Rees Blow Pipe Mfg. Co. v. Comm'r of Internal Revenue
| Decision Date | 30 January 1964 |
| Docket Number | Docket No. 2965-62. |
| Citation | 41 T.C. 598 |
| Parties | REES BLOW PIPE MANUFACTURING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Charles A. Mayer (an officer), for the petitioner.
Leslie M. Hartman, for the respondent.
In 1954 petitioner transferred a building to Sanfran Company in a three-way agreement among petitioner, Sanfran, and Stauffer Chemical. In 1955 Sanfran filed suit against petitioner for willful or negligent misrepresentation of the building. The trial court found Sanfran was entitled to a judgment of $20,000 against petitioner, which judgment was affirmed in 1959. Petitioner claimed a deduction for the judgment in 1959 and a deduction for legal fees paid in connection with the suit in 1960. Respondent disallowed the deductions in the amounts of $17,780.93 and $3,712.43, respectively. Held, the amounts disallowed should be treated as capital losses under the rationale of Arrowsmith v. Commissioner, 344 U.S. 6, and Estate of James M. Shannonhouse, 21 T.C. 422.
Respondent determined deficiencies in income tax for the calendar years 1959 and 1960 in the amounts of $7,007.16 and $1,659.99 respectively.
The only issue is whether petitioner is entitled to deduct $17,780.93 in 1959 by reason of a judgment obtained against it which was affirmed in 1959, and also whether petitioner is entitled to deduct $3,712.43 in 1960 by reason of legal fees paid in connection with the suit.
The facts were stipulated and are so found.
Petitioner is a corporation, incorporated under the laws of the State of California in 1911 and since that time has engaged in manufacturing and installing heating, air conditioning equipment, and incinerators. Its present address is 2929 Fifth Street, Berkeley, Calif. It filed its Federal income tax returns with the district director of internal revenue at San Francisco.
Shortly after petitioner's incorporation, petitioner acquired certain real property at 340 Seventh Street, in San Francisco, Calif., where it conducted its manufacturing business. Throughout the years, petitioner acquired adjoining land and made several successive additions and alterations to the original building. This property, including the additions and alterations, will be referred to herein as the San Francisco property.
In January 1954 petitioner authorized its real estate brokerage firm to obtain a site for a new factory in Berkeley, Calif., and exchange or sell its San Francisco property. Petitioner's broker found that Sanfran Co., a San Francisco corporation, wished to expand its San Francisco plant, which was located near or adjacent to petitioner's San Francisco property. Petitioner's broker also found that the San Francisco Sulphur Co., herinafter referred to as Stauffer Chemical, wished to sell a piece of land which it owned in Berkeley, Calif.
After negotiating for a period of time, the three companies consummated a three-way agreement. Pursuant to this agreement, on June 25, 1954, petitioner transferred its San Francisco property to Sanfran Co. Sanfran Co. paid $158,150 to Stauffer Chemical. Petitioner paid an additional $30,666.19 in cash and notes to Stauffer Chemical, and the latter company transferred two contiguous pieces of land in Berkeley to petitioner.
On its 1954 income tax return petitioner considered the 1954 exchange of properties with Sanfran Co. and Stauffer Chemical to be a nontaxable exchange. Thus, the Berkeley property received by petitioner in the exchange assumed the basis of the San Francisco property, transferred to Sanfran Co., plus the cash and notes given by petitioner in the exchange. The substituted basis was determined as follows:
+----------------------------------------------------+
¦Cash and notes ¦$30,666.19¦
+-----------------------------------------+----------¦
¦Adjusted basis of San Francisco property:¦ ¦
+-----------------------------------------+----------¦
¦Land ¦36,171.55 ¦
+-----------------------------------------+----------¦
¦Building ¦9,978.18 ¦
+-----------------------------------------+----------¦
¦ ¦76,815.92 ¦
+----------------------------------------------------+
On September 28, 1954, Sanfran Co. filed an application with the Department of Public Works of the city of San Francisco to change the use of the building on the San Francisco property from manufacturing to the proposed use as a commercial garage. In October 1954 this application was disapproved by the building inspector on the grounds that the building violated the provisions of the San Francisco building code relating to area, ventilation, and the type of construction required for buildings used as garages.
