Court Opinion

ID: 4610716
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:47:29.272268+00
Date Added: 2024-06-11T07:54:07.030643
License: Public Domain

D. G. Bradley, Petitioner, v. Commissioner of Internal Revenue, RespondentBradley v. CommissionerDocket No. 55823United States Tax Court26 T.C. 970; 1956 U.S. Tax Ct. LEXIS 99; August 31, 1956, Filed *99 Decision will be entered under Rule 50.  1. During the taxable years 1947 and 1948, the petitioner realized income from houses sold from 1945 to 1948.  Some of the houses were built in 1944 and 1945 under restrictions requiring rental and the others were built without restrictions in 1946.  The restrictions were removed in the latter part of 1945.  The houses sold in 1945 were sold upon completion. The houses sold thereafter were rented from the time of completion until sale.  The issue is whether or not the houses were held primarily for sale to customers in the ordinary course of trade or business.  Held, that petitioner was both a dealer and investor in real estate. The houses sold in 1945 and 1946 were property held primarily for sale to customers in the ordinary course of trade or business and the gain realized from installment payments received in 1947 and 1948 was ordinary income.  The houses sold in 1947 and 1948 were held for rental investment purposes and not primarily for sale by petitioner to customers in the ordinary course of his trade or business and were sold pursuant to liquidation in order to pay expenses and to reinvest in multiple-unit dwellings and to*100  invest in a motel in Arizona, to which State petitioner had moved.  The gains from these sales are capital gains.2. Petitioner made a loan to a nephew so that he could start in business and another to a former supplier as a personal favor.  The loans became worthless in 1947 and 1948, respectively, and petitioner deducted the amounts as business bad debts. Held, that both bad debt losses were nonbusiness bad debts since they were not proximately related to the petitioner's business.3. Petitioner failed to claim depreciation on a piece of rental property.  He now claims a depreciation allowance on that property and additional depreciation on other property on the ground that the rates allowed by the respondent are unreasonable.  Held, that petitioner is entitled to a depreciation allowance on the piece of rental property but is denied additional depreciation on the other properties except as to one piece of property, since the rates allowed by the respondent are reasonable.  Vincent S. Lamb, Esq., for the petitioner.Frederick T. Carney, Esq., for the respondent.  Black, Judge.  BLACK *971  The Commissioner has determined deficiencies in income taxes in the *101  amounts of $ 31,953.57 and $ 9,812.61 for the taxable years 1947 and 1948, respectively.  The deficiencies are due to numerous adjustments to net income, some of which are not in issue.  The items in question are:(1) The petitioner realized income from the sale of certain single-unit dwellings, as follows:(a) Income realized in 1947:  1. Completed sales in 1947$ 65,539.62  2. Installment sales:1945$ 4,338.7919464,361.1119474,617.7413,317.64(b) Income realized in 1948:  1. Installment sales in 194819,053.29  2. Installment sales:1945$ 1,525.8719463,872.831947471.605,870.30  3. Completed sales in 19487,917.54The petitioner returned the amounts in (a) as capital gains in 1947 and the amounts in (b) as ordinary income in 1948.  The Commissioner has determined that the amounts in (a) represent ordinary income.  The petitioner now contends that all of the above amounts are capital gains. Neither the amounts nor the holding periods are in question.(2) The petitioner deducted $ 9,753.77 and $ 1,065 as business bad debts in 1947 and 1948, respectively.  The Commissioner has determined that both amounts are nonbusiness*102  bad debts deductible only under the provisions of section 23 (k) (4), Internal Revenue Code of 1939.*972  (3) Petitioner contends that he is entitled to additional depreciation in the amounts of $ 1,394.06 and $ 2,197.72 for the years 1947 and 1948, respectively.FINDINGS OF FACT.A stipulation of facts has been filed and is made a part hereof by reference.The petitioner, D. G. Bradley, a resident of Tucson, Arizona, and formerly a resident of Montgomery, Alabama, filed his individual income tax returns for 1947 and 1948 with the collector of internal revenue for the district of Alabama.The petitioner, after studying construction engineering for 2 years, and after holding various jobs, entered into the business of building and selling houses in 1934.  