Foresun, Inc. v. Comm'r of Internal Revenue

Decision Date28 February 1964
Docket NumberDocket No. 91178.
Citation41 T.C. 706
PartiesFORESUN, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Richard Katcher, for the petitioner.

Eugene S. Linett, for the respondent.

Held: Transactions between petitioner and certain individuals resulted in contributions to petitioner's capital, rather than a sale and loans, so that respondent properly disallowed interest deductions. Petitioner's basis in the contributed property is that of its transferor, section 113 (a)(8)(B),I.R.C. 1939, not the ‘sale’ price.

TRAIN, Judge:

Respondent determined deficiencies in the statutory notice and asserted increased deficiencies in an amended answer to the petition in the income tax liability of petitioner for the years and in the amounts as follows:

+--------------------------------------+
                ¦Fiscal year ending¦Statutory¦Amended  ¦
                +------------------+---------+---------¦
                ¦                  ¦notice   ¦answer   ¦
                +------------------+---------+---------¦
                ¦Oct. 31—          ¦         ¦         ¦
                +------------------+---------+---------¦
                ¦1956              ¦$6,099.28¦$9,863.26¦
                +------------------+---------+---------¦
                ¦1957              ¦4,386.97 ¦8,399.98 ¦
                +------------------+---------+---------¦
                ¦1958              ¦4,421.65 ¦8,434.67 ¦
                +--------------------------------------+
                

The issues for decision are:

(1) Whether petitioner is entitled to an interest deduction for amounts paid to Ada Osborn in each of the fiscal years ending October 31, 1956, 1957, and 1958; (2) Whether petitioner is entitled to an interest deduction for amounts paid to one of petitioner's shareholders and the wives of three others for the years in question; and

(3) Whether petitioner is entitled to use $218,025 as the basis for depreciating certain property acquired from Ada Osborn in 1949.

FINDINGS OF FACT

Some of the facts have been stipulated and are hereby found as stipulated.

The petitioner, Foresun, Inc. (sometimes hereinafter referred to as petitioner), is an Ohio corporation with its principal place of business at 165 Harriman, Bedford, Ohio. Petitioner was organized on September 2, 1949, and has, at all times material herein, been engaged in the business of owning and renting real estate. Petitioner's corporation income tax returns for the taxable years ending October 31, 1956, 1957, and 1958 were filed with the district director of internal revenue, Cleveland, Ohio. During each of the fiscal years in question petitioner employed an accrual method of accounting.

At all material times, the outstanding stock of petitioner was owned as follows:

+----------------------------------------------------------+
                ¦                   ¦Number of¦Subscription¦               ¦
                +-------------------+---------+------------+---------------¦
                ¦Shareholder        ¦shares   ¦price       ¦Office         ¦
                +-------------------+---------+------------+---------------¦
                ¦                   ¦         ¦(per share) ¦               ¦
                +-------------------+---------+------------+---------------¦
                ¦Edwin H. Osborn    ¦5        ¦$100        ¦President.     ¦
                +-------------------+---------+------------+---------------¦
                ¦William P. Lindauer¦5        ¦100         ¦Vice president.¦
                +-------------------+---------+------------+---------------¦
                ¦Frank K. Byers, Jr ¦5        ¦100         ¦Secretary.     ¦
                +-------------------+---------+------------+---------------¦
                ¦Arnold W. MacAlonan¦5        ¦100         ¦Treasurer.     ¦
                +----------------------------------------------------------+
                

The Stalwart Rubber Co. (hereinafter sometimes referred to as Stalwart) is an Ohio corporation organized on June 5, 1937. At all material times, it has been engaged in the manufacture of industrial rubber products. The outstanding common stock of Stalwart was owned, at the dates indicated, as follows:

+---------------------------------------------------+
                ¦                      ¦Number of shares            ¦
                +----------------------+----------------------------¦
                ¦Shareholder           ¦              ¦             ¦
                +----------------------+--------------+-------------¦
                ¦                      ¦Sept. 10, 1949¦Dec. 31, 1958¦
                +----------------------+--------------+-------------¦
                ¦Herman W. Osborn      ¦8,489         ¦5,449        ¦
                +----------------------+--------------+-------------¦
                ¦Edwin H. Osborn       ¦939           ¦1,384        ¦
                +----------------------+--------------+-------------¦
                ¦Elizabeth J. MacAlonan¦939           ¦1,384        ¦
                +----------------------+--------------+-------------¦
                ¦Ellen E. Byers        ¦939           ¦1,384        ¦
                +----------------------+--------------+-------------¦
                ¦Margaret M. Lindauer  ¦939           ¦1,384        ¦
                +----------------------+--------------+-------------¦
                ¦Ada Osborn            ¦160           ¦380          ¦
                +----------------------+--------------+-------------¦
                ¦William P. Lindauer   ¦              ¦260          ¦
                +----------------------+--------------+-------------¦
                ¦Frank K. Byers, Jr    ¦              ¦260          ¦
                +----------------------+--------------+-------------¦
                ¦Lois Osborn           ¦              ¦260          ¦
                +----------------------+--------------+-------------¦
                ¦Arnold W. MacAlonan   ¦45            ¦305          ¦
                +----------------------+--------------+-------------¦
                ¦R. H. Tyrell          ¦50            ¦50           ¦
                +----------------------+--------------+-------------¦
                ¦Total                 ¦12,500        ¦12,500       ¦
                +---------------------------------------------------+
                

