The respondent determined deficiencies for the year 1943 in the petitioner's income taxes and declared value excess-profits taxes in the amounts of $3,324.56 and $10,035.73, respectively. The petitioner claims an overpayment of income tax for that year. The issue is whether the petitioner realized taxable gain upon foreclosure of a mortgage on certain real property in 1943, and, if so, in what amount.
FINDINGS OF FACT.
Petitioner herein is a corporation organized under the laws of the State of New York on or about December 29, 1934, and since that date has been wholly owned and operated by Evelyn L. Wood and Samuel J. Wood, her husband.
On January 20, 1922, Evelyn L. Wood purchased from Realty Managers, Inc. the property known as 66-98 East Burnside Avenue, New York, N.Y., (hereinafter referred to as "the property"), for a total consideration of $296,400, by paying $101,400 in cash, by taking title to the property subject to an existing first mortgage of $120,000, and by executing and delivering a purchase money bond and second mortgage for $75,000.
Between January 20, 1922, and December 30, 1925, Evelyn L. Wood reduced the face amount of the first mortgage, referred to above, to $112,500 by making principal amortization payments totaling $7,500.
On December 30, 1925, the first mortgage was assigned to the Title Guarantee Trust Company. On January 4, 1926, the purchase money bond and second mortgage, referred to above, were also acquired by assignment by the Title Guarantee Trust Company.
On January 4, 1926, Title Guarantee Trust Company made a new mortgage loan on the property to Evelyn L. Wood in the principal amount of $137,500, over and above the existing first and second mortgages referred to above. On the same date, Evelyn L. Wood executed and delivered to Title Guarantee Trust Company a consolidated bond and mortgage combining the two original mortgages with the mortgage referred to in this paragraph to form a single consolidated bond and mortgage in the principal amount of $325,000.
Evelyn L. Wood was personally liable on this consolidated bond and mortgage executed on January 4, 1926.
On July 9, 1931, the consolidated mortgage of $325,000 was assigned to East River Savings Bank.
In 1931 Evelyn L. Wood negotiated for a new mortgage of $400,000 on which she was to bear no personal liability. To this end she transferred the property on July 8, 1931, to Edward B. Kenny, a professional "dummy" whose transitory title holding was to enable him to execute the new bond and mortgage and receive the proceeds thereof for Evelyn L. Wood's account. On July 9, 1931, East River Savings Bank made a new mortgage loan on the property in the principal amount of $75,000, over and above the consolidated mortgage in the amount of $325,000. This amount was paid by East River Savings Bank to Edward B. Kenny, who executed a bond and mortgage in that amount to East River Savings Bank, and immediately paid the amount of $75,000 received by him from East River Savings Bank to Evelyn L. Wood. On July 9, 1931, Edward B. Kenny executed and delivered to East River Savings Bank a consolidated bond and mortgage on the property in the principal amount of $400,000. By the terms of this agreement dated July 9, 1931, between the East River Savings Bank as party of the first part, and Edward B. Kenny as party of the second part, the three mortgages on the property, in the amounts of $112,500, $75,000, and $137,500, or a total of $325,000, were consolidated with a fourth mortgage against the property in the amount of $75,000, making a total joint first mortgage lien against the property in the amount of $400,000.
Immediately after accepting the consolidated mortgage in the amount of $400,000, referred to above, Edward B. Kenny, in accordance with his status as "dummy" in these transactions, executed and delivered a deed reconveying the property to Evelyn L. Wood, subject to the consolidated mortgage.
On or about December 29, 1934, Evelyn L. Wood and Samuel J. Wood organized the petitioner, Woodsam Associates, Inc., to take over the various properties then owned by Evelyn L. Wood and Samuel J. Wood. Evelyn L. Wood and Samuel J. Wood each received 25 shares of the capital stock of the petitioner on December 31, 1934, representing the entire issued capital stock of the petitioner. Evelyn L. Wood and Samuel J. Wood on December 31, 1934, transferred to petitioner certain properties including the property known as 66-98 East Burnside Avenue, New York, N.Y., referred to herein as "the property," which transfer was made to the petitioner subject to the consolidated mortgage for $400,000 last referred to above. As a result of this transfer the petitioner acquired the same basis for the property as it had in the hands of Evelyn L. Wood.
