Kelly v. Comm'r of Internal Revenue

• Decision Date: 20 January 1955
• Docket Number: Docket No. 37943. fIled January 24,1955
• Parties: DANIEL S. W. KELLY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

23 T.C. 682

DANIEL S. W. KELLY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 37943. fIled January 24

1955

Tax Court of the United States.

Harvey W. Peters, Esq., for the petitioner.

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

1. Petitioner brought suit against his sister in 1947 to perfect title to an undivided one-half interest in certain rental properties and to recover money advanced to pay the mortgage indebtedness on the properties. In connection with this suit petitioner incurred expenditures in 1947 for legal fees and expenses. Held, those portions of the expenditures attributable to the perfection of title to the properties and the recovery of loan principal are capital expenditures and are not deductible under section 23(a)(2), Internal Revenue Code of 1939. Held further, that expenditures allocable to the recovery of interest and rental income are deductible under section 23(a)(2).

2. The expenditure for rental of a safety-deposit box wherein investment securities were kept in 1947 is deductible under section 23(a)(2), Internal Revenue Code.

The respondent determined a deficiency in income tax of the petitioner for the year 1947 in the amount of $1,447.11. The issues for determination are whether (1) legal fees, travel, and out-of-pocket expenses incurred in connection with a lawsuit between petitioner and his sister, and (2) rental of a safety-deposit box amounting to $9.60 are deductible as ordinary and necessary expenses paid during the taxable year ‘for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income’ within the meaning of section 23(a)(2), Internal Revenue Code of 1939.

FINDINGS OF FACT.

Some of the facts are stipulated and are found accordingly. Other facts are found from the evidence.

The petitioner is an individual with his residence at Milwaukee, Wisconsin. He kept his books and filed his income tax returns upon the cash method of accounting. His return for the taxable year 1947 was filed with the collector of internal revenue for the district of Wisconsin.

In that return petitioner included as a miscellaneous deduction $2,231.10 for attorneys' fees and expenses. The legal fees amounting to $1,823.75 were expended in 1947 in conjunction with a suit brought by petitioner against his sister, Ilma Kelly Gram. These payments were on account and did not by the close of that calendar year equal attorneys' charges for services rendered up to that time, nor was any part of the payments for services rendered in conjunction with the subsequent appeal to the South Dakota Supreme Court. In addition, during the year 1947, petitioner expended $407.35, representing the cost of travel, hotel, meals, and incidentals for himself and wife and some meals for his attorneys, all in connection with the preparation and trial of the above litigation.

The litigation between petitioner and his sister grew out of a controversy over land which had originally belonged to Robert L. Kelly, their father. Robert L. Kelly owned certain rental properties in South Dakota which he deeded to Ilma Kelly Gram in 1929 and 1930. The father retained the deeds in his possession and exercised complete control and possession of the properties until his death in 1934. After the death of the father petitioner and Ilma had the deeds recorded, with Ilma remaining as sole grantee. They treated the properties as being jointly owned and opened a joint bank account for the rental income. Before and after the death of the father petitioner supplied money totaling $5,000 to pay on mortgages against the properties. No evidence of debt or security therefor was received by petitioner. Ilma used income from the properties to apply on the advances made by petitioner. The sums received by petitioner were applied against the principal. They were not treated as interest.

In 1944 Ilma transferred the properties through a third party to her husband and herself, as joint tenants. Petitioner learned of the transfer in 1945, and filed a complaint against his sister in the Sixth Judicial Circuit Court of South Dakota, asking that he be declared the owner of a one-half interest in the properties and that he be given judgment for $4,835.92, representing money loaned his father and payment of mortgage indebtedness.¹ The trial thereof began on March 27, 1946, and decision was entered June 16, 1947, wherein the trial court granted petitioner judgment against his sister in the amount of $6,311.45, being the balance of loans advanced in the amount of $3,059.77 and interest thereon, but denied that petitioner had a one-half interest in certain real properties, or in the net income that had been realized from said properties.

