Frazier v. Commissioner
| Decision Date | 03 July 1975 |
| Docket Number | Docket No. 9145-72. |
| Parties | Frederick M. Frazier and Alicia Frazier v. Commissioner. |
| Court | U.S. Tax Court |
Paul R. Hodgson, Harvard Tower, Tulsa, Okla., and James R. Hays, for the petitioners. Randolph A. Monsur, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined a deficiency in petitioners' Federal income tax for the taxable year 1969 in the amount of $278,919.24. The issues for decision are:
(1) Whether the Commissioner abused his discretion under section 482 of the Code1 in allocating to Petitioner Frederick M. Frazier gain from the sale of his interest in appreciated real property distributed to him by a partnership of which he was a 50 percent partner and transferred by him to wholly owned corporations having large net operating losses who, within 26 days, sold such interests to a major creditor of the corporations at a substantial gain;
(2) The year of worthlessness of corporate stock; and
(3) Whether losses sustained by Petitioner Frederick M. Frazier in connection with a guaranty and advance to his wholly owned corporations are deductible as business bad debts or nonbusiness bad debts or whether they represent contributions to capital. Also involved is the year of worthlessness.
Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated by this reference.
Frederick M. and Alicia Frazier, husband and wife, filed their joint Federal income tax returns for the taxable years 1969 and 1970 with the Internal Revenue Service Center, Austin, Texas. They resided in Bella Vista, Arkansas, at the time they filed their petition.
Petitioner Frederick M. Frazier (hereinafter petitioner) entered the real estate construction industry in 1953 and since that time has been actively engaged in such business activity in his individual capacity, as a partner in various general real estate partnerships, and as a corporate shareholder. A good credit rating and reputation was required in the construction and real estate investment business which relied heavily on borrowed funds. It was the general practice of the construction industry and the institutions petitioner dealt with to deny credit to an individual who controlled a corporation unable to pay its debts.
Petitioner was, at all times material herein, the sole shareholder, president and manager of Beck Homes Company, Inc., (hereinafter Beck Homes) and Southside Cabinet Company, Inc., (hereinafter Southside Cabinet). Beck Homes filed its Federal income tax returns for taxable years ending May 31 and was in the business of residential and commercial construction in the Tulsa, Oklahoma, area. Southside Cabinet filed its Federal income tax returns for taxable years ending November 30 and was in the business of cabinet manufacturing and wood trim work on residential property with Beck Homes as its principal customer.
Tulsa Rig, Reel and Manufacturing Co., Inc. (Tulsa Rig) was the primary supplier of lumber to Beck Homes from 1958 to 1970, having sold to it between a million to a million and a half dollars worth of lumber. Tulsa Rig guaranteed a $300,000 line of credit for Beck Homes at Farmers and Merchants Bank (F & M Bank) in Tulsa.
During 1968 or 1969, it became apparent to Tulsa Rig that Beck Homes was having difficulty in making its payments to F & M Bank on the line of credit guaranteed by Tulsa Rig and in making its payments to Tulsa Rig for lumber purchases. Accordingly, on or about the same time, Tulsa Rig terminated the line of credit at F & M Bank. In early September 1969, Tulsa Rig and petitioner discussed the possible use of Harvard Towers to aid Beck Homes with its financial problems. Harvard Towers was a commercial office building and shops owned and operated by Frazier-Baker Properties, a partnership in which petitioner was a 50 percent owner. Harvard Towers had been constructed by the partnership on February 9, 1965.
Tulsa Rig did not consider the purchase of Harvard Towers as an investment but rather as a method to obtain repayment of its debts from Beck Homes and Southside Cabinet. In its negotiations, Tulsa Rig did not demand that petitioner transfer Harvard Towers to Beck Homes and Southside Cabinet prior to its purchase, but it did consider a transfer to the corporations and a purchase directly from them to be a means to insure that the proceeds of the purchase would be applied to satisfy the indebtedness to Tulsa Rig.
