Kirschenmann v. Comm'r of Internal Revenue
| Decision Date | 26 January 1972 |
| Docket Number | 4928-69.,Docket Nos. 4901-69,4914-69— 4916-69 |
| Citation | 57 T.C. 524 |
| Parties | WALTER KIRSCHENMANN AND ROHNA KIRSCHENMANN, ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Curtis Darling and Bruce Maclin, for the petitioners.
Richard L. Bacon, Robert H. Feldman, and Stephen B. Zorick, Jr., for the respondent.
A partnership sold real estate in which it had an adjusted basis of $98,509.36 for a total price of $432,000 and incurred selling expenses of $23,378.42. The purchaser assumed an existing mortgage of $160,000, paid cash of $80,011.54, and gave a note for the balance of $191,988.46. Held, the amount of the mortgage assumption in excess of the basis must be included in the payments received in the year of sale, sec. 1.453-4(c), Income Tax Regs., and the selling expenses may not be added to the basis; therefore, petitioners, members of the partnership, do not meet the requirements of sec. 453, I.R.C. 1954, for reporting the gain from the sale under the installment method.
Respondent determined deficiencies and overassessments in petitioners' Federal income tax as follows:
The issues for decision are as follows:
(1) Whether, for the purpose of determining a seller's qualifications for the installment sale provisions of section 453,2 the amount by which an assumed mortgage exceeds the seller's basis must be included in the payments received in the year of sale; and
(2) Whether, for purposes of determining petitioners' qualifications for the installment sale provisions of section 453, the seller's selling costs must be offset against gross profit or may be added to the seller's basis.
All the petitioners in these proceedings were legal residents of California at the time they filed their respective petitions. They timely filed their Federal income tax returns for each of the years in controversy with the district director of internal revenue, Los Angeles, Calif.
Adolf and Bertha Kirschenmann were the parents of Walter Kirschenmann, Lenora Preszler, and Ruth Handel. (For convenience these persons will usually be referred to by their first names.) In 1957, Ruth and Otto Handel, as grantors, created the O. D. Handel Trust for the benefit of their children, Dennis Handel and Janice Handel Vanatta. Bertha died in 1959, and Adolf was named trustee of her estate. Adolf subsequently remarried.
The facts, all stipulated, show that in 1964 A-K Associates (hereinafter A-K), a family partnership, was organized under the laws of California. Its principal business involved rental properties. During the period in issue, Walter, Edwin Preszler, and the O. D. Handel Trust each owned a 25-percent interest in A-K, and Adolf and the Estate of Bertha Kirschenmann each owned a 12.5-percent interest therein.
In 1965, A-K sold a farm in Cuyama, Calif., for a total price of $432,000. The farm was a capital asset in the hands of the partnership, and the gain realized from the sale qualified as long-term capital gain. Neither A-K nor any of its partners was a dealer with respect to the real estate in issue.
A-K's original cost in the property was $304,552.22; depreciation had been claimed in the amount of $206,042.86, leaving an adjusted basis of $98,509.36. A-K's selling expenses in connection with the sale amounted to $23,378.42. At the time of the sale, the farm was encumbered by a mortgage in the amount of $160,000; this mortgage was assumed by the buyers as part of the purchase price. In addition, A-K received cash in the year of sale in the amount of $80,011.54. The balance of the purchase price was represented by a note in the amount of $191,988.46 secured by the property and payable with interest over a period of years.
A-K elected to report its gain from the sale of the farm in its partnership return for 1965 under the installment method provided by section 453. In computing its gain from the sale, A-K added its selling expenses to its depreciated basis in the property to arrive at a total adjusted basis of $121,887.78 and subtracted this amount from the total price of $432,000 to calculate its total gain from the sale at $310,112.22. The partnership treated the total contract price as equal the total amount of gain realized, arriving at a gross profit ratio of 100 percent. In making this computation, A-K treated the total contract price as $310,112.22, consisting of the cash ($80,011.54), the note executed by the buyers and secured by the property ($191,988.46), and the excess of the mortgage over the partnership's basis in the property ($38,112.22). The partnership calculated the amount of such excess by adding its selling expenses ($23,378.42) to its adjusted basis ($98,509.36) in the property and subtracting both sums from the amount of the mortgage ($160,000).
