Foster v. Commissioner , 19 B.T.A. 958 ( 1930 )

ED FOSTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

SEFFIE FOSTER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Foster v. Commissioner

Docket Nos. 22753, 22754.

United States Board of Tax Appeals

19 B.T.A. 958; 1930 BTA LEXIS 2288;

May 15, 1930, Promulgated

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1. Certain purchase-money note taken in 1920 held to have had no fair market value, and should not be included in income for that year.

2. The petitioners purchased a lease covering certain land in order to protect their titles to other leases, and to enable them to carry out contracts they had made. Held that the amount paid for said lease should be capitalized.

Don T. Haynes, Esq., for the petitioners.

J. Arthur Adams, Esq., and R. B. Cannon, Esq., for the respondent.

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MARQUETTE

These proceedings, which were consolidated for hearing, are for the redetermination of deficiencies in income taxes for the year 1920 asserted by the respondent against each petitioner in the amount of $3,079.62. Each petitioner admits a deficiency of $564.21 and contests the balance of the amount asserted. The deficiencies arise: (1) From the respondent's inclusion as income to the partnership of Foster & Allen, the amount of $27,500, represented by an unsecured promissory note held by the firm, which was given and fell due, but was not paid during 1920; and (2) from the respondent's disallowance of a deduction of $21,000, as a business expense, from the gross income of Foster & Allen for 1920.

FINDINGS OF FACT.

The petitioners are husband and wife and in 1920 they lived in the State of Texas, at or near Electra. The law of community property was in force in that State at that time.

During 1920 the petitioners engaged in farming and the oil business as individuals and as owners of a one-half interest in the partnership of the firm of Foster & Allen. They conducted their business on the cash receipts and disbursements basis. The husband made an income-tax return for 1920 as a community return for both petitioners.

In the latter part of April, 1920, the firm of Foster & Allen leased some oil wells to one Clois R. Greene for a consideration of $55,000. One-half of the amount was paid in cash, and the remaining $27,500 was represented by an unsecured promissory note, due in sixty days, signed by Greene and one R. M. Waggoner.

Both makers were solvent when the note was given in April, 1920, and Waggoner remained so throughout the year. Greene became insolvent in July, 1920. Waggoner received a large income monthly during that year and owned unencumbered real estate of considerable value. He was financially able to pay the note when it fell due.

When the note was first acquired the petitioner Ed Foster made several attempts to sell it to different banks in Wichita Falls and elsewhere, but none would buy it. After maturity Foster placed the note in a bank for collection, but the bank was unable to obtain payment. The note was then placed with a lawyer for collection, but with instructions from Foster not to sue the makers. The note was not paid in 1920, but the principal and interest were paid in 1921 and 1922, through renewal notes.

In his community income-tax return for the year 1920 Foster did not include any part of the $27,500 represented by the Greene and Waggoner note. He did report for 1921 and 1922 the amounts received by himself and wife during those years, respectively, from the proceeds of the renewal notes. Respondent has reaudited those returns and treated the proceeds of the renewal notes entirely as income in 1920 and has made the adjustments in the subsequent years.

In 1917 the petitioners leased to the Producers Oil Co. the south 400 acres of a tract of land in Wichita County, Texas, known as the Stephen Dennison Survey No. 832. The lease was transferred to the Texas Co., which in turn leased to the Bowers Oil Co. the north 50 acres of the 40-acre tract. Through an error the boundary lines of the Bowers Co. lease were incorrectly located on the ground. The Bowers Co. drilled a well, supposedly within the lease boundaries, but in fact beyond them and upon a lease owned by one Danciger. The well came in in May or June, 1920. The petitioner Foster knew before the well came in that it was not within the Bowers Co. lease, but neither Danciger nor the Bowers Co. knew it. The firm of Foster & Allen had already contracted to lease some $30,000 worth of acreage and had incurred liabilities for broker's fees in connection with such contracts. Foster & Allen feared they would be unable to close these contracts or make other leases in that vicinity if the confusion regarding the Bowers lease became known. To avert such confusion and to enable them to complete their leasing contracts, Foster & Allen purchased from Danciger the lease of 4 1/9 acres immediately surrounding the well of the Bowers Co. They paid $20,000 cash for that acreage. The transaction was carried on through a broker, to whom Foster & Allen paid $1,000 for his services. This took place in June, 1920. The 4 1/9 acres were then transferred by Foster & Allen to the Bowers Co. without consideration. Later, by agreement with the Texas Co., various leases were adjusted and reallocated, and from the Bowers Co. Foster & Allen received another 4 1/9 acres. At the time they bought the acreage from Danciger, Foster & Allen had no agreement or understanding with anyone as to reimbursement or reallocation of leases.

