEN E. BURGE, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 53083.

Tax Court of the United States.

Filed April 30, 1957.

Leon L. Rice, Jr., Esq., and C. W. Womble, Esq., for the petitioners.

L. P. Shields, Esq., and Herman Wolff, Jr., Esq., for the respondent.

SEC. 117(m), I.R.C. 1939— COLLAPSIBLE CORPORATIONS.— The petitioner and others formed a corporation to construct an apartment building and obtained a loan guaranteed by the Federal Housing Administration in an amount in excess of the cost of construction. When the building was completed, and prior to the realization by the corporation of a substantial amount of the net income to be derived from the property, the corporation redeemed and canceled its outstanding class B stock, distributing in exchange therefor a part of the excess of the loan over the construction cost. The petitioner has not shown that the corporation was not formed with a view to such redemption and distribution and the realization by the shareholders of gain attributable to the property. The respondent's determination that the corporation was a collapsible corporation and his treatment of the gain to the petitioner upon such redemption and upon the sale of his class A stock about 3 months later as gain upon the sale or exchange of property which is not a capital asset are approved.

ATKINS, Judge:

The respondent determined deficiencies in income taxes for the calendar years 1950 and 1951 in the respective amounts of $12,591.24 and $10,525.80.

The item in issue for 1950 represents gain realized on the redemption of stock in a housing corporation and reported as long-term capital gain which the respondent determined to be ordinary income, either as compensation under section 22(a) or income from the sale or exchange of stock in a collapsible corporation under section 117(m) of the Internal Revenue Code of 1939. The item in issue for 1951 represents gain from the sale of stock in the same corporation which was also reported as long-term capital gain, but which the respondent contends represented ordinary income under section 117(m).

Kathleen E. Burge is a party here only by reason of having made joint income tax returns with her husband, Raymond G. Burge.

FINDINGS OF FACT.

Some of the facts have been stipulated and are so found.

The petitioners are husband and wife. For the calendar years 1950 and 1951, they filed joint income tax returns with the collector of internal revenue for the district of North Carolina at Greensboro, North Carolina. Petitioner Raymond G. Burge is herein referred to as the petitioner or as Burge.

When Burge was about 21 years of age he went into the business of building houses for sale, one at a time. His practice was to buy a lot, build a house on it, subcontracting the carpentry work, and sell the house on completion. He discontinued that business in the latter part of 1938, and during the depression period and until 1940 he was a workman and later a foreman for a construction company that was engaged in the construction of large buildings. From 1940 to 1946 he operated a combination drug and confectionery store in Martinsville, Virginia. He sold the store in 1946 and resumed the construction of houses for sale. In 1945 or 1946 he and another individual, as partners, acquired a lumber yard in Mayodan, North Carolina. The partnership constructed some houses for sale. It discontinued business in the early part of 1955.

In 1946, and during a short period in 1947, Burge built 12 or 15 houses in Martinsville, Virginia. He built 2 or 3 at a time, and was financed by a bank in Martinsville.

In 1946 Burge met Lawson Lester, Jr., and they explored the possibility of constructing houses in North Carolina as a joint project. In the latter part of 1947 or early 1948, Burge and Lester and several others, operating under the firm name of Burge and Lester, constructed a group of houses in High Point, North Carolina, all of which they sold. The construction of that group was financed through the Federal Housing Administration (F.H.A.). Thereafter Burge, Lester, and W. B. Pollard, a real estate and insurance agent, organized the Skyland Development Corporation in which Burge, Lester, and Pollard were officers. That corporation acquired a tract of land in or near Winston-Salem and in 1949 and 1950 it constructed thereon a group of about 25 houses which it sold. The actual construction was done by the Burge and Lester Construction Company, a partnership in which Burge and Lester were the partners. That partnership also constructed 15 houses at Madison, North Carolina, for Burmac Corporation in which Burge owned stock from 1948 to 1951.

