Bradford v. Commissioner , 22 T.C. 1057 ( 1954 )

J. C. Bradford, Petitioner, v. Commissioner of Internal Revenue, Respondent. Eleanor A. Bradford, Petitioner, v. Commissioner of Internal Revenue, Respondent

Bradford v. Commissioner

Docket Nos. 35990, 36895

United States Tax Court

22 T.C. 1057; 1954 U.S. Tax Ct. LEXIS 123;

August 18, 1954, Filed August 18, 1954, Filed

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Decisions will be entered under Rule 50.

1. A dealer in securities realized a gain upon the sale of certain stocks to its customers in the ordinary course of its dealer business. Held, the gain constituted ordinary income rather than a capital gain.

2. Petitioner was released from his liability as endorser of a note upon part payment of the amount due. The creditor retained the note upon which there was an unpaid balance. Held, petitioner did not become subrogated to the rights of the creditor under Tennessee law, and the payment was not deductible as a worthless bad debt. The payment was deductible, however, as loss within the purview of section 23 (e), Internal Revenue Code of 1939.

3. Petitioner's wife acquired certain rights in redemption of preferred shares given to her by petitioner. Included among the rights received were the right to purchase and sell FHA mortgage loans covering 383 houses and the benefits of a contract having no ascertainable fair market value entitling her to 20 per cent of the net income on power sold to the houses. Held, the gain realized on the rights constituted income to petitioner's wife rather than to petitioner. Petitioner's wife realized capital gains upon the sale of right to purchase and sell the FHA mortgages and upon the receipt of payments under the power contract.

4. In 1938 petitioner's wife gratuitously assumed $ 205,000 of petitioner's indebtedness to the bank. In 1946 $ 100,000 of the indebtedness was discharged for $ 50,000. Held, the indebtedness was that of petitioner's wife and not petitioner. The discharge of the $ 100,000 indebtedness for $ 50,000 did not represent a gift to petitioner's wife of $ 50,000 within the purview of section 22 (b) (3), Internal Revenue Code of 1939, and she realized ordinary income in the amount of $ 50,000.

William Waller, Esq., and Lawrence Dortch, Esq., for the petitioners.

Homer F. Benson, Esq., for the respondent.

Bruce, Judge.

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BRUCE

The respondent determined deficiencies in income tax of the petitioners as follows:

	Year	Deficiency
James C. Bradford	1943	$ 48,538.00
	1944	658.49
	1945	21,520.99
	1946	103,461.29
Eleanor A. Bradford	1945	718.98
	1946	69,942.79

James C. Brandford did not petition for a redetermination of the deficiency against him for the year 1944. Eleanor A. Bradford did not petition for a redetermination of the deficiency against her for the year 1945. The proceedings were consolidated.

The issues for decision are:

1. Whether the Commissioner erred in determining that James C. Bradford's distributive share of the gain realized by a partnership in 1943 on the sale of certain stocks was ordinary income rather than capital gains.

2. Whether the Commissioner erred in failing to allow as a deduction the amount paid by James C. Bradford in 1943 to secure his release as an endorser on a note.

3. Whether the Commissioner erred in determining that the gains realized on certain rights received upon the redemption of preferred shares given to Eleanor A. Bradford by James C. Bradford were taxable to him rather than to her, and that the gains represented ordinary income rather than long-term capital gains.

4. Whether the Commissioner erred in determining that the discharge of a $ 100,000 note signed by Eleanor A. Bradford for $ 50,000 was not a gift but constituted ordinary income in the amount of $ 50,000, and that the income was taxable to James C. Bradford rather than Eleanor A. Bradford.

FINDINGS OF FACT.

Issue I.

Petitioners, James C. Bradford (hereinafter referred to as petitioner) and Eleanor A. Bradford (hereinafter referred to as Eleanor), are husband and wife, residing in Davidson County, Tennessee. They filed their returns for the calendar years involved with the collector of internal revenue for the district of Tennessee.

Petitioner was, during the years in question, a member of J. C. Bradford and Co., a partnership engaged in the investment banking and securities business in Nashville, Tennessee. J. C. Bradford and Co. was a member of the New York Stock Exchange and the scope of its business included underwriting and dealing in securities, buying various forms of obligations, and general financing apart from commercial banking.

Throughout 1943 J. C. Bradford and Co. actively bought and sold, in the ordinary course of its dealer business, stocks of two local insurance companies, National Life and Accident Insurance Company and Life and Casualty Insurance Company. At some time prior to April 17, 1943, it became obvious to the members of J. C. Bradford and Co. that both of the named companies would pay large stock dividends later in the year 1943 which would enhance the price of the stock. It seemed to the members of the firm an opportunity to realize a capital gain rather than ordinary income on the resale of the stock.

On March 25, 1943, J. C. Bradford and Co. had purchased for resale to customers 1,375 shares of National Life and Accident Insurance Company voting trust certificates at $ 32.25 per share. The purchase was entered in the "trading account" on the firm's books, and the shares were available for resale by the firm's trading department. Of the shares purchased 1,000 were sold on March 31, 1943; and on April 17, 1943, the remaining 375 shares were transferred to the "stock and bond account" ledger at $ 32.25 per share. Shares listed in the "stock and bond account" were not available for resale by the trading department.

