Willow Terrace Development Co. v. CIR

• Decision Date: 01 July 1965
• Docket Number: No. 21241.,21241.
• Citation: 345 F.2d 933
• Parties: WILLOW TERRACE DEVELOPMENT CO., Inc. and Post Oak Manor Building Co., Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. WILLOW TERRACE DEVELOPMENT CO., Inc. and Post Oak Manor Building Co., Inc., Respondents.
• Court: U.S. Court of Appeals — Fifth Circuit

345 F.2d 933 (1965)

WILLOW TERRACE DEVELOPMENT CO., Inc. and Post Oak Manor Building Co., Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. WILLOW TERRACE DEVELOPMENT CO., Inc. and Post Oak Manor Building Co., Inc., Respondents.

No. 21241.

United States Court of Appeals Fifth Circuit.

June 1, 1965.

Rehearing Denied July 1, 1965.

Robert H. McCanne, W. Carlos, Jr., and Morris, Termini, Harris, McCanne & Lacas, Houston, Tex., for petitioners.

Robert I. White, Atty., Dept. of Justice, Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Meyer Rothwacks, Melva M. Graney, Attys., Dept. of Justice, Sheldon S. Cohen, Chief Counsel, I.R.S., Max G. Amsbacher, Atty., I.R.S., Crane C. Hauser, Chief Counsel, Internal

Revenue Service, Washington, D. C., for respondent.

Before GEWIN and BELL, Circuit Judges, and McRAE, District Judge.

GRIFFIN B. BELL, Circuit Judge.

Taxpayers are the Willow Terrace Development Co., Inc., and its wholly-owned subsidiary, Post Oak Manor Building Co., Inc. Both corporations engaged in developing real estate subdivisions in the Houston area, and filed consolidated corporate income tax returns for the tax years here involved, 1955-1958. They petition to review a decision of the Tax Court requiring the Building Company to include in gross income the full amount of "trade-in-allowances" given to purchasers of new homes in return for equities in their old homes. The Commissioner cross-petitions from the Tax Court's decision allowing the Building Company to add the cost of constructing water and sewage facilities to the cost basis of the houses it built and sold. The opinion of the Tax Court is reported at 40 T.C. 689. We affirm on both questions.

I. The Taxpayers' Appeal

Building Company built and sold new houses in the Post Oak Manor Subdivision in Harris County, Texas. In making sales of new houses, the building company often accepted the purchaser's interest or equity in his old house as part of the sales price for the new house in Post Oak Manor. The credit received by the purchaser, or "trade-in allowance," was treated as part of the down payment on the new house. The trade-in houses all had outstanding mortgages on them, and Building Company acquired them subject to the prior encumbrances. During the tax years here involved, Building Company made trade-in allowances on the equities in 151 houses in the total amount of $348,609.73.¹

Rather than taking title to the trade-in houses directly, Building Company had the new house purchasers deed them to Terwil Corporation, a corporation owned in the same proportions by the same three men who owned Development Company which in turn owned Building Company.² Terwil attempted to resell the houses as soon as possible to avoid making mortgage payments, and all 151 were sold under contracts for a deed, with a small down payment, usually $200, and with the balance of the purchase price to be paid after the existing mortgage was satisfied. Interest on the contract price was to be paid in the interim. The total face amount of the 151 contracts was approximately $392,600, but when sales expenses were deducted from the initial payments totaling $34,200, the net amount of cash received was only $9,345.13. The balance due on the contracts was $358,600. There was no established market in the Houston area for the contracts received by Terwil Corporation for the trade-in houses.

The Commissioner determined that the entire amount of the trade-in allowances ($348,609.73) should be included in Building Company's gross income as part of the amount realized from the sale of new houses under § 1001(a), (b) of the Internal Revenue Code of 1954. That section provides that the "amount realized from the sale * * * of property shall be the sum of any money received plus the fair market value of the property (other than money) received." In the Tax Court, Building Company contended that the fair market value of the trade-in houses was not equal to the trade-in allowances, but was zero, or in any event, not more than from $8,000 to $12,000. The Tax Court held that Building Company failed to sustain its burden of showing that the fair market value of the trade-in houses was less than $348,609.73. We agree.