He helped organize Bradley and Talent, Inc., about 1936, to engage in the real estate business.  He was the owner of two-thirds of the capital stock and became its president.  The petitioner handled the construction and Talent, the other shareholder, handled the sales, rentals, and insurance part of the business.  The petitioner, in 1941, constructed twenty-eight 4-unit apartment houses for rental investment purposes.  He sold*103  his interest in Bradley and Talent, Inc., and went to Mobile, Alabama, to work for a firm engaged in defense housing in 1942.  The petitioner returned to Montgomery in the fall of 1943 and engaged in the real estate brokerage business under the name of Bradley Realty Sales Co. (hereinafter referred to as Realty), a sole proprietorship.  On July 31, 1944, he sold Realty to his wife and brother-in-law and returned to the construction business under the name of Dave Bradley Construction Co., a sole proprietorship.Capital Gains.Petitioner procured priorities to build about 100 units of defense housing in August 1944.  He procured other priorities and by March 1, 1945, he had constructed 134 single-unit dwellings and several multiple-unit dwellings. The Government restrictions attendant to the priorities required two-thirds of the units to be 2-bedroom houses and two-thirds of the units to be held for rental. The petitioner also built 24 single-unit dwellings in 1946 that were not subject to any restrictions.  They were built on the petitioner's own land and the F. H. A. mortgages covered the entire cost.All of the multiple-unit dwellings were held for rental purposes.  Twenty-eight*104  of the 134 houses completed in 1945 were sold upon completion before the restrictions were lifted.  The restrictions that required rental of two-thirds of the houses were lifted in the latter part of 1945.  The remainder of the 134 houses and the 24 houses completed in 1946 were rented on 1-year oral leases from the time of completion *973  until the time of their sale.  Information relative to the sale of the houses is set out below:Gain realizedNo. of unitsYearType of salesold19471948(a) 281945Installment sales$ 4,338.79$ 1,525.87(b) 711946Completed sales (all of gainrealized prior to 1947(c) 121946Installment sales4,361.113,872.83(d) 21947Installment sales4,617.74471.60(e) 211947Completed sales65,539.62(f) 51948Completed sales7,917.54(g) 191948Installment sales19,053.29(a) through (e) represent the 134 units.(f) and (g) represent the 24 units.The gain realized in 1947 from items (a), (c), and (d) is $ 13,317.64.The gain realized in 1948 from items (a), (c), and (d) is $ 5,870.30.Almost all of the houses were sold through Realty and the petitioner *105  paid Realty the standard 5 per cent commission.  The petitioner's wife, Olivia J. Bradley, owned the following interests in Realty, which operated as a partnership:Per cent of interestand profitsFrom --To --50Aug. 1, 1944Jan.  1, 194625Jan. 1, 1946Apr.  1, 194750Apr. 1, 1947Oct. 31, 1949The income of Realty is not in issue in this proceeding.There was a seller's market and real estate values were rising during the period when the sales took place.  There was little or no sales promotional activity on the part of petitioner or Realty.  No "for sale" signs were posted.  In many instances the tenants were notified that the houses were for sale and a good many of the houses were sold to tenants.  In many instances persons came to Realty looking for houses to buy.Of the 134 houses, the 2-bedroom houses were sold first.  They were not regarded as a good investment and were all sold upon completion or in the year following the removal of the restrictions.  The 3-bedroom houses rented for about $ 20 more per unit while their cost was only slightly more than the 2-bedroom houses.  The petitioner held on to the 3-bedroom houses for rental because they were a good*106  investment.  The record does not show exactly how many 3-bedroom houses were built. The record does show that two 3-bedroom houses were sold prior to 1947, one to a relative and one to a personal friend as favors.The 24 houses that were built in 1946 and sold in 1948 were small houses that were easy to rent.  They were all rented on 1-year oral leases from the time of completion to the time of sale in the first half of 1948.The petitioner was in Arizona a good part of the time in 1946 and 1947, and in 1948 he moved there permanently.  