The trading department continued to purchase and sell National Life and Accident Insurance Company shares. On October 16, 1943, at a time when the balance in the "trading account" was zero, the trading department sold 100 shares to a customer at $ 43.50 per share. On October 18, 1943, the 375 shares in the "stock and bond account" were transferred to "trading account." One hundred of the shares returned to the "trading account" were used to cover the purchase of October 16, 1943, and the remaining 275 shares were sold in the ordinary course of business on October 18, 1943, to two customers at $ 44 per share.

Any member of J. C. Bradford and Co. could order stock transferred from the "trading account" to the "stock and bond account" and vice versa. A balance remaining in a "stock and bond account" at the end of the calendar year was transferred temporarily to inventory.

Throughout 1943 J. C. Bradford and Co. actively traded in two classes of Life and Casualty Insurance Company stock, "B" stock and "actual stock." On March 15, 1943, the balance in the "B" stock "trading account" was 58 shares. On April 17, 1943, 25 of the 58 shares were transferred on the books of the firm to the "stock and bond account" at $ 10.50 per share, which was the lowest price paid for these shares after November 4, 1942.

On April 5, 1943, the balance in the "actual" stock "trading account" was 986 shares. On April 17, 1943, 975 of the 986 shares were transferred on the books of the firm to the "stock and bond account." Three hundred and fifty-three shares were transferred at $ 16.125 per share, 3 shares at $ 11.50 per share, 130 shares at $ 11.875 per share, and 489 shares at $ 12 per share. The prices ascribed to the shares represented an attempt by the bookkeeper to equate the shares transferred with the prices paid for various shares purchased on or after February 11, 1943.

The following is a summary of the ledger entries which were made in Life and Casualty Insurance Company "stock and bond accounts":

Life and Casualty "B" -- stock and bond account
	Shares
			Cost and/or	Shares on
1943			market value	hand
	Increase	Decrease	per share
Apr. 17	1 25		$ 10.50	25
Aug. 27	1 1,500		18.375	1,525
		2 1,200		325
Oct. 6		3 200	20.00	125
Oct. 14		3 100	21.00	25
Oct. 18		3 25	21.00	0

Life and Casualty "Actual" -- stock and bond account
	Shares
			Cost and/or	Shares on
1943			market value	hand
	Increase	Decrease	per share
Apr. 17	1 353		$ 11.125	353
Apr. 17	1 3		11.50	356
Apr. 17	1 130		11.875	486
Apr. 17	1 489		12.00	975
Aug. 27	1 500		18.375	1,475
Aug. 27	2 1,200			2,675
Oct. 6		3 200	20.00	2,475
Oct. 14		3 500	21.00	1,975
Oct. 14		3 200	21.00	1,775
Oct. 18		3 775	21.00	1,000
Oct. 19		3 200	22.50	800
Oct. 25		3 300	22.75	500
Oct. 25		3 15	23.00	485
Oct. 28		3 37	22.00	448
Nov. 3		3 100	22.25	348
Nov. 3		3 200	22.00	148
Nov. 3		3 82	23.00	66
Nov. 3		3 18	22.50	48
Nov. 4		3 25	22.00	23
Nov. 6		3 23	22.375	0

Entries on the books of J. C. Bradford and Co. reflecting the transfer from the stock and bond accounts to the trading accounts and the sale of shares of Life and Casualty Insurance Company stock are contained in the following excerpts from the ledger accounts:

Life and Casualty "B" -- trading account
	Shares
			Cost and/or	Shares on
1943			market value	hand
	Increase	Decrease	per share
Sept. 30		49	$ 22.50	(27)
Oct. 2		14	22.50	(41)
Oct. 2		14	22.50	(55)
Sept. 30		100	22.50	(155)
Oct. 4	1 14		22.50	(141)
Oct. 6	2 200		20.00	59
Oct. 8	100		21.50	159
Oct. 8		100	21.75	59
Oct. 8		25	21.75	34
Oct. 8		40	22.00	(6)
Oct. 11		100	21.75	(106)
Oct. 13		100	21.50	(206)
Oct. 13		100	21.75	(306)
Oct. 14	2 600		21.00	294
Oct. 14		100	22.00	194
Oct. 14		50	22.00	144
Oct. 14		50	21.75	94
Oct. 16		50	23.00	44
Oct. 18	2 25		21.00	69
Oct. 18		10	23.00	59
Oct. 19	2 200		22.50	259
Oct. 19		182	22.50	77

Life and Casualty "Actual" -- trading account
	Shares
			Cost and/or	Shares on
1943			market value	hand
	Increase	Decrease	per share
Sept. 29		150	$ 22.00	(64)
Oct. 4		14	22.50	(78)
Oct. 6		100	21.75	(178)
Oct. 6	1 200		20.00	22
Oct. 13	100		21.50	122
Oct. 14		5	22.00	117
Oct. 14		100	22.00	17
Oct. 14		100	22.00	(83)
Oct. 14		100	22.00	(183)
Oct. 14	1 200		21.00	17
Oct. 16		50	22.00	(33)
Oct. 16		50	23.00	(83)
Oct. 16	1 775		21.00	692
Oct. 18		100	22.75	592

Some attempt was made by the bookkeeper of J. C. Bradford and Co. to transfer to a different envelope stock certificates representing shares transferred to the "stock and bond account." In several instances, however, no single purchase or combination of purchases by the firm equalled the number of shares claimed to have been segregated. No attempt was made to identify or record which particular shares were transferred between the two accounts.

