Denco Lumber Co. v. Comm'r of Internal Revenue

• Decision Date: 02 October 1962
• Docket Number: Docket Nos. 85529,85530.
• Citation: 39 T.C. 8
• Parties: DENCO LUMBER COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.WENCO, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

39 T.C. 8

DENCO LUMBER COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.WENCO, INC., PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 85529

85530.

Tax Court of the United States.

Filed October 2, 1962.

Gene W. Reardon, Esq., and Fred W. Mattson, Esq., for the petitioners.

Joseph D. Skinner, Esq., for the respondent.

Petitioners were in the business of building and selling low-priced homes. With the exception of a few homes, petitioners obtained first mortgage loans on these homes prior to their sale. When a home was sold there was no downpayment by the purchaser. The purchaser assumed the first mortgage and gave the selling petitioner a second mortgage for the difference between the first mortgage and the selling price of the home. The purchase price was payable in monthly installments. Held: Petitioners are entitled to report the income from the sale of their homes on the installment method accounting as provided for in section 453, 1954 Code. Payment in the year of sale did not exceed 30 percent of the selling price. Respondent erred in determining that payments (exclusive of evidences of indebtedness of the purchaser) in the year of sale included the entire amount of the first mortgage assumed by the purchaser.

TRAIN, Judge:

The respondent determined deficiencies in the income tax of petitioners for the years and in the amounts as follows:

+-------------------------------------------------+
                ¦                    ¦Docket No.¦Year  ¦Deficiency¦
                +--------------------+----------+------+----------¦
                ¦Denco Lumber Company¦85529     ¦( 1954¦$79,243.15¦
                +--------------------+----------+------+----------¦
                ¦                    ¦          ¦( 1955¦64,223.74 ¦
                +--------------------+----------+------+----------¦
                ¦                    ¦          ¦      ¦          ¦
                +--------------------+----------+------+----------¦
                ¦Wenco, Inc.         ¦85530     ¦1955  ¦63,954.22 ¦
                +-------------------------------------------------+
                

The sole issue for decision is whether petitioners are entitled to report the sale of certain homes on the installment method of accounting.

FINDINGS OF FACT.

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

The petitioners, Denco Lumber Company (hereinafter sometimes referred to as Denco) and Wenco, Inc. (hereinafter sometimes referred to as Wenco), are Colorado corporations with their principal place of business in Denver, Colorado. The Federal income tax returns of Denco for its taxable years 1954 and 1955 and of Wenco for its taxable year 1955 were filed with the district director of internal revenue, district of Colorado.

During the taxable years, each of the petitioners contemplated engaging in the real estate business of subdividing land into home building sites, constructing low-priced houses on those lots and selling houses and lots to prospective individual home buyers. Before construction, Denco began negotiations with the Colorado Federal Savings and Loan Association (hereinafter referred to as Colorado Savings) for the purpose of obtaining financing. These negotiations resulted in Colorado Savings agreeing to make first trust deed loans, equal to the cost of land and house construction, to Denco on the houses it planned to build. The lending association made such a loan commitment because of its prior satisfactory lending experience with the individual organizers and operators of Denco.

Pursuant to its commitment, Colorado Savings made 20-year first trust deed loans to Denco on 68 of its houses built in 1954 and 56 of its houses built in 1955. Generally, obtaining such loans was delayed as long as possible in order to keep interest costs to a minimum. Some of these loans were made in groups or blocks before home buyers had been procured and as finance money was needed. To evidence each such loan, Denco gave Colorado Savings its promissory note secured by a first trust deed on each house at the time the loan was made. The first trust deed loans bore interest at the rate of 6 percent with principal and interest payable monthly. The amount of each loan was approximately 65 percent of the selling price of the home, the amount of the loan being in excess of the cost of the lot and home. Colorado Savings would not have made such loans to the individual buyers of the Denco homes under these conditions and terms of financing.

Before construction, the organizers of Wenco entered into financing negotiations with Guardian Savings and Loan Association (hereinafter referred to as Guardian Savings). These negotiations resulted in a written commitment by Guardian Savings to make first trust deed loans to Wenco. Originally, the commitment provided for the lending association to approve the credit of buyers of Wenco homes. This requirement proved too severe because the first 15 home buyer applications were rejected by Guardian Savings. Further negotiations were had and as a result thereof Wenco deposited $20,000 with Guardian Savings as a guaranty against any delinquent payments on its first trust deed loans and Guardian Savings then relaxed its credit restrictions on buyer applications. Wenco also agreed to deposit an additional $300 for each house loan made to it.