He sold the *974  groups of 23 houses in 1947 and 24 houses in 1948 in order to pay the expenses incident to his wife's illness, to buy a motel in Arizona and make substantial improvements thereto, and to invest in multiple-unit housing.In 1948, petitioner ceased to operate as Dave Bradley Construction Co. and sold the equipment of the company.  The petitioner and his construction foreman, Henry Pyron, formed a corporation, Bradley and Pyron, Inc., and built 2 apartment houses in 1948.  He later purchased the apartment houses from the corporation.The value of petitioner's holdings of single- and multiple-unit dwellings between March 1, 1945, *107  and January 1, 1949, is as follows:DateTotalMultipleSingle unitsholdingsunitsMar. 1, 1945$ 832,534.52$ 236,887.86$ 595,646.66Jan. 1, 1946693,749.02236,887.86456,861.16Jan. 1, 1947728,582.07473,863.27254,718.80Jan. 1, 1948615,000.79478,690.72136,310.07Jan. 1, 1949850,961.99850,961.99During the taxable years 1942 to 1948, inclusive, the petitioner had income and losses in amounts and from sources as follows:GrossNet rentalNet gainOtherTaxable yearwagesincomefrom realtransactionsestate sales1942$ 7,776.41$ 8,122.87194311,500.0010,326.34194413,820.15$ 726.46($ 444.07)194532,095.5011,948.31(13,730.09)194623,332.2596,494.04(10,215.15)194732,403.3392,925.924,944.09 19487,500.0048,200.1738,863.151,272.82 On April 12, 1945, the petitioner's wife, Olivia J. Bradley, suffered a tubercular hemorrhage from which she never recovered.  She was bedridden in Montgomery, Alabama, from then until August 13, 1946, when the petitioner moved her to a sanitarium in Tucson, Arizona.  She was hospitalized in Tucson from August 15, 1946, to July 3, 1947, when*108  the petitioner moved her to a hospital in Los Angeles, California, where she was subjected to surgery on three occasions, and remained until July 7, 1948, when the petitioner took her back to Tucson by chartered hospital plane.  On July 7, 1948, she reentered the sanitarium in Tucson, and remained there until her death on September 7, 1950.The petitioner purchased a house in Arizona in 1946 for $ 20,000.  In 1948, he purchased a motel in Arizona for $ 54,000 in order to have a business near his wife.  He spent about $ 50,000 more in order to expand and recondition the motel. The petitioner sold his farm and home in Alabama in 1947.*975  In his Federal income tax returns for the years 1945 through 1948, the petitioner claimed, and was allowed, deductions for medical expenses as follows:Amount allowableAmountunder sec. 23 (x),YearclaimedI. R. C. 19391945$ 1,115.5619465,773.98$ 739.9619479,689.622,500.0019488,150.342,500.00Expenses incident to his wife's illness, including medical expenses but excluding the cost of the house and motel in Arizona, were approximately $ 42,000 for the 3 years 1946 through 1948.  This includes moving*109  to Arizona and traveling back and forth between Arizona and Alabama to tend to his business interests.  The petitioner used the proceeds of the houses sold in 1947 and 1948 to help pay these expenses and to purchase the motel in Arizona.The twenty-three 3-bedroom houses which petitioner sold in 1947 and the 24 single-unit houses sold by petitioner in 1948, which he had constructed in 1946 and had rented until they were sold, were not properties held by petitioner primarily for sale to customers in the ordinary course of his trade or business.  These houses, prior to and up to the time of their sale, were held by petitioner primarily for investment and production of income.  The gains from such sales are taxable as capital gain and not as ordinary income.  The 28 houses sold by petitioner in 1945 on the installment basis and on which installment gains were realized in 1947 and 1948, and the 12 houses sold by petitioner in 1946 on the installment basis and on which installment gains were realized in 1947 and 1948, were held by petitioner primarily for sale to customers in the ordinary course of his trade or business.  The gains realized from these installment sales in 1947 and 1948*110  are taxable as ordinary income and not as capital gain.Bad debts.In 1946, the petitioner owned a building containing a vacant store which he wanted to rent.  His nephew, E. P. Bradley, who had just returned from the Army, wanted to open a grocery store in it.  E. P. Bradley did not have sufficient money so the petitioner loaned him $ 10,000 to start in business.  The money was used to equip and stock the store.  The nephew gave the petitioner a mortgage covering the fixtures and the stock.  