All of the stock of both the National Life and Accident Insurance Company and the Life and Casualty Insurance Company owned by J. C. Bradford and Co. during 1943 was purchased for resale and was held at all times primarily for resale to customers in the ordinary course of its trade or business.

Issue II.

In October 1942, the petitioner loaned C. H. Briley, Jr., $ 57,500, and received Briley's note secured by all of the preferred and common stock of Mobile Homes, Inc., with the exception of 375 shares of preferred stock which petitioner received outright as compensation for making the loan. In order to secure funds for his loan to Briley, the petitioner borrowed $ 57,500 from the American National Bank of Nashville on his own note, secured by Briley's note together with the collateral thereon. Petitioner was in the trade or business of making loans of this type and the loan was a transaction entered into for profit.

At the beginning of 1943 the stock of Mobile Homes, Inc., pledged as collateral, was of sufficient value to cover the amount of the loan. By the fall of 1943, Mobile Homes, Inc., was insolvent.

Mobile Homes, Inc., was engaged in building 578 houses on a tract of land near Mobile, Alabama. In connection with the construction of the houses, Briley, together with the three other promoters of Mobile Homes, Inc., had signed a performance bond in the amount of $ 236,000. In September of 1943, the obligee, American National Bank and Trust Company of Mobile, Alabama (hereinafter referred to as the Mobile Bank), informed the surety, Standard Accident Insurance Company, that the cost of completion would exceed the amount available for completion by approximately $ 460,000. The claim by the Mobile Bank exceeded the amount of the bond.

The surety contended that the Mobile Bank had interfered with the completion of the houses and was able to settle for 50 per cent of the bond, or $ 118,000. The expenses of the surety were in excess of $ 21,000. The payment was made by the surety in 1946. The surety attempted to collect from Briley and the other primary obligors. The surety ascertained that the combined liquid resources of the four promoters, including Briley, did not exceed $ 4,000 in January of 1946. All four had been wrecked financially by the project. The surety received $ 4,000 and nothing more.

In addition to the performance bond, Briley and the other three promoters had given a $ 1,500,000 continuing guaranty to the Mobile Bank to secure credit for Mobile Homes, Inc. The Mobile Bank had spread the risk but, even so, lost $ 30,000. Nothing was recouped from Briley and the other guarantors. The Mobile Bank did not consider it worthwhile to pursue its remedies against them.

In August of 1943, the petitioner concluded that Briley's $ 57,500 note was virtually worthless. In order to evidence the loss for tax purposes, he persuaded the American National Bank to accept a note for $ 57,500 executed in favor of the bank by Briley, with petitioner as endorser and secured by the stock of Mobile Homes, Inc., in place of the note previously executed by the petitioner in favor of the bank. Subsequently the bank demanded payment of Briley, which was refused, and on December 15, 1943, the bank sold the collateral, consisting of the stock of Mobile Homes, Inc., to the petitioner at public auction for $ 1,000. On December 21, 1943, the petitioner paid the bank $ 53,000, and was released from liability as endorser on the Briley note. Approximately 1 year later petitioner purchased the Briley note from the bank for $ 100.

On his income tax return for the year 1943 the petitioner claimed a deduction of $ 53,000, representing the amount paid in discharge of his liability as endorser. Respondent disallowed the deduction.

In August 1945, the petitioner sued Briley in the Chancery Court of Davidson County, Tennessee, alleging that Briley was indebted to him in the amount of $ 53,000 paid by petitioner as endorser, plus $ 3,500, the unpaid balance on the note. Briley filed an answer and cross-bill alleging want of consideration for the note sued upon and breach of a fiduciary obligation in connection with a change brought about in the operation and management of Mobile Homes, Inc., for which he sought damages against Bradford in the amount of $ 60,000. The substantive allegations on which the answer and cross-bill were based were subsequently withdrawn by Briley and a decree entered dismissing both the original and cross-bills, "all matters in controversy having been compromised and settled out of court." Petitioner's purpose in bringing the suit was to induce Briley, as the representative of the Tennessee Title Company, to furnish certain title policies, which the title company was obligated to furnish, on the basis of which FHA insured mortgages could be issued. The suit was dismissed at Briley's cost after the title insurance was issued.

Briley was hopelessly insolvent prior to the end of 1943 and was still hopelessly insolvent in 1946.

Issue III.

