Schoenheit v. Lucas

• Decision Date: 21 October 1930
• Docket Number: 2956,2973.,No. 2955,2955
• Citation: 44 F.2d 476
• Parties: SCHOENHEIT et al. v. LUCAS, Commissioner of Internal Revenue (three cases).
• Court: U.S. Court of Appeals — Fourth Circuit

44 F.2d 476 (1930)

SCHOENHEIT et al. v. LUCAS, Commissioner of Internal Revenue (three cases).

Nos. 2955, 2956, 2973.

Circuit Court of Appeals, Fourth Circuit.

October 21, 1930.

Julius C. Martin, of Asheville, N. C., for petitioners.

Andrew D. Sharpe, Sp. Asst. to Atty. Gen. (G. A. Youngquist, Asst. Atty. Gen., J. Louis Monarch and Sewall Key, Sp. Assts. to Atty. Gen., and C. M. Charest, Gen. Counsel, and De Witt M. Evans, Sp. Atty., Bureau of Internal Revenue, both of Washington, D. C., on the brief), for respondent.

Before PARKER, Circuit Judge, and GRONER and SOPER, District Judges.

SOPER, District Judge.

This group of three cases may be most conveniently considered in a single opinion because all of them relate to the legal effect of certain transactions of Karl Von Ruck, late of Asheville, N. C., deceased, during the closing years of his life. Federal income taxes for the years 1919, 1920, and 1921, and the federal estate tax which became payable by reason of his death on November 5, 1922, are involved.

The first case, No. 2955, concerns a deficiency assessment by the Commissioner of Internal Revenue for the income tax for the year 1919, arising by reason of the failure of Von Ruck to include in his income: (a) A profit of $140,619.25, alleged to have been received by him in the exchange of certain real estate in and near Asheville, N. C., for certain stock of the Spray Cotton Mills, a corporation of which he was the sole stockholder; and (b) a salary of $1,000 per month for the last nine months of the year 1919 alleged to have been received by him from the Von Ruck Memorial Sanitarium, Inc., a nonstock corporation whose activities he directed.

Karl Von Ruck was an accomplished German physician, who for a long time had resided at Asheville, N. C., and had conducted in that city the Winyah Sanitarium, an institution for tubercular patients. Some time prior to 1918, he retired from active practice, and leased his sanitarium to his son, an only child, who continued its operations until he died in that year. About the same time, the only child of the son also died, and Von Ruck was left without descendants. Thereupon he again resumed his professional activities and was so engaged until the time of his death on November 5, 1922, at the age of seventy-three. In the year 1919, he disposed of several pieces of real estate which he had acquired, by conveying them to a corporation which he owned, so that it became vested with title to the larger part, if not all, of his assets; and it was his apparent purpose to make easy distribution of a large part of his estate to various collateral relatives and friends in the United States and Germany. Subsequently he carried this purpose into effect, and the questions which arise in these cases largely revolve around these transactions.

Dr. Von Ruck was also interested in the manufacture of cotton. He was the president and sole stockholder of the Spray Cotton Mills, a North Carolina corporation, engaged in business at Spray, N. C., having outstanding 4,000 shares of stock of the par value of $100 each. He had gradually acquired all of this stock during the period from 1897 to 1915. He was also the owner of valuable real estate which consisted of the hospital for tubercular persons, with 20 acres of land adjoining, a residence and 20 acres of land adjoining, a farm of 140 acres, and in addition some odd lots in the neighborhood of the sanitarium. All of this real estate was located in or near the city of Asheville. On July 1, 1919, he caused the capital stock of the Spray Cotton Mills to be increased to 10,000 shares of a par value of $100 each, and conveyed to the corporation the real estate described in exchange for the 6,000 shares of newly issued common stock together with $75,000 in cash or cash credits.