The nephew made some payments but the business failed and the unpaid balance of the loan in the amount of $ 9,753.77 became worthless in 1947.The petitioner was required to pay on an accommodation endorsement for H. W. Nichols and also loaned him other amounts.  Nichols *976  was a lumber dealer with whom the petitioner used to deal in the late 1930's and the petitioner felt personally obligated to advance the money to him.  Nichols died in 1948, leaving no assets and the debt due to the petitioner in the amount of $ 1,065 became worthless in that year.The petitioner was not in the business of making loans nor did he ever previously lend a person money to start in business.  The loan*111  by petitioner to E. P. Bradley was not a business loan; neither was petitioner's loan to H. W. Nichols a business loan.Depreciation.The amounts of depreciation claimed and allowed are as follows:AmountAllowed byAmountDifferenceYearclaimed onCommissionerclaimedin issuereturnnow1947$ 26,422.06$ 27,172.18$ 28,566.24$ 1,394.06194829,485.9928,215.7230,413.442,197.72The differences are due to rates claimed and allowed on certain properties as follows:ClaimedAllowedNowProperty1947byclaimedreturnCommissioner1947Pershing St., 3, 4-unit frame apartmentsAtlanta Highway, 14-unit brickapartmentDecatur St. store building:Old334    New332 1/2Arizona motel, frame stuccoArizona residence, adobe house5    ClaimedAllowedNowProperty1948byclaimedreturnCommissioner1948Pershing St., 3, 4-unit frame apartments2 1/22 1/24    Atlanta Highway, 14-unit brickapartment2 1/22 1/23    Decatur St. store building:Old2 1/22 1/24    New2 1/22 1/22 1/2Arizona motel, frame stucco5    3    4    Arizona residence, adobe house5    *112  The Pershing Street units were frame with a brick foundation and were of average or below average construction.  A reasonable rate of depreciation is 3 per cent.The Atlanta Highway apartment was constructed of brick. A reasonable rate of depreciation would be 2 1/2 per cent.The Decatur Street store building was about 25 years old when purchased.  It was a frame building but was completely remodeled and substantially enlarged.  A depreciation rate of 2 1/2 per cent for the entire building is reasonable.The Arizona motel was of frame and stucco construction and was 8 or 10 years old when purchased in 1948.  New units were added and the older part was completely reconditioned.  A depreciation rate of 3 per cent is reasonable.*977  The petitioner did not claim depreciation on his 1947 or 1948 income tax return on the adobe house in Arizona that he purchased in 1946.  It cost $ 20,000, with $ 15,000 being allocated to the building.  The house was well built and several years old when purchased.  It was rented for 6 months in 1948.  A depreciation rate of 2 1/2 per cent is reasonable for the period when it was rented.OPINION.Capital Gains Issue.At the hearing of this proceeding*113  petitioner abandoned certain issues raised in his petition, and respondent on his part conceded certain errors in his determination of the deficiencies.  Effect will be given to these concessions in a recomputation under Rule 50.The question involved with regard to the gain realized from the sale of the houses is whether or not the gain is ordinary income or capital gain. The answer depends upon whether the houses were "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." The respondent contends that they were and that all the gain is therefore taxable as ordinary income.  The petitioner contends that the houses were held for rental investment purposes, that he was not in the business of selling houses, and that the sales were incident to a liquidation of investment property and, therefore, all the gain should be taxed as capital gain.The applicable section of the Internal Revenue Code of 1939 is set out below.  1*114  The question is essentially one of fact with no single factor being decisive.  The purpose for which the property was acquired; the substantiality, frequency, and continuity of sales; the nature and extent of the taxpayer's business; the activity of the taxpayer and those *978  acting for him; and the treatment of the property in the taxpayer's records are all to some extent determinative of the purpose for which the property was held during the period in question.In Nelson A. Farry, 13 T. C. 8 (1949), and Walter R. Crabtree, 20 T. C. 841 (1953), we recognized that a taxpayer may occupy the dual role of a dealer in real estate and an investor in real estate. We believe the facts in this case warrant the same treatment.  