Scharf v. Commissioner
| Decision Date | 04 December 1973 |
| Docket Number | Docket No. 2351-72. |
| Citation | 1973 TC Memo 265,32 TCM (CCH) 1247 |
| Parties | Morris N. Scharf and Frances S. Scharf v. Commissioner. |
| Court | U.S. Tax Court |
Harold Kamens, 10 Commerce Court, Newark, N.J., and Rexford L. Lyon, for the petitioners. John P. Reis, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined the following deficiencies in petitioners' Federal income taxes:
Year Deficiency
1968 ................... $ 804.76
1969 ................... 3,406.21
The issues for decision are: (1) Whether fire insurance proceeds received in 1968 are includable in petitioners' income as long-term capital gain or whether they constituted a nontaxable return of capital; (2) whether petitioners are entitled to a charitable contribution deduction for a building donated to a volunteer fire department for use in fire drills or, alternatively, whether petitioners are entitled to an abandonment or demolition loss as a result of its use by the fire department; and (3) whether petitioners are entitled to deduct a loss for a building demolished by a lessee prior to the effective date of the lease.
Some facts have been stipulated by the parties and are found accordingly.
Morris N. Scharf and Frances S. Scharf (herein called petitioners) are husband and wife whose legal residence was in Ramsey, New Jersey, when they filed their petition in this proceeding. They filed their joint Federal income tax returns for 1968 and 1969 with the district director of internal revenue at Newark, New Jersey.
Morris N. Scharf (herein called petitioner) is an attorney and a real estate broker. He has also served as a municipal magistrate for approximately 30 years.
In 1949 the petitioner purchased some property (herein referred to as the Margolin property) at a cost of $15,000. He allocated the purchase price for Federal income tax depreciation purposes as follows: $13,500 to the building and $1,500 to the land. From 1949 until 1967, the building was leased successively to various tenants for whom the petitioner made alterations and repairs. Other repairs and improvements to the building were made and paid for by the tenants. At no time between 1949 and 1967 did the petitioner increase his reported basis in the Margolin building to reflect the cost of any capital improvements he may have expended. Since all records with respect to any capital expenditures were destroyed in the cellar storage room of petitioner's office building when it was flooded in August 1970, petitioner estimated that he expended at least $7,500 of his own funds for capital improvements for lessees of the Margolin building between 1949 and 1967. Petitioner claimed depreciation of $12,000 on the Margolin building over his 18-year period, using a cost basis of $13,500.
Respondent reallocated the purchase price of $15,000 for the Margolin property as follows: a cost basis in the building of $12,000 and a cost basis in the land of $3,000. The effect of such reallocation is that the Margolin building would be fully depreciated for Federal income tax purposes by the end of 1967, leaving a basis of zero against which any future deductions or return of capital for the building may thereafter be applied.
On October 29, 1967, a fire partially destroyed the Margolin building. As a result of this fire, petitioner received in 1968 insurance proceeds totaling $5,914.05, which respondent determined to be taxable as a long-term capital gain. Petitioner did not report this amount as gain in 1968, treating it instead as a return of capital.
The Margolin building was so badly damaged by the fire in 1967 that it could not be rented without substantial renovation. By early 1968 the building was about to be condemned because of its unsafe condition. In addition, steadily rising land values in that area had made the land far more valuable than the damaged building, and the petitioner decided it would not be economically feasible to restore the existing building.
With the encouragement of municipal authorities, the petitioner arranged for the Mahwah Volunteer Fire Department to use the building to conduct fire drills and test the use of its new fire equipment. During three ensuing fire drills conducted by the fire department with petitioner's consent, the Margolin building was completely burned down. After the fire there was debris around the building which petitioner covered and filled in. He also had the rest of the foundation and the chimney pushed over to avoid injury to persons nearby.