On April 19, 1955, the Sanfran Co. filed suit against petitioner, petitioner's real estate brokers, and their employee. The suit against the brokerage company and its employee was dismissed before trial. The complaint filed set forth two causes of action: The first, for willful or negligent misrepresentation that the San Francisco building, purchased from petitioner, was a class ‘C’ building under the building code of the city and county of San Francisco, and that the building had side walls; the second, for fraudulent concealment of the missing walls and the building code violations. The trial court concluded that Sanfran Co. was entitled to nothing under the first cause of action but was entitled to judgment against petitioner in the amount of $20,000 on the second cause of action. Petitioner appealed to the District Court of Appeals of the State of California for the First Appellate District, which court, in 1959, affirmed the findings of the trial court.
In 1954 petitioner constructed a plant on the Berkeley property which, at the time of the 1957 sale of the balance of the Berkeley property to Rees Development Co. hereinafter referred to, had an adjusted basis of $128,986.41. In 1956 further capital improvements were made which, at the time of the 1957 sale hereinafter referred to, had an adjusted basis of $29,032.19.
In 1956 petitioner advanced legal fees of $5,009.06 to its attorneys in connection with the suit filed against it by Sanfran Co. This sum was deducted as a business expense on petitioner's tax return for 1956 and is not in issue here.
In 1956 petitioner sold 8,000 square feet of the Berkeley property for $8,000.
In 1957 petitioner sold the balance of the Berkeley property consisting of two parcels to Rees Development Co., a corporation controlled by the majority stockholders of petitioner. The contract provided that petitioner would be paid in a series of monthly installments of $1,000 each beginning in 1957 until the total net sales price of $178,063.67 was paid.
On petitioner's income tax return for 1957 petitioner reported a profit realized which was determined as follows:
+-----------------------------------------------------------------------------+
¦Received for first parcel of Berkeley property with improvements ¦$283,986.41¦
+-----------------------------------------------------------------+-----------¦
¦Received for second parcel of Berkeley property ¦20,000.00 ¦
+-----------------------------------------------------------------+-----------¦
¦Received for improvements made on Berkeley property (sold ¦29,032.19 ¦
¦separately) ¦ ¦
+-----------------------------------------------------------------+-----------¦
¦Gross sales price ¦333,018.60 ¦
+-----------------------------------------------------------------+-----------¦
¦Less mortgage assumed by buyer ¦154,954.93 ¦
+-----------------------------------------------------------------+-----------¦
¦Net sales price as reported ¦178,063.67 ¦
+-----------------------------------------------------------------+-----------¦
¦Less adjusted basis ¦71,879.59 ¦
+-----------------------------------------------------------------+-----------¦
¦Profit realized ¦106,184.08 ¦
+-----------------------------------------------------------------------------+
Petitioner received $12,000, or 6.73 percent, of the net sales price in 1957 and reported a gain in 1957 of $7,146.19 (which is 6.73 percent of $106,184.08).
No payments were received on the installment sale of the Berkeley property in 1958, 1959, or 1960.
At the end of petitioner's 1958 taxable year, $166,063.67 ($178,063.67 minus $12,000) of the net sales price of the Berkeley property and $99,037.89 ($106,184.08 minus $7,146.19) of the expected profit remained to be reported in future years as payments are received by petitioner under the installment sale contract.
Petitioner claimed a deduction on its 1959 income tax return in the amount of $22,685.10 captioned ‘Loss on San Francisco Lawsuit’ which referred to the suit brought by Sanfran Co. against petitioner. The claimed loss was made up as follows:
+-----------------------------------------------------+
¦Judgment plus court costs ¦$21,764.47¦
+------------------------------------------+----------¦
¦Interest ¦4,904.17 ¦
+------------------------------------------+----------¦
¦Cost of appeal ¦272.26 ¦
+------------------------------------------+----------¦
¦Loss on bond put up as security ¦753.26 ¦
+------------------------------------------+----------¦
¦Total ¦27,694.16 ¦
+------------------------------------------+----------¦
¦Less amount deducted as legal fees in 1956¦5,009.06 ¦
+------------------------------------------+----------¦
¦1959 deduction...To continue reading
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