Court Opinion

ID: 4597867
Source: CourtListenerOpinion
Date Created: 2020-11-20 19:20:05.044479+00
Date Added: 2024-06-11T07:51:52.030053
License: Public Domain

ESTATE OF JOHN Q. SHERMAN, DECEASED, KATHERINE M. SHERMAN, EXECUTRIX, WILLIAM C. SHERMAN AND WELLMORE B. TURNER, EXECUTORS, and MRS. KATHERINE M. SHERMAN, SURVIVING WIFE, PHILADELPHIA ROAD, R.R. #1, DAYTON, OHIO, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Sherman v. CommissionerDocket No. 103041.United States Board of Tax Appeals44 B.T.A. 853; 1941 BTA LEXIS 1261; July 3, 1941, Promulgated *1261  Petitioners' decedent, a solvent taxpayer, denied, in a court proceeding, his liability under a mortgage given in lieu of one assumed in connection with the purchase of a piece of real estate, alleging, as grounds for defense, fraudulent misrepresentations made in the sale of the property to him.  The mortgage indebtedness of $174,438.47 was liquidated in full under the terms of a negotiated settlement by payment of $64,465.92 in cash and certificates of claim having a cost basis to decedent of $46,194.80 and a face value of $109,972.55.  At the time of settlement the real estate had a value of not in excess of $73,360.  Held, that the transaction did not result in taxable income to the decedent.  W. B. Turner, Esq., and G. H. Wells, Esq., for the petitioners.  Paul A. Sebastian, Esq., for the respondent.  DISNEY*854  This proceeding involves the redetermination of a deficiency of $20,548.57 for 1936.  The issue is whether payment of a mortgage for less than its face amount resulted in taxable gain.  FINDINGS OF FACT.  Petitioners' decedent died testate July 27, 1939, a resident of Montgomery County, Ohio.  The return for the taxable*1262  year was filed with the collector for the first district of Ohio.  In November 1929 the decedent purchased a lot in Dayton, ohio, improved by a four-story brick storeroom and office building, known as the Hamiel Building, for $25,000 cash and the assumption of an outstanding mortgage on the premises in the amount of $175,000.  Thereafter the decedent and his wife gave the Dayton Savings & Trust Co., holder of the mortgage, a new note, secured by a mortgage on the premises, for the unpaid purchase price.  The note matured in two years, with interest at the rate of 6 percent per annum.  The sum of $561.53 was paid on the principal of the note in 1931, leaving a balance of $174,438.47.  Interest was paid regularly until December 15, 1932.  The note and mortgage securing it were acquired by the Union Trust Co. after their maturity.  In July 1932 the Winters National Bank & Trust Co. acquired the note and mortgage by purchase in connection with the liquidation of the Union Trust Co., by the Superintendent of Banks of the State of Ohio.  On December 15, 1934, the Winters National Bank & Trust Co., as owner of the note and mortgage, filed suit in the Common Pleas Court of Montgomery*1263  County, Ohio, against the makers of the note, seeking judgment in the amount of $174,438.47, the unpaid balance of the note, plus interest at 6 percent per annum from December 15, 1932, and the foreclosure of the mortgage.  The answer of the defendants to the suit denied liability and alleged, among other things, various fraudulent misrepresentations in connection with the sale of the property to them as grounds for defense.  The plaintiff filed an amended petition on January 23, 1935.  On numerous occasions the plaintiff filed motions to set the case down for hearing, but the case was never heard on the merits.  On May 29, 1935, the note and mortgage were reacquired by the Union Trust Co., which was in liquidation.  On September 21, 1935, the superintendent of banks was substituted as party plaintiff in the suit instituted by the Winters National Bank & Trust Co.  The defendants petitioned the court in November 1935 to remove the action to the United States District Court for the Southern District of Ohio, alleging, among other things, that the reconveyance of the note and mortgage by the Winters National Bank & Trust Co. to the *855  superintendent of banks violated a Federal*1264  Statute and that the transferee was without right or power to maintain the action filed on the note and mortgage.  The petition was granted.  The proceeding was subsequently remanded to the state court.  Negotiations for settlement of the liability of the payors under the note were begun about 90 days prior to the filing of the suit, were discontinued when the suit was filed, and were resumed when the proceeding was ready for trial.  On January 29, 1936, the makers of the note addressed a letter to the superintendent of banks in which, after setting forth that at the time of its purchase actual value of the property was considerably less than the selling price thereof to them, which fact was concealed from them by misrepresentations, and claiming that there were further misrepresentations as to the amount of income the building was producting, all of which the bank had denied, they offered, for the purpose of compromising the suit, to pay the accrued interest on the note, amounting to $35,534.08, and to satisfy the unpaid balance of the principal of the note, amounting to $174,438.47, by a cash payment of $64,465.92 and an assignment of certificates of claim against the Union Trust*1265  Co. having a payable balance and face value of $109,972.55.  