While the petitioner was the owner of the property and before November 13, 1936, the petitioner paid to East River Savings Bank the sum of $10,000 in reduction of the principal of the consolidated mortgage, originally in the amount of $400,000.
On October 22, 1936, Evelyn L. Wood and Samuel J. Wood organized and received all the stock of a corporation known as 68-98 East Burnside Corp., and on October 23, 1936, petitioner transferred the property to the 68-98 East Burnside Corp. subject to the mortgage. This corporation had no business purpose, except to hold title to the property temporarily and solely as a "dummy" in order to execute and deliver an agreement extending the term of the consolidated mortgage, and no assets were transferred thereto except as set forth in this paragraph. On November 13, 1936, 68-98 East Burnside Corp. entered into a mortgage extension agreement with East River Savings Bank extending the mortgage to August 1, 1941. The agreement recited that there was due to the East River Savings Bank the sum of $390,000 with interest thereon and in consideration of the various terms of the agreement, the bank would extend the payment of the principal indebtedness to August 1, 1941, and the party of the second part covenanted to pay the principal sum of the bonds securing the indebtedness together with interest at 4 3/4 per cent. It was further provided that the agreement and all covenants were binding on the heirs, executors, successors and assigns of the party of the second part.
On May 3, 1937, and in accordance with its status as "dummy" in the transaction, 68-98 East Burnside Corp. executed and delivered a deed reconveying the property to the petitioner, subject to the consolidated mortgage as reduced to $390,000, and, as so reduced, extended by the extension agreement.
On October 22, 1941, petitioner transferred the property to John F. Burns, who was to hold title to the property temporarily and solely as a "dummy" in order to execute and deliver another extension agreement, referred to next below.
On October 24, 1941, John F. Burns entered into a mortgage extension agreement with East River Savings Bank extending to August 1, 1944, the consolidated mortgage, on which there was then unpaid the principal amount of $390,000.
On October 24, 1941, immediately after securing the second extension agreement, referred to above, John F. Burns executed and delivered a deed reconveying the property to petitioner, subject to the consolidated mortgage as reduced to $390,000, and as so reduced, extended by the terms of the agreement of October 24, 1941.
Subsequent to the transfer of the property back to the petitioner on October 24, 1941, petitioner made the following additional payments to the East River Savings Bank in further reduction of the principal of the consolidated mortgage: 1941, $1,500; 1942, $6,000; and 1943, $1,500.
During 1943 the East River Savings Bank instituted a proceeding in the Supreme Court of the State of New York to foreclose the consolidated mortgage. At the time of the institution of that foreclosure proceeding, and at all times subsequent thereto, there was unpaid on the consolidated mortgage the principal amount of $381,000. A judgment of foreclosure was entered on October 2, 1943. Pursuant to that judgment the property was sold at foreclosure on October 29, 1943, and the East River Savings Bank, as the purchaser, received a deed to the property from the referee on foreclosure, dated October 29, 1943.
As a result of the foreclosure, the petitioner, in 1943, lost all its right, title, and interest in the property, and since has had no interest therein.
At the time of its acquisition by Evelyn L. Wood on January 20, 1922, the property was improved with a one-story brick building consisting of 15 units all of which were designed for occupancy by retail businesses. Certain expenses of title acquisition and certain assessments for local improvements were incurred between 1922 and 1932 totaling $1,541.90, which amount was included as part of petitioner's cost basis in its income tax return for 1943. From January 20, 1922, to October 29, 1943, deductions for depreciation attributable to the building were taken and allowed at the rate of $3,000 a year.
Petitioner filed its corporation income tax return and its corporation excess profits tax return for the calendar year 1943 with the collector of internal revenue for the third district of New York.
The facts as stipulated are so found and incorporated herein by this reference.
OPINION.