It is stipulated in the case that all of the real estate involved in this transfer had been acquired by deed prior to March 1, 1913, and that its value on that day was $534,380.75. The Commissioner contended, and the Board of Tax Appeals held, that the fair market value of the property transferred and the stock and credit of the corporation exchanged therefor was $675,000, and that consequently the decedent realized a taxable gain in the transaction of $140,619.25; and hence that this sum should have been included by Von Ruck in his income tax return for the calendar year 1919. The evidence showed that there had been no sales of the stock of the corporation since the year 1915, when Von Ruck purchased the last block of stock outstanding at par. The Board therefore had no evidence of sales from which the value of the stock in 1919 could be determined. It did refer in its opinion to the fact that the corporation had made substantial earnings during the four years from 1916 to 1919 as follows: $109,763.32, $102,423.69, $75,751.36, and $183,784.13; and the findings show that before the issue of the additional $600,000 of stock, the book value was $212, and after the issue, $157.33 per share. But the Board did not base its valuation upon the assets of the manufacturing corporation or on the earnings thereof, but arrived at its conclusions in the following manner (see 14 B. T. A. 33):

"The method of determining the value of stock issued in exchange for property has been considered by the Board in Appeal of William Ziegler, Jr., 1 B. T. A. 186-192, where we held:

"The usual method of appraising stock issued for property where there is no evidence of the market value of the stock is to say that the stock is deemed equivalent in value to the property for which it was issued, and by determining the value of the property one can determine the value of the stock.

"In the instant case we are of the opinion that the fair market value of the property transferred was $675,000. Applying the rule laid down in the Ziegler appeal, the fair market value of the Spray Cotton Mills stock exchanged therefor is the same amount. This is the figure used by the respondent and the petitioners have offered no proof that convinces us that the fair market value of the stock was in a different amount than that here found. See also Appeal of Napoleon B. Burge, et al., 4 B. T. A. 732."

We have then to determine whether the record contains evidence to support the Board's findings of fact under the rule laid down in Atlantic Coast Distributors v. Commissioner (C. C. A.) 33 F.(2d) 733; and whether the taxpayer made a gain or profit which formed a part of his taxable income for the year 1919. The Revenue Act of 1918, c. 18, 40 Stat. 1057, amongst other things provides:

"Sec. 202 (a) That for the purpose of ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, the basis shall be —

"(1) In the case of property acquired before March 1, 1913, the fair market price or value of such property as of that date; and

"(2) In the case of property acquired on or after that date, the cost thereof; or the inventory value, if the inventory is made in accordance with section 203.

"(b) When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any. * * *" 40 Stat. 1060.

Section 202(b) lays down the rule applicable to the exchange of property and makes it necessary to determine the fair market value, if any, of the property received. The Board's valuation of the stock was based on its opinion of the fair market value of the real estate which it declared to be $675,000. Was there any substantial evidence to support this estimate? That the property was of large value, the stipulation that on March 1, 1913, it was worth $534,380.75, abundantly shows. On the other hand, the estimate that it had advanced in value to the amount of $140,619.25 by July 1, 1919, rests entirely upon the valuation placed upon it by the parties to the transfer of that date; and when we recall that these parties resolve themselves into the single personality of Von Ruck, who was in effect at one and the same time both the buyer and the seller of the real estate, that valuation loses much of its probative force. Von Ruck's figures were accepted in the exchange as a matter of course, for he had not only the power but the will to run the business of the corporation substantially as if it were his own. He reached his valuation by taking the original cost of the property and adding thereto 6 per cent. per annum, together with the outlay for improvements, taxes and assessments, and deducting therefrom the income during the period of ownership. Much of the property was unproductive. Indeed, the sanitarium, whose earning power depended largely upon the personal efforts and reputation of Dr. Von Ruck, was the only revenue-producing property. Upon this a rental of $2,000 per month had been placed during the regime of his son. There was uncontradicted evidence that a valuation of $250,000 upon the sanitarium and $96,000 on the residence, placed by Von Ruck at the time of the transfer, was grossly inflated. These circumstances contribute to make an affirmative answer to the inquiry whether the evidence was sufficient to justify the Board's finding of fact a matter of some difficulty, even when the finality of such a finding under the law is taken into account.

But we need not decide whether there was evidence tending to show that the real estate was worth $675,000, or whether it was proper to ignore the other assets which the corporation owned both before and after the transfer, in determining the value of the new stock; for even if it be assumed that the value of the shares was correctly ascertained, it is clear that Von Ruck made no profit out of the transaction. At bottom, the inquiry is whether the change made by the taxpayer in the technical ownership of his property created taxable income separated from his original capital...