See D. L. Phillips, 24 T.C. 435">24 T. C. 435.The petitioner admittedly was in the business of building and selling houses prior to the construction of the houses in question.  The sale of some of the houses upon completion and the sale of others shortly after the restrictions on sale were removed are clear indications that he remained in that business.The petitioner, on the other*115  hand, had for some time been in the process of accumulating rental investment property.  We think the evidence clearly establishes that fact.  His rental income further substantiates his role as an investor.The problem here is to segregate the houses sold into their proper categories.  With regard to the houses sold in 1945 and 1946 on the installment basis, we do not believe that the petitioner has proved that they were not held for sale to customers in the ordinary course of trade or business.  The 28 houses sold in 1945 without prior rental were clearly held for sale.  Petitioner's own testimony was to that effect.  The 12 houses sold in 1946 were rented upon completion, but by law they had to be rented. They were held for a short time after the restrictions were removed.  The record indicates that they were all probably 2-bedroom houses.  Petitioner's own testimony was to the effect that the 2-bedroom houses were rented because of the restrictions.  The fact is that they were all sold when completed or in the year following the removal of restrictions.  See Rollingwood Corporation v. Commissioner, (C. A. 9, 1951) 190 F. 2d 263. We, therefore, *116  hold that the installment gains realized in 1947 of $ 4,338.79 and $ 4,361.11 from 1945 and 1946 sales and the installment gains realized in 1948 of $ 1,525.87 and $ 3,872.83 from 1945 and 1946 sales were ordinary income.  Respondent's determination as to these items is sustained.With regard to the 23 houses sold in 1947 and the 24 houses sold in 1948, we believe that the facts show that they were held for investment purposes.  The group of 23 were all 3-bedroom houses.  The 3-bedroom houses were a good investment.  They rented for about $ 20 more per unit, while they cost only slightly more than the 2-bedroom houses.  They were retained in 1946 while all of the 2-bedroom houses in the 134-house group were being sold.  Most of them were rented for at least 2 years before they were sold.*979  The 24 houses that were sold in 1948 were not subject to any restrictions when they were built in 1946.  The petitioner was not required to invest any of his own funds in order to build them.  He borrowed all the money from the F. H. A.  They were small houses and easy to rent.  They were all rented from the time of their completion in 1946 until their sale in the first half of 1948.The*117  petitioner had good reason to sell both groups of property.  He was incurring considerable expenses incident to his wife's illness.  He entered the motel business in Arizona at a cost of $ 54,000 in order to have a business near his wife.  Later he expended about $ 50,000 in enlarging the facilities of this motel. He was also transferring all of his investments to multiple-unit dwellings which were easier for an absent owner to manage.The facts indicate to our satisfaction that his decision to sell was based on these factors and that prior to the sales he was holding the property in question for rental investment purposes.  The sales were incident to a liquidation in order to transfer his holdings to other types of investment and to relocate in Arizona. Walter R. Crabtree, supra.The fact that his income from sales was greater than his income from rentals does not mean that all property sold was held primarily for sale in the ordinary course of trade or business.  Cf. Delsing v. United States, (C. A. 5, 1951) 186 F. 2d 59, 61.We therefore hold that the gains in 1947 of $ 65,539.62 from completed sales and $ 4,617.74*118  from installment sales made in 1947, and the gains in 1948 of $ 19,053.29 from installment sales made in that year and $ 7,917.54 from completed sales in 1948, and $ 471.60 realized gains in 1948 from installment sales made in 1947, were long-term capital gains rather than ordinary income.  Petitioner's assignments of error to this extent are sustained.Bad Debt Issue.The question of whether the loans of $ 9,753.77 and $ 1,065 which became worthless in 1947 and 1948, respectively, were business or nonbusiness bad debts is essentially a question of fact.  The applicable provision of the Internal Revenue Code of 1939 is noted below.  