VAN FOSSAN, Judge:
Petitioner or its transferor placed various mortgages on the property in the years 1922 to 1931. Petitioner acquired the property in a tax free exchange. In 1943 the mortgage liability was $381,000. The mortgagee then foreclosed the mortgage and bought the property at the foreclosure sale for a nominal sum. The original cost of the property to petitioner's transferor in 1922 was $296,400. From 1922 to 1943 deductions for depreciation attributable to the building on the property were taken and allowed at the rate of $3,000 per year, or a total of $63,000. Capital expenses were incurred over the years in the amount of $1,541.90. The respondent contends that petitioner realized a capital gain in the amount of $146,058.10, upon the foreclosure sale computed as follows:
Mortgage in 1943 as reduced by principal payments — the amount respondent contends was "realized" $381,000.00 Less adjusted basis: Original cost in 1922 ..................... $296,400.00 Improvements .............................. 1,541.90 Depreciation .............................. (63,000.00) ------------- 234,941.90 ---------- Gain ................................. 146,058.10 Section 111 (a) of the Code provides that "the gain from the sale or other disposition of the property shall be the excess of the amount realized * * * over the adjusted basis * * *." The adjusted basis as provided in section 113 (b) is the unadjusted basis (here the original cost of $296,400) less depreciation allowed (but not less than the amount allowable), plus capital expenses. In the Crane case it was held that on the sale of property, a mortgage debt was includible in the "amount realized" as "property" received.
Crane v. Commissioner, 331 U.S. 1. The taxpayer inherited mortgaged business property valued for Federal estate tax purposes at an amount equal to a mortgage on which the taxpayer was not personally liable. The taxpayer operated the property for a number of years and claimed and was allowed annual depreciation deductions on the building. When the interest on the mortgage became substantially in arrears the taxpayer, under threat of foreclosure, sold the property subject to the mortgage for a proportionately small sum and reported gain in the amount of a net cash proceeds received from the sale. It was held that the unadjusted basis under section 113 was the proper basis for depreciation and had to be reduced by allowable depreciation to arrive at the adjusted basis and that the taxpayer's gain should be determined by subtracting the adjusted basis from the amount received on the sale plus the amount of the mortgage.
The Crane case was followed by our decisions in R. O'Dell Sons Co., 8 T.C. 1165, affd. (CCA-3), 169 F.2d 247; and Mendham Corporation, 9 T.C. 320.
In the O'Dell case foreclosure and sale of petitioner's mortgaged property cancelled its mortgage indebtedness which was in excess of its adjusted cost basis. It was held that petitioner realized capital gain taxable to it in the year when the mortgagee's action for a deficiency judgment was barred by local law under which the foreclosure, sale and action for deficiency were to be regarded as one complete transaction.
In the Mendham case a foreclosure which eliminated a mortgage indebtedness greater than petitioner's basis (the same as the basis of petitioner's transferor since the property was acquired in a tax free exchange), was held to result in a taxable gain notwithstanding that the indebtedness had its inception in a borrowing by petitioner's transferor and that petitioner was not itself liable on the mortgage. The transaction was completed when the mortgage was discharged in exchange for a conveyance of the property the final disposition of which established as taxable gain the difference between the basis for the property and the amount acquired by the earlier borrowing.
Petitioner contends first that the taxable event was when the property was mortgaged in excess of cost by petitioner's transferor and that the result should thus be an increased basis for the property in petitioner's hands. This view was repudiated in our earlier case, Lutz Schramm Co., 1 T.C. 682. There the taxpayer transferred the property in 1937 to the mortgagee in satisfaction of the debt. It was argued that the taxable transaction did not take place in 1937; that the fair market value of the property at that time was only $97,000 as against the debt in the amount of $300,000; and that in 1934 the creditor had agreed to look only to the property covered by the mortgage for security. We said, however, that:
The fair market value of the property transferred is immaterial under the provisions of the revenue act in the computation of gain or loss from the disposition of the property. * * * There is no question of the fact that the petitioner had received and used for its own benefit the $300,000 and the only repayment it made on this part of the debt was the transfer of the property. The debt was finally satisfied by that transfer. The petitioner's release from personal liability in 1934 was not a taxable transaction * * *. The fact remains that the taxable transaction took place in 1937, and the net result of it was that the petitioner, over a period of years, had enjoyed the full benefit from the receipt of $300,000 by transferring a property which had a basis in its hands for gain or loss of only $257,435.42. * * *
Here, as in Lutz Schramm Co., there can be no question "that the petitioner [or its predecessors] had received and used for its own benefit" at least the amount of gain now being taxed.
