Joe Kelly Butler, Inc. v. Comm'r of Internal Revenue
| Decision Date | 29 September 1986 |
| Docket Number | 33799-84.,Docket Nos. 13069-79 |
| Citation | 87 T.C. 734,87 T.C. No. 44 |
| Parties | JOE KELLY BUTLER, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner made a bulk sale of assets which included personal property and real property. The real property was encumbered by a mortgage that exceeded the basis of petitioner in the real property. The mortgage was assumed by the purchaser as part of the consideration. HELD: For installment reporting purposes, the mortgage in excess of the aggregate basis of all the assets sold is a payment in the year of sale and the sale qualifies for the installment method of reporting. Rudy M. Groom, Andrew W. Miller, and Lawrence E. Naiser, for the petitioner.
Janet R. Kluth, for the respondent.
The Commissioner determined deficiencies in petitioner's Federal income tax as follows:
+----------------------------+
¦Docket No.¦Year¦Deficiency ¦
+----------+----+------------¦
¦13069-79 ¦1974¦$459,559.02 ¦
+----------+----+------------¦
¦ ¦1975¦41,505.09 ¦
+----------+----+------------¦
¦33799-84 ¦1977¦77,067.77 ¦
+----------+----+------------¦
¦ ¦1978¦1,039.95 ¦
+----------------------------+
After concessions, the sole issue remaining for decision is whether petitioner is entitled to use the installment method to report gain attributable to the sale of real property sold as part of a bulk sale of assets.
This case was submitted fully stipulated under Rule 122. 1 The stipulation of facts and stipulated exhibits are incorporated herein by this reference.
Joe Kelly Butler, Inc. (petitioner), was a Texas corporation during the years in issue. Petitioner's principal place of business was Houston, Texas, at the time of the filing of the petitions in this case. Petitioner filed its Federal income tax returns for the taxable years 1974, 1975, 1977, and 1978 with the Internal Revenue Service Center in Austin, Texas.
In 1947, petitioner acquired 15.73 acres of land in Harris County, Texas, for $14,676. Petitioner constructed improvements on the land during the years 1947 through 1973 at a cost of $166,918 and deducted depreciation during those years of $50,676.
On December 4, 1972, petitioner borrowed $875,000 from Great Commonwealth Life Insurance Company of Dallas, Texas, and pledged the land as collateral. The proceeds of the loan were used by petitioner for working capital or to repay prior loans for which the land had been pledged as collateral.
On October 1, 1974, petitioner sold various assets, including the land, to Mitchell Energy Corporation (Mitchell) for a total consideration of $6,401,345. The consideration consisted of $246,900 in cash, a $5,357,538 promissory note, and the assumption of the promissory note encumbering the land. The principal balance remaining on the assumed note was $796,907.
The Sales Agreement provided:
THIS AGREEMENT dated the 17th day of September, 1974, between BUTLER DRILLING COMPANY 2 (hereinafter referred to as ‘Butler‘), * * * and MITCHELL ENERGY CORPORATION, a Texas corporation, with offices at 3900 One Shell Plaza, Houston, Texas (hereinafter referred to as ‘Mitchell‘);
W I T N E S S E T H:
SECTION 1.1. Subject to the remaining provisions of this Agreement, Butler, * * * agrees to sell and convey to Mitchell (or to such affiliated corporations of Mitchell as Mitchell may designate at the closing) and Mitchell agrees to purchase * * * the entire operating assets described * * * in Exhibit ‘A‘ which is attached hereto and incorporated herein for all purposes (which are herein called the ‘Properties‘). * * *
SECTION 1.2. Subject to the remaining provisions of this Agreement, Mitchell agrees to pay the sums set forth below * * * :
(a) BUTLER. Mitchell hereby agrees to purchase the assets of Butler as set forth on Exhibit ‘A‘ for a total purchase price of $5,604,438, subject to adjustment in accordance with Sections 1.8 and 1.9 of this Agreement. Said consideration shall be payable as follows:
(i) Mitchell shall pay to Butler at closing the sum of $246,900 in cash (Mitchell's $75,000.00 payment deposited with the letter of intent dated August 2, 1974, shall be credited toward this payment); and
(ii) Mitchell shall deliver to Butler at the closing its promissory note payable to Butler in the total principal amount of $5,357,538 containing the provisions set forth in Section 1.5 of this Agreement and secured as set forth in Section 1.6 of this Agreement.