Pursuant to its commitment and after the $20,000 guaranty fund had been deposited, Guardian Savings made 20-year first trust deed loans to Wenco on 55 of its houses built in 1955. To evidence each loan, Wenco gave Guardian Savings its promissory note secured by a first trust deed on each house at the time the loan was made. These loans bore interest at the rate of 6 percent, with principal and interest payable monthly. Each loan was approximately 65 percent of the selling price of each home, the amount of the loan being slightly in excess of the cost of the house and lot. Guardian Savings would not have made such loans to the individual buyers of Wenco homes under these conditions and terms of financing.

Petitioners entered into the financial arrangements with Guardian Savings and Colorado Savings to make certain that they had adequate financing for the homes they intended to build.

The houses built by Denco in 1954 and 1955 and Wenco in 1955 were low-priced, cheaply constructed frame houses which were built on a mass-production basis. The Denco houses were in a substandard area through which unattractive Weir Gulch ran. The Wenco homes were also in a substandard area; that is, they were in close proximity to industrial plants, railroad tracks, and stockyards.

There were several types of homes built and sold by petitioners. There was a two-bedroom house without a basement, a two-bedroom home with a basement, a three-bedroom house without a basement, a three-bedroom house with a basement, and a split-level house. None of the houses could qualify for VA, GI, or FHA financing. The physical condition of the houses when sold was merely a shell without improvements such as landscaping, incinerators, garbage disposals, storm doors and windows, garages, fences, or clotheslines.

Petitioners were seeking to capture as a market for the sale of their homes the individual home buyer who could not afford to make a downpayment. Generally, these potential buyers could not qualify for home loans because of poor credit or lack of financial security or both. Petitioners advertised these homes for sale on the basis of (1) no downpayment (2) minimum monthly payments at less than rent, and (3) the buyer being allowed income tax deductions for the interest and taxes included as part of their monthly payments.

Interested buyers made application to either Denco or Wenco. Their requirements were that the potential buyer have a job, no marital difficulties, and be able to make installment payments of $75 to $90 per month depending upon the size and type house selected. If the applicant appeared to be a potential buyer, the respective petitioner would obtain a credit report.

In 1954 Denco built and sold 68 homes with an aggregate selling price of $684,900 and 56 such houses in 1955 with an aggregate selling price of $572,500. In 1955 Wenco built and sold 55 homes with an aggregate selling price of $556,865.

With respect to 67 of the Denco houses sold in 1954 and 50 houses sold in 1955, where the deeds were given to the individual buyers at the time the homes were sold, the transactions were handled as follows:

The buyer entered into a purchase contract and deposited with the real estate selling agent a nominal amount of cash, together with a note in a nominal amount to pay closing costs. At the time of closing, Denco executed its deed subject to the existing first trust deed, special improvement taxes, and Alsher Sewer lien, conveying the house and lot to the individual buyer. The purchaser made no cash downpayment but paid all of part of the closing costs. The purchaser assumed and agreed to pay the existing first trust deed which Denco had obtained from Colorado Savings on the property. The buyer also agreed to pay outstanding special improvement taxes for installation of streets, curbs and gutters, and the Alsher Sewer lien. The purchaser then gave Denco his promissory note, secured by a second trust deed for the balance of the selling price.

With respect to 44 of the Wenco homes sold in 1955, where the deeds were given to the individual buyers at the time the homes were sold, the transactions were handled as follows: At the time of the sale, Wenco executed its deed subject to the existing first trust deed and the Alsher Sewer, conveying the house and lot to the individual buyers; the buyers made no cash downpayment but paid the closing costs; the buyers assumed and agreed to pay the existing first trust deed loan that Wenco had previously obtained from Guardian Savings; the buyers agreed to pay the Alsher Sewer lien; the buyers then gave Wenco their promissory note, secured by a second trust deed on the house for the balance of the selling price.

The buyers of the Denco houses normally...