Petitioner has introduced evidence and requested a finding of fact to the effect that the fair market value of the property at the time of foreclosure of the mortgage in 1943 was not more than $320,000, as against a debt of $381,000. Under the view of Lutz Schramm Co., supra, this value is immaterial and we have, therefore, disregarded the requested finding of fact. Petitioner's attempts to distinguish Lutz Schramm Co. are without merit as are its other arguments on this point to the effect that mortgaging without personal liability is a sale of but a lien, security for which is recourse only to the property, with the result that no debt is created. Petitioner finds itself traveling in two ways at once on this argument, for later in its brief it states that:
* * * A debt payable only out of certain property is just as surely a debt as one payable in legal currency. * * *.
This statement was made in connection with the argument that:
* * * Since his debt is limited to the value of the property, the property owner cannot be deemed to receive, by way of consideration for his property, debt discharge in a greater amount than the value of the property.* * *.
In any event, petitioner's argument that a mortgage without personal liability is but a lien was refuted by the Circuit Court in Commissioner v. Crane, 153 F.2d 504:
* * * The mortgagee is a creditor, and in effect nothing more than a preferred creditor, even though the mortgagor is not liable for the debt. He is not the less a creditor because he has recourse only to the land, * * *.
Petitioner next contends in the alternative that the amount (if any) "realized" on the foreclosure cannot exceed the fair market value of the property and relies principally on the following footnote 37 to the Supreme Court's opinion in the Crane case:
Obviously, if the value of the property is less than the amount of the mortgage, a mortgagor who is not personally liable cannot realize a benefit equal to the mortgage. Consequently, a different problem might be encountered where a mortgagor abandoned the property or transferred it subject to the mortgage without receiving boot. That is not this case.
It is apparent from the quoted footnote and the context of the opinion that the Court intended to reserve its views on the situation where, as here, there was no boot in the transfer and the mortgage was foreclosed. We have already dealt with this aspect of the petitioner's argument in our discussion of Lutz Schramm Co., supra. We are not persuaded that the language from the Crane case quoted above is authority for changing our views. If the footnote from the Crane case rises above the status of dictum, we are unable to conclude that it is of any application, at least in circumstances such as those here presented where the entire rationale must be dependent upon the concept of basis and "realized" gain on foreclosure. Petitioner cannot elude the impact of the fact that it realized an economic gain of $146,058.10 when the mortgage was foreclosed. None of this amount was taxable prior to the foreclosure of the mortgage in 1943. That event was the first "disposition" of the property within the meaning of section 111 (a).
The situation presented in Hirsch v. Commissioner, 115 Fed. 2d 656, is not presented here. In that case there was a compromise of the amount of the mortgage as between the parties thereto when it became apparent that the value of the property had declined. It was said that there was "nothing of exchangeable value" received. In the present case, however, petitioner borrowed "new money" on the property greatly in excess of the amount respondent seeks now to tax as gain.
It cannot be seriously argued that the various mortgagees were making gifts to the petitioner or its predecessor. The indebtedness was at all times a loan and the fluctuation of market value of the property so mortgaged does not change the nature of the security. Nor does a change in the market value affect the amount of the indebtedness outstanding and eliminated at the time of foreclosure. The amount thus became, at that time, a "realized" gain. Petitioner's premise that the amount of the debt secured by the foreclosed mortgage is limited to the market value of the property, is untenable.
Petitioner's third point is that it should not be charged on foreclosure with a gain that accrued to its predecessor. Petitioner states:
* * * The rule in [the Mendham case, supra], were it to stand, would be dispositive of the present case on the question of whether a predecessor's economic benefit may be attributed to the successor; * * *. Petitioner invites us to "reconsider" the Mendham case, but its arguments are not persuasive, and we adhere to that decision.
We hold that the respondent did not err in his manner of computation of gain resulting to the petitioner on the foreclosure of the property.
Reviewed by the Court.
Decision will be entered under Rule 50.
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