The letter contained the following additional matter: The Shermans will carry upon their books the Hamiel property at $135,894.35 in order to effect this compromise; this book value being comprised of the original $25,000.00 in cash paid by the Shermans to the seller in 1929, plus the $100,894.35 compromised payment on principal pursuant to this offer.  The application of the superintendent of banks to the court for approval of the settlement provided, in part, as follows: Said note is secured by first mortgage on the property known as The Hamiel Buliding, located at the South-east corner of Fifth and Ludlow Sts., Dayton, Ohio.  The makers of said note are solvent but for more than a year last past have, and will continue to contest and deny their liability on said note.  Suit has been filed by your applicant against said makers for judgment on said note and for foreclosure of the mortgage security, to which action a defense has, is and will be continually interposed.  * * * Your applicant avers that said litigation has been pending now for more than a year, and will continue to pend for an indefinite length of*1266  time.  Your applicant avers that should said cause be decided against said defendants in the Common Pleas Court of Montgomery County, Ohio, that Said defendants will remove said cause to higher courts where they will continually resist payment of said claim by reason of the defenses theretofore interposed.  Said litigation is and will be indefinitely prolonged, is expensive to maintain by reason of the legal expense required to prosecute it, and your applicant avers and believes that a compromise settlement of said casue would be for the best interest of the depositors and creditors of the Union Trust Company.  The offer was approved by the court on February 14, 1936, and accepted on February 19, 1936, by the superintendent of banks.  *856  The settlement was concluded in accordance with the terms set forth in the letter, and the suit was dismissed on July 21, 1936.  At the time of the settlement certificates of claim against the Union Trust Co. had a fair market value of 55 percent of face value.  The certificates of claim had a cost basis of $46,194.80.  At the time the settlement was concluded the property in question had a fair market value of mot in excess of $73,360. *1267  The certificates of claim above referred to were issued by the banking department of the State of Ohio against the assets of the Union Trust Co. in favor of those who had deposits in the bank at the time it closed.  The face amount of the certificates represented the balances in the accounts.  The certificates were bought and sold on the market like stocks and bonds.  In his determination of the deficiency the respondent determined that the use of the certificates of claim in the satisfaction of the mortgage indebtedness resulted in capital gain, limited under section 117(a) of the Revenue Act of 1936 to the amount of $52,755.99, representing net capital gain upon $63,777.75, the difference between the amount of $109,972.55, the face value of the mortgage liquidated with the certificates, and $46,194.80, the cost of the certificates, less attorneys' fees paid to effect the settlement, and an adjustment for the amount of gain to be taken into account.  OPINION.  DISNEY: The petitioners contend that the settlement did not contemplate the use of the certificates of claim in the settlement at any amount other than the price paid for them and that, so far as they are concerned, *1268  the situation is the same as it would have been if they had increased the cash payment from $64,465.92 to the compromise figure, $110,894.35, leaving to the bank the question of how to use the additional money.  Under this theory they argue that not more than $46,428.43 was received for the certificates of claim and, as this amount is equal to cost, there was no gain to be taxed.  The proof here is that the certificates had a cost basis of $46,194.80.  The respondent asks us to view the case as one in which there was a satisfaction of indebtedness of a solvent taxpayer for less than the amount due, resulting in taxable gain within the principle of . In the Kirby case there was a purchase by the taxpayer of its own bonds at less than the selling price, in a previous year.  No other property was involved.  In , the liabilities of a corporation, including outstanding bonds, were assumed in connection with the purchase of its assets and later the taxpayer purchased blocks of bonds for amounts less than their *857  face value.  The record did not*1269  disclose the disposition made of the assets acquired.  Under the circumstances, the difference between the par value of the bonds and the amounts for which they were taken up was held to be taxable gain, following the doctrine announced in the Kirby case.  In each proceeding the court distinguished , upon the ground that therein the transaction as a whole showed loss, not gain.  