Warren Jones Co. v. Comm'r of Internal Revenue
| Decision Date | 07 August 1973 |
| Docket Number | Docket No. 424-71. |
| Citation | 60 T.C. 663 |
| Parties | WARREN JONES COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Warren V. Clodfelter, for the petitioner.
Thomas N. Tomashek, for the respondent.
Petitioner, a cash basis taxpayer, sold an apartment building in 1968 for a total price of $153,000, receiving a downpayment of $20,000 and the contractual right to receive $1,000 per month plus 8-percent interest. The remaining balance was to be paid at the end of 15 years. During 1968 petitioner received $24,000, which included the downpayment, with $20,457.84 allocable to principal. Its basis in the property at the time of sale was $61,913.34. On its Federal income tax return for 1968 petitioner did not report any gain from the sale, but elected, in the alternative, to use the installment method of reporting if it should be ultimately determined that it is not entitled to use the cost-recovery method. Immediately following the sale of the building, petitioner could have sold the real estate contract for approximately $76,980 ‘free and clear’ plus approximately $41,000, which would have had to have been set aside in an assigned savings account to insure the contract buyer against nonpayment by the buyer of the building. Petitioner would not be in constructive receipt of the $41,000 in the year of the sale of the contract. Held: While the real estate contract was salable, it was not the equivalent of cash because petitioner could not presently receive for it an amount anywhere near its face value, i.e., stated contract price less an appropriate interest discount. Accordingly, (1) the contract does not constitute ‘property (other than money)‘ under sec. 1001(b), I.R.C. 1954, and (2) the petitioner properly deferred reporting income from the sale.
Respondent determined a deficiency in petitioner's Federal income tax in the amount of $2,523.94 for the taxable year ended October 31, 1968. The only issue to be decided is whether the petitioner, a cash basis taxpayer, realized income in 1968 upon the sale of appreciated property in return for a deferred-payment obligation under a real estate contract.
Some facts have been stipulated by the parties and are found accordingly.
Warren Jones Co. (herein called petitioner) was incorporated in the State of Washington in 1955. Its principal place of business was in Seattle when it filed its petition in this proceeding. Its Federal corporate income tax return for the taxable year ended October 31, 1968, was filed with the district director of internal revenue at Tacoma, Wash.
Petitioner uses the cash receipts and disbursements method of accounting. It is owned by Marlyn L. Jones and Wayne R. Jones, both of Seattle. It owned and operated two residential rental properties in Seattle and one coin-operated laundry and drycleaning facility. The sale described herein was not made in the ordinary course of petitioner's business.
In December 1955, petitioner acquired the Wallingford Court Apartments at a cost of $145,961.02. On June 15, 1968, its adjusted basis in the property was $61,913.34.
On May 27, 1968, petitioner entered into a real estate contract with Bernard J. Storey and Jo Ann Storey. Under the terms of the contract the Storeys purchased the Wallingford Court Apartments for a total price of $153,000.1 The date of closing was set for June 15, 1968, at which time the Storeys made a cash downpayment of $20,000. The balance of $133,000 was payable $1,000 per month over the next 15 years. Interest on the declining balance was payable at the rate of 8 percent per year. At the end of the 15-year period the balance due is to be paid in a lump sum. Upon receiving full payment the petitioner is to execute and deliver to the Storeys a statutory warranty fulfillment deed to the property.
The Storeys took possession of the apartment building after the purchase from petitioner and began managing it. The apartment tenants mail their rent payments to them at their home. They pay the property taxes and insurance on the building. At the time of the purchase in 1968 the Storeys' assets exceeded their liabilities by $200,000 to $300,000. They had sufficient resources to meet their obligations as they matured in the ordinary course of business.
During the remainder of its 1968 taxable year following the sale the petitioner received the cash downpayment of $20,000 plus four monthly payments of $1,000 each. Of this total of $24,000, $20,457.84 was principal. The difference was interest.
On its Federal corporate income tax return for 1968 the petitioner reported no gain on this sale, stating as follows:
Taxpayer reports income and expenses on the cash method of accounting, and, in accordance with Nina J. Ennis v. Com., 17 T.C. 465, no profit is realized until the basis of the property sold has been recovered. * * *
If it is ultimately determined that taxpayer is not entitled to use the recovery of cost method of accounting for the sale, then taxpayer hereby elects to use the installment method of reporting * * * (Provided under sec. 453, I.R.C. 1954.)