Upon purchasing the collateral held by the American National Bank, petitioner became the owner of all the outstanding stock of Mobile Homes, Inc. On January 31, 1944, petitioner surrendered to the corporation, without consideration, all of the preferred shares which he had purchased at the bank sale. He retained the 375 shares of preferred stock which he had received outright in 1942 and all of the outstanding common stock. On April 1, 1944, he gave to his wife, Eleanor, the 375 shares of preferred stock. A certificate representing the 375 shares of class B preferred was issued to Eleanor by Mobile Homes, Inc., on that date. The certificate provided in part:

This preferred stock shall be redeemed at any time within one year from the 15th. day of October 1942. The owner of this preferred stock shall not be entitled to receive any dividends, but all dividends, earnings and assets of the company are pledged to retire this preferred stock as herein provided and until this preferred stock is retired, no dividends shall be paid to the other stockholders and the other stockholders shall be entitled to receive none of the assets of the company.

When received, the certificate was placed with Eleanor's other stock certificates.

Virtually all of the assets of Mobile Homes, Inc., were mortgaged. Petitioner informed the Federal Reserve Bank, the fiscal agent of the War Department, that if the creditors attempted to foreclose on their mortgages in the State courts he would place the corporation in voluntary bankruptcy. This would have delayed recoupment by the War Department and the banks of funds which they had advanced.

In order to obtain control of the corporation, the Federal Reserve Bank, on behalf of the creditors, consented to the redemption of the preferred shares held by Eleanor in return for certain contingent rights held by Mobile Homes, Inc., which had not been mortgaged. In accordance with the agreement reached, petitioner placed his common stock is escrow with the Federal Reserve Bank of Atlanta for the benefit of the War Department and the other creditors shortly after Eleanor's 375 shares of preferred stock were redeemed by Mobile Homes, Inc., on August 16, 1944.

In return for her stock Eleanor received, first, the benefits under a contract dated September 2, 1942, between Mobile Homes, Inc., and the Alabama Power Company. The Alabama Power Company regarded Mobile Homes, Inc., as a war housing project which would probably be abandoned at the close of the war. It required Mobile Homes, Inc., to advance the money to run the wires into the project. In return, Mobile Homes, Inc., was to receive 20 per cent of the net income that the Alabama Power Company realized upon power sales to the occupants of the houses. When received by Eleanor, this contractual right had no ascertainable fair market value, and Mobile Homes, Inc., had not recouped the money advanced to run the wires into the project. Eleanor received from the Alabama Power Company $ 2,808.74 in 1945 which she reported as ordinary income, and $ 3,978.15 in 1946 which she reported as a long-term capital gain.

Eleanor also received the right to purchase at par and to sell FHA guaranteed mortgage loans covering 383 houses and aggregating approximately $ 1,905,000. Due to a subsequent drop in interest rates, Eleanor was able to sell this right on July 2, 1946, to the Guaranty Mortgage Company of Nashville for $ 59,432.59. Eleanor reported the full amount of the sale price as a long-term capital gain on her 1946 return.

The final benefit received by Eleanor was the right, for a 5-year period, to place all hazard insurance purchased by Mobile Homes, Inc., on 383 houses and units not yet mortgaged and insured. Eleanor received brokerage commission fees of $ 11,963.18 in 1945 which she reported as ordinary income and refunded, because of cancellations, $ 1,921.75 in 1946, which she claimed as a deduction. The insurance was placed with an agency other than the one in which petitioner was a partner.

The value of the rights when received by Eleanor in redemption of her stock did not exceed the amount originally contributed to the corporation in exchange for the stock. The distribution of the rights to her was in no way essentially equivalent to the distribution of a taxable dividend. The profits realized by Eleanor on the rights were made possible primarily by the fact that the housing development built by Mobile Homes, Inc., became a permanent part of the city of Mobile and was not abandoned at the conclusion of the war.

All of the transactions set forth above were handled for Eleanor by petitioner. He negotiated the agreement with the Federal Reserve Bank and arranged the contract with Mobile Homes, Inc., for the redemption of Eleanor's stock. He also negotiated the contracts with the Guaranty Mortgage Company of Nashville and with the insurance agency. Eleanor signed all of the contracts personally. All of the amounts received by Eleanor were deposited in her separate investment account.

Issue IV.

In the year 1938 petitioner owed the American National Bank approximately $ 305,000. The indebtedness had grown out of investment banking ventures entered into prior to the depression. Petitioner had pledged most of his assets to the bank as collateral, but the greater part of the debt was unsecured. On October 26, 1938, the New York Stock Exchange adopted a rule requiring each general partner of a member firm to submit a detailed report of his indebtedness. Because of his large bank debt, petitioner feared that J. C. Bradford and Co. would lose its seat on the Exchange. As that would have seriously curtailed petitioner's earning power, petitioner was able to persuade the bank to accept Eleanor's note in lieu of his own for a portion of the indebtedness. Accordingly Eleanor, without receiving any consideration in return, executed a note to the bank for $ 205,000. Petitioner remained the obligor on two notes to the bank totaling $ 100,000. Petitioner furnished the collateral for Eleanor's note and paid the interest thereon. The bank realized when it took Eleanor's note that the money for any payments thereon would probably be furnished by petitioner.

