COMMISSIONER OF INTERNAL REVENUE v. SIMMERS'ESTATE

• Decision Date: 21 March 1956
• Docket Number: 7119.,No. 7118,7118
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. ESTATE of Ralph W. SIMMERS, Deceased, Mary E. Simmers, Executrix, and Mary E. Simmers (Surviving Wife), Respondents. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Ralph W. SIMMERS and Son, Incorporated, Respondent.
• Court: U.S. Court of Appeals — Fourth Circuit

231 F.2d 909 (1956)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. ESTATE of Ralph W. SIMMERS, Deceased, Mary E. Simmers, Executrix, and Mary E. Simmers (Surviving Wife), Respondents.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Ralph W. SIMMERS and Son, Incorporated, Respondent.

Nos. 7118, 7119.

United States Court of Appeals Fourth Circuit.

Argued January 11, 1956.

Decided March 21, 1956.

As Corrected April 25, 1956.

Kenneth E. Levin, Atty., Dept. of Justice (H. Brian Holland, Asst. Atty. Gen., Lee A. Jackson and Hilbert P. Zarky, Attys., Dept. of Justice, on the brief), for petitioner.

Stanley Worth, Washington, D. C. (Edward S. Smith, Washington, D. C., Issac Hecht, Baltimore, Md., and Blair, Korner, Doyle & Worth, Washington, D. C., on the brief), for respondents.

Before PARKER, Chief Judge, and SOPER and DOBIE, Circuit Judges.

SOPER, Circuit Judge.

Each of these cases relates to the income tax of a landowner in Maryland who, under the practice in vogue in the City of Baltimore and its environs, divided the land into lots and built houses thereon and sold each house subject to the payment of a specified annual ground rent on the lot which was reserved in an agreement of lease. The issue is whether the landowner realized a taxable gain not only on the purchase price of the house at the time of the sale, but also a taxable gain on the reserved ground rent at the time of its creation measured by its fair market value. The Tax Court answered this question in the negative and the Commissioner appeals.

Ralph W. and Mary E. Simmers were engaged in the business of constructing and selling group houses in the city and suburbs of Baltimore during the tax years 1946 to 1949. Ralph W. Simmers and Son, Incorporated, acquired certain land and equipment from them and conducted the same sort of operations in the tax year 1950. The Commissioner asserted deficiencies in income and excess profit taxes against Mary E. Simmers and the estate of Ralph W. Simmers, deceased, in the aggregate sum of $153,014.93 for the years 1946 to 1949 and a like deficiency of $41,105.82 against the Simmers Corporation for the year 1950. The method of operations now to be described was the same in both cases.

The taxpayer acquired unimproved land, divided it into lots and built a dwelling house on each lot. When the houses on a group of lots were completed the taxpayer first created ground rents on the lots by entering into an agreement of lease with a wholly owned or straw corporation, as lessee, covering the lots and improvements thereon for a term of ninety-nine years, renewable forever, at a specified rental on each lot. Subsequently, upon the sale of a house, the taxpayer caused the straw corporation to assign to the purchaser the lease on the premises sold. This course was followed because under the Maryland law the original lessee of the lot is liable for the payment of the ground rent during the entire term of the lease, but an assignee of the lessee is liable for the rent only during the period of his tenancy.¹

Typical of the course of operations were the following transactions of the Simmers Corporation. On December 11, 1950 it leased to the Que Holding Corporation, the straw man, twenty-four lots of ground to be held by the lessee, its successors and assigns, for the term of ninety-nine years, yielding and paying to the lessor, its successors and assigns, a fixed yearly rent on each lot over and above all deductions for taxes and assessments in such manner that each lot was liable only for its own rent. The lease provided that if a ground rent should be in arrears at any time the lessor might make distress therefor; and if the rent should be in arrears for sixty days, the lessor might reenter and hold the premises until the rent was paid; and if the rent should be in arrears for six months, the lessor might reenter and hold the premises the same as if the lease had never been made. The lessee covenanted for itself and its successors and assigns to pay the rent and the taxes; and the lessor for itself and its successors and assigns covenanted upon the performance by the lessee of its covenants to renew the lease at any time for another term of ninety-nine years upon the payment of one dollar.