Subsequently petitioner appealed to the Supreme Court of South Dakota that part of the decision of the Sixth Judicial Circuit Court which denied him a one-half interest in the rental properties and a one-half interest in the accumulated net income therefrom. No appeal was taken by Ilma from the money judgment against her. The Supreme Court of South Dakota reversed the judgment of the trial court which had denied petitioner an interest in the rental properties or the rental income therefrom, on the ground that Ilma Kelly Gram was estopped to deny that she had title to one-half of the property in trust for petitioner. (Kelly v. Gram, 73 S.D. 11, 38 N.W.2d 460 (July 19, 1949).) Subsequently, on October 16, 1950, pursuant to a stipulation of settlement of that action, petitioner acknowledged receipt from his sister of $11,129.57 in cash and warranty deeds for an undivided one-half interest in certain real estate described therein. The real estate interest had a fair market value of $15,000. Of the cash received, $3,059.77 represented loan principal and $4,514.34 interest thereon; $2,993.91 ($1,681.48 plus $1,312.43) represented rental income on the real estate in litigation; and $561.55 was for court costs.

In addition to the attorneys' fees and expenses petitioner included as a deduction $9.60 for rental of a safety-deposit box wherein he kept his Series E Bonds.

Respondent disallowed both deductions.

OPINION.

BRUCE, Judge:

The principal question to be determined herein is whether attorneys' fees, travel, and out-of-pocket expenses, incurred in connection with a suit instituted by the petitioner to recover a one-half interest in certain real estate, legal title to which was in his sister, and to recover money advanced to his father or paid subsequent to his death on mortgage indebtedness, together with accumulated rentals and interest,² are deductible as ordinary and necessary expenses paid during the taxable year ‘for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income,‘ with the meaning of section 23(a) (2) of the Internal Revenue Code of 1939.³

Respondent contends that the entire sum of $2,231.10 was incurred in perfecting title to property or in recovering property and therefore constituted a part of the cost of the property which is not deductible under section 23(a)(2).

Petitioner argues, first, that the total expenditures for legal fees and expenses were incurred solely for the recovery of his own funds theretofore advanced as loans together with interest, and, consequently, that he is entitled to deduct (1) that portion of his expenditures attributable to the recovery of interest as an ordinary and necessary expense paid for the collection of income, and (2) the balance as an ordinary and necessary expense for the management, conservation, or maintenance of property held for the production of income. Petitioner bases this contention on the fact that the trial court in 1947 gave him judgment only for the loan principal and interest thereon, and because none of his expenditures related to the appeal to the Supreme Court of South Dakota where he was held entitled to a one-half interest in the real property.

We agree with petitioner that, insofar as it may be allocated, the portion of the expenditures attributable to the recovery of interest may be deducted as an ordinary and necessary expense. (Discussed infra.)

We do not agree, however, that the total expenditures were incurred solely for the recovery of these two items. The deductibility of the legal fees and expenses here involved is to be determined from the character of the suit in connection with which they were expended, the nature of the relief sought, and not merely the relief granted. Title to the rental properties was not only an issue in the suit before the Sixth Judicial Circuit Court of South Dakota in 1947, but it was the principal issue and was in fact determined, though adversely to petitioner, when the trial court decided that petitioner did not have a one-half interest in the property. It is well established that expenditures made to perfect or acquire title to property are capital expenditures which constitute a part of the cost or basis of the property. Garrett v. Crenshaw, 196 F.2d 185; Bowers v. Lumpkin, 140 F.2d 927; E. W. Brown, Jr., 19 T.C. 87, affirmed as to this point (C.A. 5) 215 F.2d 697; Virginia Hansen Vincent, 18 T.C. 339, on appeal (C.A. 9).

We do not understand petitioner to disagree with this principle, but, rather, to contend that it is not applicable under the facts and circumstances of this case. We cannot agree. The authorities relied upon by petitioner are, in our view, distinguishable. In Allen v. Selig, 200 F.2d 487, affirming 104 F.Supp. 390, the decision was based upon the fact that the taxpayer had, and was recognized as having, a full equitable title to a half interest in the real property involved and therefore acquired nothing except the determination (in the judgment) that she was the equitable owner and a decree requiring the holder of the naked legal title to divest himself of, and invest her with, it. The circumstances...