On their 1968 Federal income tax return the petitioners claimed a deduction for a charitable contribution of $13,131.65 for the value of the fire-damaged building donated to the volunteer fire department. Respondent disallowed the claimed charitable deduction in its entirety. By an amendment to their petition filed February 15, 1973, the petitioners alleged that the value of their charitable contribution is $28,500 rather than the $13,131.65 originally claimed on their Federal income tax return for 1968, and that they are entitled to an increased charitable contribution carryover to 1969 and subsequent years.
The Margolin building was given by the petitioner to the fire department partly for the purpose of having it burned down. The transfer was not evidenced by any deed or other formal conveyance.
Donations of buildings for use in fire drills provide a rural fire department with opportunities to determine its "firematic" skills under controlled conditions. Funds are not available to purchase buildings for this purpose.
The fair market value of the Margolin building at the time it was given to the fire department was $12,835.95.
Petitioners owned other property (herein referred to as the Conrad property) which they leased to the Conrad Development Corporation on September 23, 1969, for a term of 95 years beginning January 1, 1970. Under the terms of the lease Conrad was to pay petitioners a rental four times greater than the rental paid by the prior lessees. Petitioner Morris Scharf was aware that existing structures on the Conrad property would not produce this higher rental, and, as a real estate broker, he knew Conrad would have to build other structures to sustain its financial commitments under the lease.
The lease gave Conrad the right to demolish any buildings on the property at Conrad's expense. In seeking to lease the property, it was Conrad's intention to demolish the existing buildings so that it could construct a new office building thereon. Shortly after the execution of the lease but prior to its effective date, Conrad demolished a 50-year old building on the property. The remaining useful life of the building was less than 95 years.
On their 1969 Federal income tax return the petitioners claimed a demolition loss deduction of $12,020, which was disallowed by the respondent.
OpinionWhether the fire insurance recovery of $5,914.05 should be included in petitioner's income in 1968 as long-term capital gain depends upon what his basis in the Margolin building was when he received the insurance proceeds.
Petitioner claims that his basis in the building was at least equal to, if not greater than, the $5,914.05 he received, and that the proceeds were therefore a return of capital. He testified that he had expended at least $7,500 for capital improvements to the Margolin building. However, this amount was never added to his reported cost basis in the Margolin building prior to 1968. The amount of these claimed improvements obviously exceeds the insurance proceeds received, and, if substantiated, would alter the character of the insurance proceeds from taxable gain to nontaxable return of capital.
Petitioner also testified that the actual purchase price of the Margolin property exceeded his reported basis of $15,000. The amount of excess purchase price the petitioner claims is $6,000, and, if proved, would alter the character of the insurance proceeds received to that of a nontaxable return of capital rather than a long-term capital gain.
Respondent, on the other hand, argues that the petitioner's basis in the Margolin building was totally depreciated by the end of 1967, and therefore the insurance proceeds were taxable to petitioner as a long-term capital gain. Respondent has reallocated the originally claimed purchase price of $15,000 for the Margolin property to reflect a cost basis to petitioner of only $12,000 in the building thereon, and would not allow any claimed adjustment to this basis for the cost of capital improvements by petitioner between 1949 and 1967 due to lack of substantiation.
At trial, petitioner introduced evidence of the original purchase price of the Margolin building, including two mortgages, a deed, a bond, a closing statement and his 1967 Federal income tax return. Taken as a whole, we think these documents are conflicting and fail to support petitioner's attempt to establish a purchase price in excess of $15,000. The asserted purchase price of $21,000 conflicts with the amount shown as the purchase price in the closing agreement signed by the petitioner and the Margolins. It also conflicts with the amount shown by petitioners on their joint Federal income tax returns. And it is inconsistent with the purchase price reflected in a letter dated May 29, 1970, which the petitioner sent to the Internal Revenue Service. Hence, we conclude that the original cost of the Margolin property to petitioner was $15,000.
It is well settled that respondent may reallocate depreciation deduction allowances by adjusting the basis of property between depreciable and nondepreciable assets if the facts warrant it. Caxton Printers, Ltd. Dec. 7996, 27 B.T.A. 1110 (1933). Such a reallocation by respondent is presumably correct, and the burden of proving it...
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