SECTION 1.4. The Mitchell affiliated corporation receiving title to the 15.73 acres of land described in Exhibit ‘D‘ will assume the outstanding balance at closing of that certain promissory note in the original principal sum of $875,000.00, dated December 4, 1972, executed by Butler Drilling Company and payable to the order of Great Commonwealth Life Insurance Company, Dallas, Texas, secured by a deed of trust covering said land; the balance of said promissory note at October l, 1974, will be no more than $796,906.72.
The parties agree that the fair market value on September 17, 1974, of each category of property sold was as follows:
+---------------------------------+
¦Land ¦$1,268,585¦
+----------------------+----------¦
¦Building ¦478,322 ¦
+----------------------+----------¦
¦Furniture and fixtures¦72,000 ¦
+----------------------+----------¦
¦Equipment ¦11,976 ¦
+----------------------+----------¦
¦Drilling rigs ¦4,570,462 ¦
+----------------------+----------¦
¦Total ¦6,401,345 ¦
+---------------------------------+
The cost, expenses of sale, accumulated depreciation, and adjusted basis of each category of property sold was as follows:
+-----------------------------------------------------------------------+
¦ ¦ ¦Expenses ¦Accumulated ¦Adjusted basis¦
+----------------------+---------+----------+------------+--------------¦
¦ ¦Cost ¦of sale ¦depreciation¦as of 10/1/74 ¦
+----------------------+---------+----------+------------+--------------¦
¦Land ¦$14,676 ¦$46,450 ¦0 ¦$14,676 ¦
+----------------------+---------+----------+------------+--------------¦
¦Building ¦166,918 ¦9,764 ¦$50,676 ¦116,242 ¦
+----------------------+---------+----------+------------+--------------¦
¦Furniture and fixtures¦73,395 ¦4,260 ¦48,641 ¦24,754 ¦
+----------------------+---------+----------+------------+--------------¦
¦Equipment ¦26,904 ¦708 ¦24,214 ¦2,690 ¦
+----------------------+---------+----------+------------+--------------¦
¦Rigs ¦2,003,284¦270,444 ¦1,330,463 ¦672,821 ¦
+----------------------+---------+----------+------------+--------------¦
¦Total ¦2,285,177¦1 331,626¦1,453,994 ¦831,183 ¦
+-----------------------------------------------------------------------+
Petitioner elected to report the gain on the sale of the assets to Mitchell using the installment method. In the year of sale petitioner recognized $27,155 as income from the sale of the real property. It is unclear exactly how petitioner calculated this amount but it is presumably some percentage of the cash received. It is clear, however, that petitioner did not treat the amount of the mortgage assumed by Mitchell in excess of the basis of the real property as a payment in the year of sale. In subsequent years, petitioner increased the gross profit percentage to an amount in excess of 100 percent in order to recognize as income the excess of the mortgage assumed over the basis of the real property.
The Commissioner, in his statutory notices of deficiency, determined that the portion of gain attributable to the sale of the real property did not qualify for reporting under the installment method because more than 30 percent of the purchase price was received in the year of sale. The Commissioner calculated the payments received by petitioner in the year of sale with respect to the real property as follows:
+------------------------------------------------------------+
¦Mortgage assumed ¦$796,907 ¦
+-------------------------------------------------+----------¦
¦Less: Adjusted basis ¦1 187,132¦
+-------------------------------------------------+----------¦
¦Mortgage over adjusted basis ¦609,775 ¦
+-------------------------------------------------+----------¦
¦Cash received ¦41,851 ¦
+-------------------------------------------------+----------¦
¦Total payments ¦651,626 ¦
+-------------------------------------------------+----------¦
¦Total sale price ¦1,746,907 ¦
+-------------------------------------------------+----------¦
¦Percentage of sale price received in year of sale¦37% ¦
+------------------------------------------------------------+
If the mortgage assumed is compared to the aggregate basis of all the assets sold there is no mortgage in excess of basis and the percentage of the purchase price received in the year of sale does not exceed 30 percent.
The statutory provisions permitting the installment method of reporting income were enacted because when sales are made on the installment basis, application of the cash or accrual basis of reporting creates a hardship. Payment of the entire tax on the profit may be required in a single year, even though the seller receives little or none of the selling price at that time. If the entire gain is taxed in that year the seller might well be faced with a substantial tax without having a sufficient portion of the sales proceeds available to pay the tax. The installment reporting privilege is designed to alleviate this potential hardship by spreading the tax over the periods in which sales proceeds are received....
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