The property was then ready for the market and when a house was sold the following steps were taken. An agreement of sale between the taxpayer and the purchaser was executed in which the property was described as a two story brick row dwelling, subject to a specified annual ground rent for ninety-nine years renewable forever and redeemable in five years; and the amounts of the purchase price and of the down payment were set out.

The owner then caused the straw corporation to execute and deliver a deed of assignment to the purchaser for the leasehold interest in the premises and on the day of settlement the purchaser simultaneously executed and delivered a mortgage of his leasehold interest to a third party for the balance of the purchase price.

It is stipulated that through such a series of transactions the purchaser becomes the owner of the leasehold and is entitled to hold the premises so long as he pays the ground rent, and that he is entitled to redeem the rent at the end of five years and acquire an absolute fee simple title to the land, but that he can never be compelled to redeem the rent. Meanwhile the builder retains the legal title to the lot and is known as the owner of the ground rent. In common parlance the purchaser owns the house and the builder the land. The interest of the latter is held to be realty and the interest of the former personalty under the Maryland decisions.²

Prior to 1884 ground rents were not redeemable in Maryland unless the lease expressly provided for redemption at a specified rate. By statutes passed by the Legislature of Maryland in 1884 and subsequent years ground rents were made redeemable³, and in consequence all ground rents created by the taxpayers in these cases were redeemable after five years by paying to the owner of the rent the amount thereof capitalized at six per cent. When a ground rent is redeemed the owner conveys the land to the owner of the leasehold by a deed in fee simple whereby the ground rent is extinguished. None of the ground rents involved in these cases were redeemed during the tax years.

All of the ground rents created by the taxpayers in these cases were readily saleable for investment purposes; and some of them were sold and transferred during the tax years prior to the expiration of the five years period at prices in excess of their redemption value. The transfer to the purchaser in such a case was accomplished by a deed which conveyed a fee simple title to the lot subject to the leasehold interest of the purchaser of the house. The profits on these sales, as well as on the sales of the houses, were reported by the taxpayers and reflected in the determinations of the Commissioner. Some of the ground rents, however, were not sold; but the Commissioner nevertheless contends that a profit was also earned on them at the time the lease to the straw corporation was made and should have been reported by the taxpayers. In the alternative the Commissioner contends that a profit on these rents was received when the houses were sold and the leases as to them were assigned to the purchasers by the straw corporation.

The contention of the Commissioner is that under a fair interpretation of §§ 111(a), 111(b) and 112(a) of the Internal Revenue Code of 1939, 26 U.S.C. §§ 111(a, b), 112(a)⁴ the creation of a ground rent and the transfer of the improvements on the land to a purchaser, subject to the ground rent, is a disposition if not a sale of the whole property, and that the taxable gain therefrom is the excess of the amount realized over the basis of the property and that the amount realized is the cash received from the purchaser for the house plus the fair market value of the ground rent reserved by the taxpayer. It is asserted that the purchaser acquires not only the exclusive right to enjoy the property but also the option to obtain "the bare legal title" which the property owners retain, and that the property owners on their side receive not only the purchase price of the house but also the right to receive the ground rent which is readily saleable usually at a premium. Hence it is said that a profit is earned on the lot as well as on the house and must be accounted for. The gist of the argument is that in economic if not in legal effect the transaction is not a lease of the property but a sale of real estate subject to a mortgage.

Cited in support of the argument is the opinion of the Supreme Court of the United States in 1852 in Bosley v. Bosley's Executrix, 14 How. 390, 14 L.Ed. 468, in which it was held that a sale of land subject to a redeemable ground rent so altered the condition of the property as to amount to revocation of a devise of the land which the owner had previously made. In the course of the discussion Chief Justice Taney said that the interest which the testator had in the land at the time of making his will was converted into money by his contract with the purchaser, and that it was a sale of the land and an agreement to convey his whole interest in the land. He added in explanation that the form of the contract used by the parties had been found more convenient than the older form in which the vendor conveys the land and takes back a purchase money mortgage, because it enabled the purchaser to postpone the payment of a large part of the purchase money as long as he found it convenient, and at the same time allowed the vendor to obtain the balance of the purchase money by selling the ground rent on the market, if he should choose to do so. Obviously the conversion of the interest of the vendor of the land into money, to which the Chief Justice referred, was not complete until the purchaser redeemed the ground rent or the vendor sold it to...