Around 1940 Eleanor, at the bank's request, executed two notes to replace the $ 205,000 note. She executed one note for $ 105,000, on which all the collateral was placed, and another note for $ 100,000 which was unsecured. In December of 1943 the bank examiner required the bank to write off $ 50,000 of the $ 100,000 note.

In 1946 the bank advised petitioner that it was willing to sell the $ 100,000 note to anyone for its book value of $ 50,000. Having decided to purchase the note, but hoping to avoid tax liability on the transaction, petitioner persuaded his half brother, Duval, to purchase the note from the bank with $ 30,000 or $ 31,000 furnished by petitioner and $ 19,000 or $ 20,000 furnished by Eleanor. The transaction was, in essence, a discharge of Eleanor's indebtedness for $ 50,000. After the note was discharged, Eleanor was worth approximately $ 50,000. The bank's motive in selling the note for $ 50,000 was to liquidate its investment for book value. It was of the opinion that this was the best price available. Also, by selling at this price the bank avoided the realization of taxable income on the recovery of a charged-off debt as well as the difficulties and uncertainties of enforced collection. Petitioner was formerly a vice president of the bank, had paid interest and met his obligations to the best of his ability, and was one of the bank's most substantial borrowers. The discharge of Eleanor's note for $ 50,000 was not a gift, for the bank would have sold the note to anyone at that price. Nevertheless, the bank was glad that the transaction as consummated indirectly benefited petitioner. Also the bank did not wish to alienate petitioner and lose his future business by bringing suit against his wife.

OPINION.

Issue I.

The first question for determination is whether petitioner realized a capital gain or ordinary income upon his distributive share of the profit realized by J. C. Bradford and Co. in 1943 on certain securities. J. C. Bradford and Co. was a dealer in securities. Throughout 1943 it bought and sold securities identical with those in controversy. All of its sales were made to customers of the firm in the ordinary course of business. On April 17, 1943, the securities in controversy, which had been purchased for resale to customers in the ordinary course of business, were transferred on the books of the firm from the "trading account" to the "stock and bond account." There they remained until they, or identical securities, were returned from time to time on the books of the firm to the "trading account." Back in the "trading account" the securities were used to cover prior purchases by customers which had created shortages in that account, were sold to customers in the ordinary course of business, or were intermingled with identical securities constituting the firm's inventory and were presumably sold to customers in the ordinary course of business.

It is evidently petitioner's contention that the appreciation in the value of the stock while in the "stock and bond account" constituted a capital gain, taxable as such, and that upon the return of the stock to the "trading account" the cost of inventory should be increased accordingly. This position is untenable. A capital gain is realized upon the sale or exchange of an asset and not upon its transfer from one ledger account to another.

The proper question for consideration is whether J. C. Bradford and Co. realized a capital gain or ordinary income upon the sale of the securities in controversy. Petitioner contends that upon the transfer of the securities from the "trading account" to the "stock and bond account" they lost their status as securities held for sale to customers, and therefore became "capital assets" as defined by section 117 (a) (1) of the Internal Revenue Code of 1939, ¹ applicable for the years involved. Respondent argues that the securities did not lose their inventory status and with this view we are inclined to agree. The short holding period, the failure to identify the particular securities which were placed in the account, the practice of transferring the balance in the account to inventory at the end of the year, the activity in the account, and the lack of any purpose in holding the securities other than to derive a profit upon their resale, tend to show that the account was primarily a reserve to be drawn upon as needed for resale to customers rather than an investment account. Cf. Schafer v. Helvering, 299 U.S. 171. Be that as it may, the dispositive factor is not whether the securities changed their status upon their transfer to the "stock and bond account," but the purpose for which the securities were held at the time of their sale. In Pacific Affiliate, Inc., 18 T. C. 1175, 1212 (on appeal C. A. 9), it was stated:

This Court has consistently recognized the fact that a taxpayer, such as petitioner herein, may trade in securities on its own account and risk at the same time it is a dealer with respect to similar securities held for sale to customers. E. Everett Van Tuyl, 12 T. C. 900; Carl Marks & Co., 12 T. C. 1196; Stern Bros. & Co., 16 T. C. 295; and George R. Kemon, 16 T. C. 1026. As to those held for investment or speculation on its own account, the taxpayer is not a dealer and is not entitled to compute income on the inventory method. Such securities properly constitute capital assets. E. Everett Van Tuyl, supra;Stern Bros. & Co., supra;George R. Kemon, supra.On the other hand, those acquired and held primarily for sale to customers in the ordinary course of business are specifically excluded from "capital assets" by the statutory definition thereof. However, securities originally acquired and held for either purpose may be freely appropriated to the other purpose at the discretion of the taxpayer exercised in good faith. Carl Marks & Co., supra.Therefore, the ultimate question to be resolved is the purpose for which a particular security is held at the time of its sale. Such question is essentially one of fact. Stern Bros. & Co., supra.