On August 29, 1969, petitioner withdrew his 50 percent partnership interest in Harvard Towers from the Frazier-Baker Properties partnership and on September 4, 1969, transferred nine-tenths of that interest to Beck Homes and the remaining one-tenth to Southside Cabinet. The ratios were based, in part, upon the net operating losses of each corporation. The transfer was accompanied by an assumption by Beck Homes and Southside Cabinet of their proportionate shares of $812,899.72 in liabilities encumbering petitioner's interest in Harvard Towers. The board of directors minutes of Beck Homes and Southside Cabinet dated September 3, 1969, describe the transfer of Harvard Towers from petitioner to the corporations as a "contribution to capital." At the time of the transfer, petitioner's basis of his one-half interest in Harvard Towers was $676,387.57. On October 9, 1969, Beck Homes and Southside Cabinet entered into a contract to sell their respective interests in Harvard Towers to Tulsa Rig with October 1, 1969, being the effective date of the sale in order to facilitate the allocation of rents and related items. Harvard Towers was never offered for sale by petitioner or by Beck Homes-Southside Cabinet to anyone other than Tulsa Rig. Beck Homes received $382,500 in cash from Tulsa Rig and, upon Tulsa Rig's assumption of Beck Homes' share of the Harvard Towers liability, Beck Homes reported a realized gain of $382,384.80. Southside Cabinet received $42,500 in cash and, upon Tulsa Rig's assumption of Southside Cabinet's share of the Harvard Towers liability reported a realized gain of $42,487.20.
Although the drafted agreements for the sale of Beck Homes' and Southside Cabinet's interests in Harvard Towers did not contain any specific requirements concerning the use of the proceeds from the sale, $220,858.03 of the $382,500 proceeds received by Beck Homes from Tulsa Rig was paid to F & M Bank closing out Beck Homes' loan accounts with the bank. In addition, other creditors of Beck Homes were satisfied from the Harvard Towers sale proceeds, including Tulsa Rig, to the extent of $114,343.60. The $42,500 of sale proceeds received by Southside Cabinet were used for its operations. Petitioner, at that time, had outstanding a substantial account receivable for advances he had made to Beck Homes, none of which was satisfied out of the sales proceeds from the sale of the Harvard Towers interest to Tulsa Rig.
Petitioner would have transferred additional property to the corporations to aid them in meeting the demands of creditors but he had no property other than Harvard Towers. On their 1969 Federal income tax return, petitioners reported a gain of $136,512.05 taxable as ordinary income with the description "Sale under IRC Sec. 1239."
Petitioner had a basis of $450 in the stock of Southside Cabinet. Beck Homes originally issued three shares of stock to petitioner and three shares to Arthur W. Beck, Jr., at $100 per share. Arthur W. Beck, Jr.'s three shares were acquired as treasury stock on or about November 30, 1964 for $103,271.97, and petitioner's three shares were the only issued and outstanding stock during the years in question. The paid-in capital account for Beck Homes from September 30, 1958 through the years in question reflects the following activity:
BECK HOMES COMPANY, INC
Paid-in Capital
September 1958 through February 28, 1971
FROM
9/30/58 Transfer from Folio Arthur Fred M. CREDIT
Beck Homes Co. Ref. W. Beck Frazier Amount Balance
(Partnership) JR-1 $29,033.27 $29,033.27 $58,066.54 $58,066.54
9/30/59 CR-4 1,766.73 1,766.73 3,533.46 61,600.00
11/30/59 JR-12 7,000.00 7,000.00 14,000.00 75,600.00
4/30/60 CR-12 550.00 550.00 1,100.00 76,700.00
5/31/60 CR-13 187.50 187.50 375.00 77,075.00
7/31/60 CR-2 387.88 387.88 775.76 77,850.76
10/31/60 CR-6 800.00 800.00 1,600.00 79,450.76
__________ __________ __________ __________
$39,725.38 $39,725.38 $79,450.76
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During 1965 petitioner advanced $60,000 to Beck Homes and during 1968 he advanced an additional $60,000. There were no notes, no security, no provisions for the payment of interest and no date set for repayment of either $60,000 advance. Of the $120,000 advanced, petitioner withdrew $37,012.60 from Beck Homes prior to December 31, 1970, thereby leaving a balance on December 31, 1970, of $82,987.40. On January 9, 1971 petitioner received an additional $600 reducing the balance to $82,387.40. On August 29, 1969, Tulsa Rig lent Beck Homes $75,000 on a note personally guaranteed by petitioner and secured by a mortgage on real property owned by petitioner. The $75,000 Tulsa Rig loan was used by Beck Homes to pay some of its creditors including $50,287.15 paid to Southside Cabinet who in turn used the $50,287.15 to pay its creditors. Petitioner did not expect to recover any money or property from...
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