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

• Decision Date: 30 January 1948
• Docket Number: Docket No. 5641.
• Citation: 10 T.C. 175
• Parties: HOLLYWOOD, INC., A FLORIDA CORPORATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

10 T.C. 175

HOLLYWOOD, INC., A FLORIDA CORPORATION, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 5641.

Tax Court of the United States.

Promulgated January 30, 1948.

Petitioner's acquisition of property from two transferor-stockholders in exchange for its obligation to pay for the properties what it received upon sale up to an agreed amount, held to create a basis of its cost, the transaction not constituting a tax-free exchange under Internal Revenue Code, section 112(b)(4) or (b)(5), nor a capital contribution under Internal Revenue Code, section 113(a)(8)(B). Douglas D. Felix, Esq., for the petitioner.

Edward L. Potter, Esq., for the respondent.

Respondent determined deficiencies of $1,092.14 and $1,136.83 in petitioner's income and declared value excess profits taxes, respectively, for the year 1939.

The single issue is the proper basis for computing petitioner's gain or loss from the sale or other disposition of certain properties obtained under a contract dated January 22, 1931.

The record consists of a stipulation of facts and exhibits thereto and some oral testimony.

FINDINGS OF FACT.

The stipulated facts are hereby found accordingly.

Petitioner, a Florida corporation, filed its tax return, prepared on an accrual-calendar year basis, with the collector for the district of Florida.

It was created as a result, and pursuant to the terms, of a written contract dated January 22, 1931, the parties to which were the Highway Construction Co. of Ohio, Inc., an Ohio corporation, hereinafter sometimes referred to as Highway, and Mercantile Investment & Holding Co., a Florida corporation, hereinafter sometimes referred to as Mercantile. The purpose of the contract was to reconcile the apparently conflicting rights of the contracting parties to various properties situated in Hollywood, Florida.

Hollywood is a city which was planned and developed by J. W. Young some time prior to 1925; in this effort he created various corporations to perform specific services. The major developmental work was accomplished in three or four years, and in 1925 the city had a ‘year-round‘ population of from 25,000 to 30,000.

Highway, through an assignment of contracts, was engaged to construct various sidewalks and street pavements in the city. Immediately after the hurricane of September 1926, the Florida ‘boom‘ having collapsed, defaults occurred in payments due under the contract. Highway's attorneys advised it to file liens to secure the amounts unpaid. That procedure was followed and Highway also filed foreclosure suits in chancery and common law actions in damages for breach of contract. Young, acting for his companies, asked for an extension of time. It was granted on his promise to make certain specified payments. He defaulted in these payments and after many conferences he agreed that a certain amount of damages had been sustained by Highway; that Highway should file a suit setting forth the amount then due for work performed and the amount of such damages; and that he would sign answers admitting the amounts alleged in the petitions. The answers were delivered to a trustee to be filed upon Young's further default.

Young and his companies continued to default. Thereupon, after considerable litigation designed to prevent the delivery and filing of the answers, the answers were filed and two judgments were entered in favor of Highway for $1,532,654.56 and $608,569.14, respectively, in the Broward County (Florida) court. When these judgments were entered the defendants held title to 25,000 or more lots in Hollywood and additional acreage adjoining that city.

Mercantile was organized in 1929 primarily to purchase mortgages on, and through foreclosure to acquire the Hollywood Beach Hotel, one of Florida's largest, and the Hollywood Golf Course. Later its activities were enlarged by securing tax certificates and mortgages on other properties, which were subject to Highway's judgment liens.

Because of these conflicting interests, and the resulting differences, each realized that some plan for their mutual benefit should, if possible, be formulated. Mercantile thereupon offered to purchase Highway's interest in the Young properties for $2,000,000, or to sell its interest for $1,250,000. Highway was not financially able to purchase and was unwilling to sell, as it considered its interest in the properties it had already acquired and in the additional properties to be acquired through its judgment liens to be worth much more than the offered sum.