As is made clear by the foregoing discussion, the fact that the securities were acquired for investment or were held for investment prior to the decision to sell is not controlling. It is the purpose for which the property is held at the time of sale which is important. This is true even though "the taxpayer-seller's motive in selling was to liquidate his investment." Florence H. Ehrman, 41 B. T. A. 652, 663, affd. (C. A. 9) 120 F. 2d 607, certiorari denied 314 U.S. 668. Here the securities in controversy were returned to the "trading account" or inventory either to cover customers' purchases through the firm's retail outlet or for future sale to customers in the ordinary course of the firm's trade or business. The firm might have sold the securities through an exchange. But what the firm might have done is not material. It did resort to a method of disposal which in fact required that the securities be submitted and sold to its customers in the ordinary course of its dealer business. Palos Verdes Corp. v. United States, (C. A. 9) 201 F. 2d 256, 259. We have therefore found as a fact that at the time of their sale the securities were held for sale to customers in the ordinary course of the firm's trade or business. Cf. Pacific Affiliate, Inc., supra, 18 T. C. at p. 1214, where capital gain treatment was not accorded to securities originally held for investment but later "appropriated to retail distribution and sale." Our finding that the securities were not "capital assets" as defined by section 117 (a) (1) eliminates the necessity of determining whether the securities were "held for more than 6 months" within the purview of section 117 (a) (4).

Issue II.

Petitioner loaned Briley $ 57,500 in 1942. All of the stock of Mobile Homes, Inc., was pledged as collateral on the note except 375 preferred shares which petitioner received outright as compensation for making the loan. To make the loan petitioner borrowed $ 57,500 from the American National Bank on his own note, pledging as collateral Briley's note and the collateral thereon.

In August of 1943 Mobile Homes, Inc., had become insolvent and Briley's note was virtually worthless. In order to evidence a bad debt loss, petitioner induced the bank to accept Briley's 90-day note in place of his own, and he signed the note as an accommodation endorser. When the note became due, the bank demanded payment of Briley and he failed to pay. The Mobile Homes, Inc., stock held as collateral was purchased by petitioner at public auction for $ 1,000. Petitioner paid the bank $ 53,000 and the bank released him from his liability as endorser. This left the bank with Briley's unsecured note with an unpaid balance of $ 3,500. Petitioner deducted the $ 53,000 paid to the bank on his return for the year 1943.

Petitioner contends that the $ 53,000 he paid to the bank for his release from liability as endorser on Briley's note represented a worthless bad debt. We do not agree. The theory upon which petitioner rests his claim is that upon payment to the bank he became subrogated to the bank's rights against Briley to the extent of the payment. The payment, however, did not satisfy the bank's claim against Briley. The bank retained Briley's note with an unpaid balance of $ 3,500. Under Tennessee law subrogation cannot take place until the creditor has been paid in full. Knaffl v. Knoxville Banking & Trust Co., 133 Tenn. 655, 182 S. W. 232, citing Columbia Finance & Trust Co. v. Kentucky Union Railway Co., (C. A. 6) 60 F. 794. See also Third National Bank in Nashville v. Carver, 31 Tenn. App. 520, 218 S. W. 2d 66; United States v. National Surety Co., 254 U.S. 73; Maryland Casualty Co. v. Southern Pac. Co., (C. A. 9) 119 F. 2d 672; National Surety Co. v. Salt Lake County, (C. A. 8) 5 F. 2d 34. E. A. Roberts, 36 B. T. A. 549, is not in point, for under the Alabama statutes applicable in that case the endorser was entitled to commence an action against the principal immediately upon making the payment.

The $ 53,000 payment made by petitioner to the bank, however, is deductible as a loss under section 23 (e) of the 1939 Code. ² The loss was incurred in petitioner's "trade or business" of making speculative loans similar to the loan in question. It is also clear that even if the loan was not connected with petitioner's trade or business, the loss was incurred in a "transaction entered into for profit." Abraham Greenspon, 8 T. C. 431. The possibility of petitioner recovering in a future year any part of the $ 53,000 paid to the bank was extremely remote, as Briley was at that time hopelessly insolvent. Petitioner was not required "to be an incorrigible optimist," United States v. S. S. White Dental Mfg. Co., 274 U.S. 398, 403, and was entitled to deduct the loss in 1943.

Issue III.

Relying on Helvering v. Clifford, 309 U.S. 331; Higgins v. Smith, 308 U.S. 473; and Commissioner v. Sunnen, 333 U.S. 591, respondent contends that the income derived from the Mobile Homes, Inc., rights is taxable to petitioner rather than to Eleanor. He argues that the preferred shares were worthless, and, therefore, the transfer of the shares to Eleanor was a subterfuge. The rights, respondent contends, were acquired in return for voting control and were in reality owned by petitioner.

We do not agree that the gift of the preferred shares to Eleanor was a sham or subterfuge. It represented a gift of securities having little actual value but great speculative possibilities. Mobile Homes, Inc., was at that time obligated to redeem the preferred shares and had the power to distribute to Eleanor the rights which she received. However, without the consent of the Federal Reserve Bank and other lending institutions the distribution could have been set aside as a transfer in fraud of creditors. In return for voting control and the retirement of the preferred shares, the Federal Reserve Bank gave its consent on behalf of the creditors. The rights were acquired, nonetheless, from the corporation in return for the stock and not from the creditors in return for voting control and the retirement of the preferred stock. If the relinquishment of the voting control by the petitioner constituted a portion of the consideration furnished for the rights received by Eleanor, the transfer of voting control to the creditors represented an additional gift by petitioner to Eleanor.