The standard for determining fair market value under § 1001 is well established. It is the price at which property will change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the facts. French Dry Cleaning Co. v. Commissioner of Internal Revenue, 5 Cir., 1934, 72 F.2d 167. The Tax Court applied this standard. Stiles v. Commissioner of Internal Revenue, 5 Cir., 1934, 69 F.2d 951, relied on by taxpayers for their contention that the proper standard is the amount presently realizable in cash, is not to the contrary. Indeed, the court in the French Dry Cleaning Co. case so stated.

Given that the Tax Court applied the proper legal standard in determining fair market value, there was ample evidence to support its conclusion that the fair market value of the equities in the trade-in houses was at least equal to $348,609.73, the amount of the trade-in allowances. One factor considered by the Tax Court was what they were actually sold for in the open market, $392,600. The receipt of only slightly more than $9,000 net in cash after sales expenses does not alter the fact that the price at which Terwil sold the houses was substantially above the trade-in allowances. Moreover, and this is the long and short of the matter, the Commissioner introduced the testimony of two real estate appraisers which established a value for the trade-in houses in excess of the trade-in allowances. Taxpayers' appraisers testified that the value of the houses was only $12,000, and there was other evidence to support the taxpayers' contention. However, the testimony of the Commissioner's witnesses was adequate, if credited as it was by the Tax Court, to carry the day for the Commissioner, and the finding by the Tax Court was in no event clearly erroneous. See Greer v. Commissioner of Internal Revenue, 5 Cir., 1964, 334 F.2d 20.

Taxpayers argue alternatively that even if the trade-in houses were worth the trade-in allowances, Building Company sold the houses to Terwil Corporation at a corresponding loss. In this regard, the Tax Court was correct in holding that there was no sale by Building Company to Terwil. Form must give way to substance in the tax law. Commissioner of Internal Revenue v. Court Holding Co., 1945, 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981; Hindes v. United States, 5 Cir., 1964, 326 F.2d 150.³

It follows that the decision of the Tax Court requiring Building Company to include the full amount of the trade-in allowances in gross income must be and it is affirmed.

II. The Commissioner's Appeal

Building Company constructed all houses in Post Oak Manor Subdivision in accordance with Federal Housing Administration specifications and requirements in order to secure FHA or Veteran's Administration loan insurance guarantees on the mortgages to be utilized in the purchase of the new houses. As a condition to issuing loan commitments on the subdivision, the FHA required that a satisfactory water system and sewerage disposal system be made available to the new houses. Building Company first attempted to secure these facilities from the City of Houston. Post Oak Manor was at that time beyond the city limits, and Houston declined to construct the facilities. After determining that it would be more economical to construct and operate its own systems rather than obtain them from a neighboring subdivider, Building Company constructed a water plant, sewerage disposal plant, and the necessary connecting systems. The total cost of these facilities to Building Company was $157,187.49.

By an instrument dated July 30, 1954, Building Company transferred the water and sewerage facilities to Post Oak Manor Water Company, Inc., a separate corporation owned in identical proportions by the same three men who owned Development Company and Building Company. The only consideration furnished by the Water Company was its agreement to operate the systems. The transfer agreement set the rates which Water Company would charge, and provided that the rates could be increased only if they proved insufficient to cover operating costs, provide sufficient reserves for replacement, obsolescence and depreciation, and a reasonable rate of return on the basis of capital investment.

Pursuant to FHA requirements, Water Company executed a trust deed transferring title to the facilities to an approved trustee for the benefit of the property owners. Water Company retained the active control and management of the systems, but the trust deed provided that if the Water Company abandoned the plant, changed the rate structure materially, or failed to provide satisfactory service, the trustee could take over the operation of the system for the benefit of the property owners.

Water Company carried the facilities on its books at a zero basis, and no depreciation was ever claimed on them. The president of the company received no salary. Without allowance for depreciation, the operations of the company from 1955 through 1959 produced net income for the five year period of $12,934.02.⁴ Assuming a five per cent replacement factor...