In 1949 Burge conceived the idea of constructing apartments for rental purposes. He and his associates, Lester and Pollard, took an option on a tract of land in the western part of Winston-Salem with a view to the construction of apartments for white occupancy. However, they were advised by bank officials that the bank did not want to finance a project for white occupancy, but would finance one for colored occupancy, stating that there was a need for the latter. They were also advised by a representative of the Winston-Salem zoning board that 1,000 apartments for colored occupancy were needed. They were also advised by representatives of the F.H.A. that there was a greater need in that area for housing projects for colored occupancy than for white. Burge and Lester became thoroughly convinced that there was a need for housing for colored occupancy, and they thereupon abandoned the white apartment project. Burge and Lester then acquired an option on a 47.32-acre tract to the east of the city for the purpose of building apartments for colored occupancy. They also acquired an option on 43 additional acres which it was though might also be needed. This land was adjacent to a colored residential section and near a school for colored which was then being constructed.

Beginning in the spring of 1949, negotiations were opened with the F.H.A. for the purpose of procuring a guarantee of a loan for the construction of the proposed apartments. Burge, Pollard, and Lester all conferred with F.H.A. representatives in Greensboro, but Lester did most of the paperwork. A formal application for mortgage insurance was filed, dated August 18, 1949, on behalf of Park Terrace, Inc., as the proposed mortgagor. The application was signed by Burge as secretary and treasurer of the corporation. It was attested by Lester.

Pursuant to the provisions of section 608 of the National Housing Act, the F.H.A., on August 31, 1949, agreed to insure a loan in the amount of $1,632,000 for the construction of the apartments that Burge and his associates proposed to build. The estimate of the replacement cost was fixed at $1,819,908, of which $60,000 was shown as representing the fair market price of the land. The loan so insured was made to Park Terrace, Inc., by Wachovia Bank and Trust Company, Winston-Salem, North Carolina. The loan carried interest at 4 per cent and was to be repaid in 391 monthly installments of $7,344 each, commencing 18 months from the date of the mortgage.

On October 4, 1949, Burge, Lester, and Pollard organized Park Terrace, Inc., under the laws of North Carolina for the purpose of constructing the proposed apartments, which became known as Park Terrace Apartments. The F.H.A. required that the owner of a project of this size be separately incorporated, and the certificate of incorporation of Park Terrance, Inc., was in the form prescribed by the F.H.A. Article 3 of the certificate of incorporation states in part the objects for which the corporation was formed as follows:

(a) * * * to provide housing for rent or for sale, and to acquire any real estate or interest or rights therein or appurtenant thereto and any and all personal property in connection therewith.

(b) To improve and operate, and to sell, convey, assign, mortgage or lease any real estate and any personal property.

(d) To apply for an obtain or cause to be obtained from the Federal (sic) Housing Commissioner (hereinafter called the Commissioner) a contract or contracts of mortgage insurance pursuant to the provisions of the National Housing Act as amended, covering bonds, notes and other evidences of indebtedness issued by this corporation and any indenture of mortgage or deed of trust securing the same. So long as any property of this corporation is encumbered by a mortgage or deed of trust insured by the Commissioner, it shall engage in no business other than the construction and operation of a Rental Housing Project or Projects.

The total authorized capital stock consisted of 35,000 shares of class A common stock, 214,900 shares of class B common stock, and 100 shares of preferred stock. The par value of both the common and the preferred stock was $1 per share.

Under the certificate of incorporation the preferred stock carried the right to noncumulative dividends at 5 cents per share before any dividend or other distribution upon the common stock. The class B stock was entitled to noncumulative dividends of 6 per cent before payment of any dividends on the class A common stock and was entitled to preference over the class A stock on dissolution. The class B common stock could be retired after payment of all interest and principal due and after making provision for payment of operating expenses, etc., and after establishing a reserve fund for replacements. However, no such stock could be retired until after the completion of the improvements on the property, or before the final endorsement for mortgage insurance by the Federal Housing Commissioner. The class A common stock had the exclusive voting privilege, except in the case of specified defaults, in which case the preferred stock had the right to elect directors. Upon liquidation the class A common stock was entitled to the entire assets after the payment of...