The partnership reported the sum of $118,123.76 as payments received in the year of sale. This sum consisted of the cash in the amount of $80,011.54 received in the year of sale plus $38,112.22 shown as the excess of the mortgage over the partnership's basis in the property. Thirty percent of the total selling price was $129,600.
The individual partners included in their own returns for 1965 their respective shares of the gain of $118,123.76, treating the remainder of the gain as reportable in subsequent years pursuant to the installment method provided by section 453.
Respondent determined that the sale by A-K did not qualify for reporting under the installment method and that the entire realized gain in the amount of $310,112 was taxable to the partners in 1965 in proportion to their interests in the partnership. Respondent further determined that the partnership's selling expenses were not proper additions to its adjusted basis in the property for purposes of determining whether the mortgage assumed by the buyer exceeded the partnership's basis in the property. Respondent determined that the mortgage exceeded the partnership's adjusted basis by $61,490.64 ($160,000 less $98,509.36) and that, when such excess amount is added to the cash received ($80,011.54), the partnership realized in the year of sale more than 30 percent of the selling price of the property. Each partner's distributive share of total partnership capital gain was determined to be his respective share of the entire gain realized from the sale.
Section 4533 authorizes a seller of real property to report his gain on an installment basis. Under subsection (a), he must return as income from the sale the ‘proportion of the installment payments actually received in that year which the gross profit, realized or to be realized when payment is completed, bears to the total contract price.’ But under subsection (b) the use of the installment method is permitted ‘only if in the taxable year of the sale * * * the payments * * * do not exceed 30 percent of the selling price.’
Section 1.453-4(c), Income Tax Regs.,4 prescribes rules for the use of the installment method in real estate transactions involving the assumption by the purchaser of an existing mortgage on the property. It provides that in the sale of mortgaged property ‘the amount of the mortgage * * * shall, for the purpose of determining whether a sale is on the installment plan, be included as a part of the ‘selling price.“ The regulation further provides that ‘for the purpose of determining the payments and the total contract price as those terms are used in section 453 * * * the amount of such mortgage shall be included only to the extent that it exceeds the basis of the property.’
Petitioners do not challenge the correctness of respondent's determination that this regulation requires the amount of the assumed mortgage in excess of the basis to be taxed as a payment in the year of the sale. Indeed, they recognized this rule in preparing their returns. However, they contend that when this regulation is so applied as to prevent a taxpayer from using the installment method, the regulation ‘is invalid as being in derogation of legislative intent and as being legislative in character.’ They maintain that for the purpose of qualifying for use of the installment method, year-of-sale payments should include only cash or valuable property other than cash which can be used to pay the tax.
In weighing petitioners' argument, we are mindful that section 453 contains no provisions on the installment sale of real estate encumbered by liens. To deal with the many complications not readily foreseeable in such situations, Congress conferred upon the Secretary or his delegate ‘wide discretion in respect of details' by specifically authorizing him to prescribe regulations to govern the application of the section. Burnet v. S. & L. Bldg. Corp., 288 U.S. 406, 414 (1933). In reviewing the validity of such regulations, the ‘role of the judiciary in cases of this sort begins and ends with assuring that the Commissioner's regulations fall within his authority to implement the congressional mandate in some reasonable manner.’ United States v. Correll, 389 U.S. 299, 307 (1967). The regulation ‘must be sustained unless unreasonable and plainly inconsistent with the revenue statutes.’ Commissioner v. South Texas Co., 333 U.S. 496, 501 (1948).
We think it relevant that the provisions of section 453 have been repeatedly reenacted since the language of section 1.453-4(c) of the regulations, on which petitioners concentrate their attack, was first adopted in 1926. See Helvering v. Reynolds Co., 306 U.S. 110, 114-115 (1939). Insofar as that language involves the formula for...
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