The transaction here involved more than a mere purchase of a debt for less than its face amount or a voluntary forgiveness of indebtedness.  The petitioners' decedent actively contested the legal right of the mortgagor to payment of the face amount of the mortgage, alleging, in general, misrepresentations in connection with the sale of the property to him.  Nothing indicates to us a lack of good faith in the defenses set up in the litigation.  Negotiations ended in a settlement of the controversy by a payment of less than the principal of the mortgage.  It is not clear whether both parties understood the reduction of the mortgage debt to be a forgiveness of indebtedness or an adjustment of the selling price.  The decedent's offer of settlement*1270  discloses an intent to regard the adjustment as a decrease in the selling price of the property, for he recited that he would carry the property on his books at $135,894.35.  The original selling price of the property was $200,000.  The application of the superintendent of banks to the court for approval of the settlement treated the matter as a compromise of the suit to enforce payment of the principal and interest due under the mortgage, although he accepted the proposition of the decedent as made.  Irrespective of whether there was a meeting of the minds on the question, the transaction enabled petitioner's decedent to acquire unencumbered title to the property for a price less than the amount originally agreed upon.  The mortgagee, by accepting as part payment certificates of claim worth 55 percent of face value, recognized it was receiving a reduction upon the original price for the property.  There was not forgiveness of debt nor bargain payment of admitted obligation, but compromise of the question whether there was debt.  The final payment of cash and certificates of claim completed the transaction and, viewing it as a whole, there was no gain, since the property at that time*1271  was worth less than the unpaid amount of the mortgage.  The effect of the whole transaction was a reduction in the purchase price of the property.  In , a case relied upon by respondent, the property had a value at the time of settlement in excess of the mortgage indebtedness.  A like situation prevailed in . *858  In , the petitioner purchased a piece of real estate for $29,000, of which he paid $10,000 in cash and assumed mortgages outstanding on the property in the aggregate amount of $19,000.  Payments prior to the maturity of a new mortgage placed against the property reduced the indebtedness to $15,000.  Upon maturity of the mortgage the mortgagee demanded payment and the mortgagor refused.  In subsequent negotiations the mortgagor offered to reconvey the property in satisfaction of the indebtedness.  The mortgagee refused, but later, when the property had a value of $8,000, or $7,000 less than the mortgage indebtedness, accepted $8,000 in discharge of the debt.  The mortgagor*1272  was personally liable for the debt and was solvent before and after the settlement.  We sustained the action of the Commissioner in determining that the mortgagor realized taxable income of $7,000 in the settlement, upon the theory of the Kirby case, i.e., that the petitioner was relieved of a liability of $7,000, and until the property was disposed of it could not be ascertained whether the transaction as a whole would be a loss as in Upon appeal the decision was reversed.  . The reasoning of the court was, in general, that there was in essence a reduction of purchase price, and, the property having decreased in value, nothing of value moved to the mortgagor in the settlement, since the reduction of indebtedness merely decreased the loss in a capital investment; that the reduction operated as a credit upon cost, thereby to that extent reducing the purchase price; and that until the property is finally disposed of there is no way of determining whether the transaction as a whole will result in gain or in loss.  The situation here is in most material respects*1273  parallel with that in the Hirsch case, with here the additional fact of litigation as to whether there was actually any indebtedness owing by the petitioner.  Such litigation rendered incomplete the matter of purchase and payment for real estate, because of the defenses, including fraud, set up.  By the settlement of such litigation the parties thereto in effect agreed upon the actual amount of indebtedness and an actual purchase price, as the court holds in the Hirsch case.  Until that time the whole matter was unfinished.  At the time of completion of the settlement the property acquired was worth less than the amount paid, in part in cash, in part by certificates of claim.  What the petitioner paid was in substance a reduced purchase price.  On the whole transaction, purchase, execution of note and mortgage, and litigation and settlement, through which the property, free from encumbrance, was acquired, no profit was made.  Following the decision of the court in the Hirsch case, we conclude and hold that no taxable income resulted for the petitioner.  Decision will be entered under Rule 50.