Petitioner claimed that its ‘unrecovered cost’ was $43,577.65 as of October 31, 1968.
The only evidence of indebtedness associated with this transaction was the real estate contract. No notes, securities, or other such instruments passed between the Storeys and the petitioner.
The transaction between the Storeys and the petitioner was a completed sale in the taxable year ended October 31, 1968.
Real estate contracts of the type entered into by the petitioner and the Storeys are regularly bought and sold in the Seattle, Wash., area.
At the time of this sale there were funds available in the Seattle area for investment in real estate contracts of this type. Savings and loan associations provided the principal market for such real estate contracts. There were also other buyer markets available, such as mutual savings banks, investment debenture companies, and pension and trust funds.
The real estate contract in question had a fair market value of approximately $76,980 at the time of sale. It was transferable to a buyer for that amount at that time.
In his notice of deficiency dated October 19, 1970, respondent determined that a long-term capital gain of $12,098 resulted from the installments received in 1968 on the sale of the Wallingford Court Apartments.
OPINIONPetitioner constantly hammers away at the point that the contract entitling it to receive in the future the purchase price on the sale of the real estate in question was not the equivalent of cash. In support of this argument it relies heavily upon the case of Nina J. Ennis, 17 T.C. 465 (1951), and urges us to conclude that it realized no gain in 1968 when the property was sold. It is contended that the fair market value of the contract is not the equivalent of cash because a contract having a face value of $153,000 when received is not the equivalent of $76,980.
Respondent contends that the real estate contract has an ascertainable fair market value, is readily marketable, and is the equivalent of cash. He argues that it is ‘property (other than money)‘ under section 1001(b), I.R.C. 1954, 2 and, to the extent of its fair market value, constitutes an amount realized by the petitioner in the year of sale. Thus respondent asserts that the petitioner should not be permitted to defer the reporting of gain from the sale until cash payments received under the contract exceed the adjusted basis of the property sold. Respondent acknowledges, however, that petitioner's election (claimed alternatively) to use the installment method of reporting gain under section 453 is proper.
We are satisfied that the following facts hold true: The petitioner could have sold this real estate contract to a buyer, such as a savings and loan association, for approximately $117,980, which figure represents an 11-percent discount off the contract balance of $133,000. The 11-percent discount would give the buyer of the contract a 9 1/2-percent yield on the money loaned, in effect, to the buyer of the building. However, because the property was relatively old and the payment period for the contract was relatively long, it is likely that a buyer of the contract would have wanted to keep the ‘loan’ to the buyer of the property at a maximum of 60 percent of $153,000 or approximately $92,000. To do so, a buyer, such as a savings and loan association, would have required the contract seller (petitioner) to deposit approximately $41,000 of the $117,980 contract purchase prince in a savings account and to assign that account to it, the savings and loan association, in order to secure the first $41,000 worth of payments by the buyer of the property in reduction of the $153,000 debt. The petitioner would not be entitled to the $41,000 in the year of the hypothetical sale of the contract. It would only be entitled to this amount— plus any interest— if and when the ‘loan’ to the buyer of the property amounted to no more than $92,000.
On the basis of these facts and in view of the parties' arguments, we hold for the petitioner on the ground that the contract here involved is not the equivalent of cash.
Respondent has made out a rather strong case in support of his position, but in our judgment he has not cleared one major hurdle. It has been established that the real estate contract has an ascertainable fair market value. In that respect this is the usual case because ‘only in rare and extraordinary cases will property be considered to have no fair market value.’ Sec. 1.1001-1(a), Income Tax Regs. See also McCormac v. United States, 424 F.2d 607 (Ct. Cl. 1970); Darby Investment Corporation v. Commissioner, 315 F.2d 551 (C.A. 6, 1963); Marsack's Estate v. Commissioner, 288 F.2d 533 (C.A. 7, 1961); Chamberlin V. Commissioner, 286 F.2d 850 (C.A. 7, 1960); Gersten v. Commissioner, 267 F.2d 195 (C.A. 9, 1959); Estate of Abraham Goldstein, 33 T.C....
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