The firm of Foster & Allen deducted, as an ordinary and necessary business expense paid in 1920, the $21,000 which they paid for the acreage they transferred to Bowers Co. The respondent disallowed the deduction, on the ground that the purchase was a capital transaction, and increased the gross community income of these petitioners in the amount of $10,500.

OPINION.

MARQUETTE: The first question to be considered is whether the Greene and Waggoner note for $27,500 given and maturing in 1920, but not paid until a subsequent year, constituted taxable income for 1920. The note was given to the partnership of Foster & Allen in which firm the present petitioners, as a community, owned a one-half interest.

The petitioners conducted their business and made their income-tax returns upon a cash receipts and disbursements basis. It is their contention that as they received no proceeds from the note during 1920, they are not taxable with respect thereto. The respondent takes the position that the note was worth its face value in 1920 and therefore it constituted taxable income.

Section 213(a) of the Revenue Act of 1918 provides:

That * * * "gross income" includes gains, profits, and income * * * of whatever kind and in whatever form paid * * *.

Section 202(b) of the same act provides:

When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any, * * *

The note in question was property received in exchange for other property within the meaning of the above statute, and it is to be treated as though it were cash "to the amount of its fair market value, if any." What, then, was the fair market value of the note? The evidence discloses that the holder of the note, as soon as it was received, tried repeatedly to sell it to banks and moneyed men in the locality, but could not obtain a purchaser. This appears to have been due to the fact that the makers of the notes were extensively engaged in speculative enterprise, and to the further fact that the banks were already carrying large amounts of other notes given by these same makers. Whether the note might have found a ready market at another time, under different conditions, it is unnecessary for us to decide. We are here considering a situation that arose, and conditions that existed, in 1920. It is sufficient that at that time and under those conditions the note was not salable to the banks and other purchasers of securities with whom the petitioner was in a position to deal and to whom the note was offered for purchase. . We are satisfied that within the meaning of the statute the note had no fair market value in 1920. And this conclusion is not affected by the probability that the amount of the note might have been collected, after maturity, by means of a lawsuit against one of the makers, for, as we interpret the statute, the "fair market value" of property at any given time is not to be based upon and fixed by the probable outcome, at some future time, of more or less lengthy legal proceedings. In our opinion the note in question did not constitute income for the year 1920 and should not have been so treated by the respondent.

The second issue here presented is whether the $21,000 paid by Foster & Allen for a 4-acre lease which they to the Bowers Oil Co. in order to prevent confusion of titles and consequently a probable loss to the firm, was deductible as an ordinary and necessary business expense. The respondent contends that it was a capital investment, and not deductible.

We agree with that contention. When the transaction was made the firm of Foster & Allen had already contracted to sell $30,000 worth of leases, and were obligated for brokers' commissions upon those sales. The Bowers Co. had unwittingly drilled a producing oil well beyond the boundaries of its lease. Foster alone knew of the error, and before it became generally known his firm bought and assigned to the Bowers Co. the acreage necessary to complete that company's title. This was done solely for business reasons, to prevent confusion as to the lease titles and thereby to protect Foster & Allen's titles in and to other leaseholds, and, in consequence, to protect them against loss in respect to contracts for the sale of those leaseholds. Such expenditures are properly to be capitalized. See ; ; ; ; and .

Judgment will be entered under Rule 50.