After about a year of further bargaining, the parties in 1931 finally agreed to organize a new company— the petitioner— and entered into the aforesaid agreement, in which petitioner' function was described as follows :

Sub-Par. (I) That the new company shall, as soon as may be after its formation and organization, proceed, without sacrifice of its assets and property, to liquidate the properties and assets which shall be transferred, set over and delivered to it hereunder; and that the proceeds of such liquidation shall, when and as available for such purpose, be disbursed and distributed in accordance with the following schedule:

First: There shall first be repaid to the Mercantile Company and the Construction Company pro rata in proportion to the sums advanced or expended by them, such sum or sums, from time to time, as will reimburse them for the amount or amounts already or hereafter advanced or expended by them pursuant to the provisions of paragraph (H) hereof. As an illustration of what is meant by ‘pro rata proportion,‘ if it be assumed that the Mercantile Company has advanced or expended $110,000.00 and the Construction Company has advanced or expended $10,000.00, then for every $1.00 repaid or reimbursed to the Construction Company, there shall be repaid or reimbursed to the Mercantile Company $11.00. There shall also be repaid all money borrowed pursuant to the provisions of paragraph (H) hereof. The repayment of the money so borrowed may precede the repayment or reimbursement to the parties hereto, provided both parties mutually agree thereto. All sums of money expended and advanced prior to the date of the execution of this agreement shall bear interest at six per cent per annum from December 1, 1930. All other sums hereafter advanced by both parties pursuant to paragraph (H) shall bear interest at the rate of six per cent per annum from the date of the advancement thereof.

Second: After repayment provided for in the next preceding sub-paragraph designated ‘First‘ shall have been fully made, there shall be paid to said Mercantile Company the principal sum of $115,461.12, together with interest on said principal sum at 6 per cent per annum from the 1st day of December, 1930, until paid, (which principal sum is the total amount, for principal and interest, remaining unpaid and due to said Mercantile Company on the three mortgages described in sub-paragraphs (a), (b) and (c) of paragraph 8 hereof) and which sum, whether true or not, is agreed to as the principal sum for payment to the Mercantile Company on said mortgages under the provisions of this paragraph; and to said Construction Company the principal sum of $171,100.50, together with interest on said principal sum at 6 per cent per annum from the 1st day of December, 1930, until paid, (which principal sum is the aggregate amount of the sums for principal and interest remaining unpaid on the liens of the Construction Company described in paragraphs numbered 4, 5, and 6 hereof,) and which sum, whether true or not, is agreed to as the principal sum for payment to the Construction Company on said liens under the provisions of this paragraph; the payments to be made pursuant to this sub-paragraph shall be made on a pro rata basis.

Third: There shall, after the payments provided for in the preceding sub-paragraphs designated ‘First‘ and ‘second‘ have been fully made, be paid to the Construction Company the sum of $2,000,000.00, without interest, (which is the agreed amount of the judgments described in paragraphs 2 and 3 hereof), and which sum, whether true or not, is agreed to as the sum for payment to the Construction Company under the provisions of this paragraph; and to the Mercantile Company the sum of $500,000.00, without interest, (which is one-fourth of the agreed amount of said judgments), and which sum, whether true of not, is agreed to as the sum for payment to the Mercantile Company under the provisions of this paragraph; the payments to be made pursuant to this sub-paragraph, however, shall be made on a pro rata basis.

After the payment in full of all such sums Mercantile agreed to secure the assignment to Highway of the capital stock owned by it but held by its nominees upon the reimbursement to Mercantile, or its representatives, of the amounts paid for such stock.

Pursuant to the terms of the agreement, petitioner was formed, with an authorized capital of 100 shares of no par value. The price of the stock thereafter being set at $20 per share, Mercantile and Highway each received 50 shares upon the payment of $1,000 therefor. Highway, on or about February 18, 1931, delivered to petitioner a fee simple deed conveying many hundreds of lots identified on the map accompanying the stipulation in this proceeding. Highway acquired title to this land by sheriff's deeds under judgments as set forth in the contract of January 22, 1931. Highway, on or about July 5, 1932, also transferred to petition all of the capital stock of New Rivers Enterprises, Inc.

Highway did not report on its tax returns as income any amount represented in the judgments for anticipated profits or damages.

As one of its obligations under the agreement, Mercantile proceeded to foreclose the mortgages and other liens described therein during the period from January 22, 1931, to about September 17, 1935. As such foreclosures were completed and as it acquired title to the lots encumbered by its liens, it...