Also, petitioner did not retain "sufficient power and control over the assigned property or over the receipt of the income to make it reasonable to treat him as the recipient of the income for tax purposes." Commissioner v. Sunnen, supra, 333 U.S. at p. 604. It is true that without petitioner's cooperation Eleanor would not have been able to redeem her preferred shares. That, however, was the extent of petitioner's control, and to have exercised it to Eleanor's detriment would not have benefited him. The common stock was utterly worthless, as no distribution could be made on the common until the preferred was retired. Also, the common stock was of no value to the creditors while the preferred shares remained outstanding. Furthermore, the corporation was obligated to redeem the preferred shares once the consent of the creditors had been obtained. But whatever control petitioner had over the redemption of the shares, he retained no control when Eleanor realized gain on the rights she received in return.

Respondent relies heavily upon the fact that the various negotiations were conducted by petitioner on Eleanor's behalf. But the income or gain was attributable entirely to the rights owned by Eleanor and not to the services performed by petitioner. The services were of a character which a husband astute in business affairs would normally perform without compensation for his wife. Cf. Sax Rohmer, 21 T. C. 1099; Henson v. Commissioner, 174 F. 2d 846.

Respondent's next contention is that the assignment of the rights by Mobile Homes, Inc., constituted an anticipatory assignment of income and that the income derived by Eleanor on the rights represented constructive dividends, and hence ordinary income, when received. We will not attempt to analyze respondent's ingenious but involved and tenuous argument upon which he bases the above contention. It will suffice to point out that Eleanor reported the insurance commissions as ordinary income, and has not contended that they should be taxed otherwise. The right to purchase and sell the FHA mortgage loans was nothing more than an option, and its transfer to Eleanor was not an anticipatory assignment of income. Even if the assignment constituted a dividend, it was a dividend received in 1944, a year not before this Court with respect to either petitioner.

It could be argued that the transfer of the rights under the Alabama Power Company contract resulted in an anticipatory assignment of income. Cf. Commissioner v. First State Bank of Stratford, (C. A. 5) 168 F. 2d 1004, reversing 8 T. C. 831, certiorari denied 335 U.S. 867. However, as Mobile Homes, Inc., had not previously recouped the money advanced to run the wires into the project, it is not known whether or not the payments received by Eleanor would have resulted in income to the corporation if they had been received by it.

Even if the transfer of the Alabama Power Company contractual rights represented an assignment of income, it did not constitute a dividend. The rights were assigned to Eleanor in redemption of her preferred shares. Under its contract with the preferred stockholders, Mobile Homes, Inc., was required to redeem the preferred shares at that time. And, as the value of the rights received by Eleanor in redemption of her stock certainly did not exceed the amount originally contributed to the corporation in exchange for the stock, the redemption of Eleanor's stock was in no way "essentially equivalent to the distribution of a taxable dividend" within the purview of section 115 (g) of the 1939 Code, ³ applicable for the years involved. Also, as the corporation was hopelessly insolvent at that time, it is highly unlikely that the rights received by Eleanor represented "a distribution of the earnings or profits."

Respondent further contends that Eleanor realized ordinary income, rather than a capital gain, upon the receipt of the Alabama Power Company refunds. He argues that it was not a "gain from the sale or exchange of a capital asset," and was, therefore, not a capital gain within the purview of section 117 (a) (4), ⁴ applicable for the years involved. We do not agree.

Under section 115 (i) the redemption of Eleanor's stock represented a partial liquidation, and section 115 (c) provides that "amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for stock." Ordinarily, if the value of the right received exceeds the cost basis of the stock redeemed, a gain will be realized by the taxpayer when the exchange is made. But in the instant case the Alabama Power Company's contractual right had no ascertainable fair market value when it was received by Eleanor. Under circumstances indistinguishable from those here present, it was held in Commissioner v. Carter, (C. A. 2) 170 F. 2d 911, affirming 9 T. C. 364, and Westover v. Smith, 173 F. 2d 90, that where the contractual right received in exchange for the stock has no ascertainable fair market value, no gain is realized until the payments exceed the cost basis and, thereafter, the payments are taxed as capital gains. The above cases rely primarily upon Burnet v. Logan, 283 U.S. 404, which, we agree, is controlling. The fact that the payments are to be received from a third party rather than from the corporation purchasing the stock is immaterial. The fair market value of the contractual right received is equally unascertainable, and the taxpayer has not received any more of the consideration to be paid. But see the concurring opinion in Mace Osenbach, 17 T. C. 797, 804, affd. (C. A. 4) 198 F. 2d 235.

Issue IV.