2*119  The bad debt of $ 9,753.77 on the load to E. P. Bradley, the petitioner's nephew, was incurred in circumstances which we believe not to be connected with trade or business.  The petitioner had a vacant *980  store which the nephew wanted to rent so that he could open up a grocery store.  He lacked funds so the petitioner lent him the money to equip and stock the store, taking back a mortgage.  The record does not show that the store could not otherwise have been rented. Petitioner's own testimony was that he lent the nephew the money to help him go into business.  Although we do not doubt that the transaction was at arm's length, we believe that it was a personal loan and that the bad debt was not incidental or proximately related to the business of the taxpayer.  The fact that there was security for the debt is immaterial since the security was not a security as defined in section 23 (k) (3) of the 1939 Code.The bad debt of $ 1,065 incurred on the debt of Nichols was also a nonbusiness bad debt. The petitioner has not pressed the issue in his brief and it is clear that it was a personal loan.  The petitioner's own testimony verifies that.  The fact that Nichols had sold him*120  lumber in the 1930's when lumber was difficult to obtain does not remove it from that category.  It is the debt relation to the taxpayer's business at the time that it became worthless that is controlling.  Regs. 111, sec. 29.23 (k)-6.Depreciation Issue.The question involved with regard to the depreciation is whether the rates allowed by the respondent are reasonable.  The applicable provision of the 1939 Code is set out below.  3The three 4-unit frame apartments on Pershing Street were of average construction.  The respondent in his brief concedes that 3 per cent would appear to be a reasonable allowance. We agree with this conclusion.  Since the other 4-unit brick apartment was depreciated at the rate of 2 1/2 per cent, the 3 per*121  cent rate on these frame apartments would be a reasonable allowance for the year 1948.The respondent allowed a depreciation rate of 2 1/2 per cent on the Atlanta Highway 4-unit brick apartment. The petitioner has not introduced any evidence to show that that rate is not reasonable.The Decatur Street store building was about 25 years old when purchased.  It was a frame building but was completely remodeled and enlarged.  The only testimony introduced was to the effect that the old part of the building had a useful life of 25 years and the newer part, a useful life of 45 to 50 years.  Petitioner has not proved the cost of each part, and we hold that the rate of 2 1/2 per cent for the entire building, as allowed by the respondent, is reasonable.*981  The respondent allowed depreciation at the rate of 3 per cent on the stucco frame motel in Arizona.  Part of the motel was 8 or 10 years old while the other part was newly constructed. The rate of 3 per cent on the new part is clearly reasonable.  Since the older part was remodeled and reconditioned, the same rate would also be reasonable for that part.The petitioner failed to claim depreciation for the adobe house in Arizona that*122  he rented for 6 months in 1948.  The house was well built and was several years old when purchased in 1946 for $ 15,000.  Petitioner is entitled to a depreciation allowance for the 6-month rental period.  A rate of 2 1/2 per cent is reasonable under the circumstances.Decision will be entered under Rule 50.  Footnotes1. SEC. 117.  CAPITAL GAINS AND LOSSES.(j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business.  -- (1) Definition of property used in the trade or business.  -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not * * * (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * *(2) General rule.  -- If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion (as a result of destruction in whole or in part, theft or seizure, or an exercise of the power of requisition or condemnation or the threat or imminence thereof) of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. * * *↩2. SEC. 23.  DEDUCTIONS FROM GROSS INCOME.(k) Bad Debts. -- * * * *(4) Non-business debts.  -- In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.  The term "non-business debt" means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩3. SEC. 23.  DEDUCTIONS FROM GROSS INCOME.(l) Depreciation. -- A reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) -- (1) of property used in the trade or business, or(2) of property held for the production of income.↩