Herman W. Osborn (hereinafter sometimes referred to as Herman) and Ada Osborn (hereinafter sometimes referred to as Ada) were husband and wife. Herman died March 10, 1961. Their children and their children's spouses are as follows:

+------------------------------------------+
                ¦Children              ¦Spouse             ¦
                +----------------------+-------------------¦
                ¦Edwin H. Osborn       ¦Lois Osborn        ¦
                +----------------------+-------------------¦
                ¦Elizabeth J. MacAlonan¦Arnold W. MacAlonan¦
                +----------------------+-------------------¦
                ¦Ellen E. Byers        ¦Frank K. Byers, Jr.¦
                +----------------------+-------------------¦
                ¦Margaret M. Lindauer  ¦William P. Lindauer¦
                +------------------------------------------+
                

R. H. Tyrell, now deceased, was not related in any way to the Osborn family.

On July 7, 1944, Ada's preferred stock in Stalwart was redeemed in exchange for an unimproved lot and adjacent improved real property occupied by Stalwart in the conduct of its business. From July 7, 1944, to September 30, 1949, Stalwart leased this improved realty from Ada at an annual rental of $20,400. A business expense deduction of $7,000 per year for such rental was allowed by the Commissioner for the years 1944 to 1948, inclusive and was agreed to by Stalwart.

Petitioner was incorporated on September 2, 1949, for the purpose of acquiring from Ada the improved property rented by Stalwart, together with the adjacent unimproved lot. Pursuant to such purpose, petitioner on September 10, 1949, made an ‘Offer to Purchase’ (hereinafter referred to as the offer) that property (hereinafter referred to as the property) from Ada for $225,000, which she accepted on the same date.

Under the terms of that offer, petitioner agreed to pay $225,000 for the property, consisting of $25,000 in cash and a second mortgage in the amount of $200,000, which mortgage was to be second in priority only to a first mortgage for $25,000. No payments on principal were to be made on the second mortgage until the first mortgage was paid in full, after which monthly payments of not less than $625 were to be paid on the second mortgage. Interest at the rate of 6 percent per annum was payable quarterly on the balance due on said mortgage, the first of such payments to be due 3 months after September 30, 1949.

Petitioner's board of directors, at a meeting held on September 10, 1949, authorized the purchase of the property for $225,000 on the terms and conditions set forth in the offer.

In order to purchase the property from Ada, petitioner borrowed $25,000 from the National City Bank of Cleveland (hereinafter referred to as National City Bank), Cleveland, Ohio. To evidence its obligation to National City Bank, petitioner executed and delivered its promissory note to the bank for $25,000, dated September 19, 1949, payable 5 years from date in quarterly installments of $1,200 each, with interest at the rate of 4 percent per annum. This note was secured by a first mortgage on the property, which mortgage was recorded in the county recorder's office of Cuyahoga County, Ohio.

Prior to making the $25,000 loan to petitioner, National City Bank had appraised the property at $201,000, of which $18,000 represented the value of the land and $183,000 the value of the buildings.

West Brothers, Inc., on March 15, 1949, appraised the land at $7,560 and the replacement and sound values of the buildings at $398,114.99 and $282,243.14, respectively. This appraisal was the basis upon which petitioner relied in its offer to purchase the property from Ada for $225,000.

Petitioner consummated the purchase by paying Ada $25,000 in cash and executing and delivering to her its cognovit installment note, dated September 30, 1949, in the amount of $200,000. This note provided for payments of not less than $625 per month, with interest at the rate of 6 percent per annum, payable quarterly, principal payments not to commence until the first mortgage to National City Bank had been paid in full. The note was secured by a second mortgage on the property, dated September 30, 1949, which mortgage was recorded in the Cuyahoga County, Ohio, records on October 14, 1949, the same date on which the first mortgage to National City Bank was recorded.

Pursuant to the offer to purchase, Ada executed a warranty deed to petitioner as grantee. This warranty deed, which was recorded in the Cuyahoga County, Ohio, records, had affixed to it U.S. internal revenue documentary stamps...

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