Respondent has determined that the purchase of the $ 100,000 note from the American National Bank for $ 50,000 resulted in ordinary income in the amount of $ 50,000 to the petitioner or, in the alternative, to Eleanor. We do not agree that the note purchased was an obligation of the petitioner rather than Eleanor. When Eleanor was substituted as the maker of the note, most of petitioner's assets were pledged to the bank as collateral on the $ 305,000 note. The only other source of payment was petitioner's earnings through his investment banking firm. If the bank had refused to substitute Eleanor as the maker, the firm may well have lost its seat on the New York Stock Exchange, and the bank would have destroyed its chances of collecting both on the unsecured portion of the note assumed by Eleanor and on the notes upon which petitioner remained the obligor. The assumption of the note by Eleanor was not a sham. Although the bank probably expected that the money for payments on the note by Eleanor would be furnished by petitioner, the indebtedness was that of Eleanor's and she was the only person legally obligated to pay.

The purchase of the note for $ 50,000 resulted in ordinary income in the amount of $ 50,000 unless the gain constitutes an exempt gift under section 22 (b) (3) of the 1939 Code. ⁵Commissioner v. Jacobson, 336 U.S. 28; Helvering v. American Dental Co., 318 U.S. 322. A gift means "the receipt of financial advantages gratuitously." Helvering v. American Dental Co., supra, 318 U.S. at p. 330. "The situation in each transaction is a factual one. It turns upon whether the transaction is in fact a transfer of something for the best price available or is a transfer or release of only a part of a claim for cash and of the balance 'for nothing'." Commissioner v. Jacobson, supra, 336 U.S. at p. 51.

The American National Bank had been required by the bank examiner to write off $ 50,000 of Eleanor's $ 100,000 note and had presumably taken the appropriate deduction. Cf. Regs. 111, sec. 29.23 (k) (1). The bank had become restless about the note and was willing to sell it to Eleanor, to petitioner, or to anyone else for $ 50,000 or book value. Upon being informed of this fact, petitioner, acting through his half brother, purchased the note from the bank with $ 30,000 or $ 31,000 furnished by him and $ 19,000 or $ 20,000 furnished by Eleanor. There is no dispute that the above transaction was in reality a discharge of the indebtedness for $ 50,000. Eleanor was worth approximately $ 50,000 after the note was discharged.

The instant transaction did not represent the discharge of a $ 50,000 indebtedness "for nothing." The bank sold the note for $ 50,000, a price for which it was willing to sell the note to anyone. Evidently, it was of the opinion that $ 50,000 was the best price available. By selling the note for $ 50,000 the bank would not be charged with income upon the recovery of a worthless debt (Cf. Commissioner v. First National Bank of Stratford, supra) and would avoid the uncertainties and difficulties of enforced collection. It is highly unlikely that a bank would intend to make a gift to one of its borrowers. Cf. Noel v. Parrott, (C. A. 4) 15 F. 2d 669, certiorari denied 273 U.S. 754. Most of the consideration for the purchase of the note was furnished by petitioner, rather than by Eleanor, the maker, and this in itself is a valid consideration for releasing the remaining indebtedness. 1 Williston on Contracts, sec. 125; Restatement, Contracts, sec. 421, cited with approval in Brown v. Cowden Livestock Co., (C. A. 9) 187 F. 2d 1015, 1018.

We are unimpressed with the testimony of the president of the bank that he gave $ 50,000 to petitioner. He also testified that petitioner was not indebted to the bank on the note. Furthermore, petitioner testified that he had been informed that the bank was willing to sell the note to anyone for $ 50,000. We can only interpret the bank president's testimony as meaning that the bank was willing to sell the note at book value, and, if the transaction benefited petitioner, so much the better. We conclude, therefore, that the discharge of the note in 1946 did not constitute a gift from the bank to Eleanor, but resulted in her realization of ordinary income in the amount of $ 50,000. Commissioner v. Jacobson, supra.

Decisions will be entered under Rule 50.

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Footnotes

• 1. Transferred from trading account.↩

• 2. Transferred to "Actual" -- stock and bond account.↩

• 3. Transferred to trading account.↩

• 1. Transferred from trading account.↩

• 2. Exchanged from "B" stock.↩

• 3. Transferred to trading account.↩

• 1. Transferred from "Actual."↩

• 2. Transferred from stock and bond account.↩

• 1. Transferred from stock and bond account.↩

• 1. SEC. 117. CAPITAL GAINS AND LOSSES.

  (a) Definitions. -- As used in this chapter --

  (1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. * * *↩

• 2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.

  In computing net income there shall be allowed as deductions:

  * * * *

  (e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise --

  (1) if incurred in trade or business; or

  (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *↩

• 3. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

  (g) Redemption of Stock. -- If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.↩

• 4. SEC. 117. CAPITAL GAINS AND LOSSES.

  (a) Definitions. -- As used in this chapter --

  * * * *

  (4) Long-term capital gain. -- The term "long-term capital gain" means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing net income.↩

• 5. SEC. 22. GROSS INCOME.

  (b) Exclusions from Gross Income. -- The following items shall not be included in gross income and shall be exempt from taxation under this chapter:

  * * * *

  (3) Gifts, bequests, devises, and inheritances. -- The value of property acquired by gift, bequest, devise, or inheritance. There shall not be excluded from gross income under this paragraph, the income from such property, or, in case the gift, bequest, devise, or inheritance is of income from property, the amount of such income. * * *↩