Connally v. Commissioner , 32 B.T.A. 920 ( 1935 )

MARY W. T. CONNALLY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Connally v. Commissioner

Docket No. 60434.

United States Board of Tax Appeals

32 B.T.A. 920; 1935 BTA LEXIS 872;

July 11, 1935, Promulgated

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1. The respondent's determination as to the fair market value of lands acquired by the petitioner from her mother's estate sustained upon evidence of record.

2. Respondent's prayer for affirmative relief by correction of error made in his original audit, granted.

3. Deduction from gross income for legal expenses paid in the taxable year allowed in part.

James I. Mason, Esq., for the petitioner.

Samuel L. Young, Esq., for the respondent.

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TURNER

This proceeding involves an income tax deficiency determined by the respondent for 1928, in the amount of $15,255.10. The question presented by the petitioner is whether or not the petitioner realized taxable gain by reason of the involuntary conversion, through condemnation proceedings, of certain lands belonging to her.

In his answer the respondent claims that in computing the taxable gain he applied section 214(a)(12) of the Revenue Act of 1921 instead of section 112(f) of the Revenue Act of 1928, which is applicable, and by so doing, erroneously reduced the net gain by a proration between basic cost and tentative profit of the amount used in the purchase of similar property by way of replacement. Prayer is accordingly made for an increased deficiency.

FINDINGS OF FACT.

The petitioner is one of three surviving daughters of Alice T. Connally, who died October 20, 1917, leaving an estate in lands and other property situated at and near Asheville, North Carolina.

At her death Alice T. Connally left a will, by the terms of which she bequeathed all of her estate, after debts and certain minor bequests were paid, to her three daughters, equally. This will was probated in Buncombe County, North Carolina, and the three daughters qualified as executrices. The pertinent provisions of the will read as follows:

FERNIHURST

Asheville, North Carolina, Feb. 26, 1912.

In event of my death I bequeath to my three daughters Mary Connally Coxe, Alice Connally Cheesborough, and Curry Connally Andrews all that I possess real and personal to be divided equally between them the three daughters acting as Executors without giving bond * * *.

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To the Executors -

Nov. 1, 1912.

It is my wish that "my cabin" and Black Mt. Land, North Fork Boundary should be assigned to Mary Connally Coxe as a part of her legacy. The timber being cut, it is not so valuable - at whatever valuation you decide upon - the other two daughters are to receive the same amount in other property.

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The daughters carried out this expressed wish of their mother and by mutual agreement divided the residue of the estate among themselves, according to their own appraisals of value and apportionments of the property. This division was accomplished without aid of court, by conveyances to each other through joint deeds, assignments, and releases of title to the lands and other parcels of property allocated under their agreements. Title to the Black Mountain lands, which were situated immediately north of the city of Asheville, was confirmed in the petitioner by a deed executed by her sisters and their husbands on September 10, 1920. Originally it was thought that this tract contained approximately 3,719 acres, but in 1928, when it was acquired by the city of Asheville, it was described as being a tract of 2,629.19 acres.

On November 20, 1918, the daughters filed a Federal estate tax return for the estate of Mary T. Connally, in which they placed a value of $15,000 on the Black Mountain lands. In the inventory of the estate filed in the Superior Court of Buncombe County, North Carolina, on January 24, 1918, the value was fixed at $19,742.

The Black Mountain property was very rough and only a small portion was suitable for farming. It had been cut over and contained very little merchantable timber, and most of this was second growth. In 1925 the Asheville area suffered a severe drought, and there was an extreme shortage of water in the city of Asheville, which resulted in steps being taken to acquire additional lands as a watershed for the city. Several tracts were considered, but due to its proximity and the fact that a stream known as North Fork traversed the property and offered certain advantages, the city of Asheville, in 1927, instituted condemnation proceedings to acquire petitioner's lands and considerable adjoining acreage. In these proceedings the condemnation jury appointed by the court to determine and assess the petitioner's damages fixed the value of the lands so taken at $182,709.50, which sum was paid to her in the taxable year. Up to the present time the property so acquired has not been developed for water purposes. The reasons for the failure to use the property are that the city of Asheville has not grown to the extent anticipated and sufficient water has been obtained through the development of what is known as the Bee Tree Watershed.

On December 27, 1928, the petitioner made application to the Commissioner of Internal Revenue to establish a replacement fund of the proceeds of the condemnation sale. In that application she stated that the lands condemned had an estimated March 1, 1913, value of $36,531.66 and estimated her taxable gain at $100,000. A bond filed with the application was later withdrawn and the application was abandoned by the petitioner before action on it was taken by respondent.

Of the sum received by the petitioner from the city of Asheville, $39,973.13 was invested in other lands similar to those sold.

At neither October 20, 1917, nor September 10, 1920, was there any market or demand for the property in question for watershed purposes.

During the taxable year the petitioner paid the sum of $5,000 to each of two attorneys for legal services rendered in connection with the condemnation and sale of her Black Mountain lands.

The petitioner did not report any of the land proceeds in her income tax return for the year received. She made claim, however, in her return, for a deduction of $17,388.64 as expenditures for legal services connected with the condemnation proceedings.

In auditing the petitioner's income tax return for 1928 the respondent found that she realized a taxable gain from the sale of the Black Mountain lands to the city of Asheville. In arriving at this result, respondent used $36,531.66 as his cost base for the lands, this sum being the March 1, 1913, value assigned to them in petitioner's application for a replacement fund. Against the taxable profit the respondent allowed a credit of $34,137.05 which was a proportionate part of a replacement expenditure of $39,973.13, but disallowed the expense deduction of $17,388.64 mentioned above.

OPINION.

TURNER: The principal point contended for by the petitioner is that in no event can any part of the money paid to her for condemned lands be taxed as profit, because all of it represents "compensation for losses sustained", and, being payment for losses, the proceeds can not be taxed as gains.

From the standpoint of taxable profit, there is no magic in the term "compensation." When applied to awards in condemnation matters, it relates entirely to the value of property at the date of its appropriation to public use, plus any special damages suffered by the owner. It therefore has nothing to do with the cost of the property taken and may represent profit, or actual loss to the owner, depending entirely upon whether its amount is greater or less than his investment in the property.

The petitioner relies chiefly on the decision of the Supreme Court in . Clearly that case is not in point. The question there was whether the proceeds of certain insurance policies payable to a corporation on the life of one of its officers should be included in gross income. The court held that such proceeds did not constitute income under the statute as then worded and specifically avoided the question as to whether or not Congress, if it so desired, might require the inclusion of such payments in corporate income. Contrasting that situation with the situation here, Congress, in section 112(f) ¹ of the Revenue Act of 1928, has specifically provided for the taxation of profits on property condemned for public uses, and, as we have pointed out in the preceding paragraph, the mere fact that under the law a person is entitled to be indemnified for property at its fair market value as of the date condemned is in no way determinative of the fact as to whether or not there is an actual realization of gain.

The petitioner and the respondent agree that the fair market value of the property on March 1, 1913, is not the proper basis for computing the petitioner's gain from its disposition, but differ as to whether the fair market value on September 10, 1920, when the deed to the property was signed by her sisters and their husbands, or the fair market value on October 20, 1917, the date of her mother's death, is the correct basis for computing the gain. This question is governed by section 113(a)(5) ² of the 1928 Act, which fixes the basic date, in such cases, as that of the death of the decedent. Under this provision of the statute the fair market value of the property on October 20, 1917, is the basis for determining the gain realized by the petitioner as a result of the condemnation proceedings.

On the question of land values, a voluminous record made up of depositions and testimony given at the hearing has been produced. Each of the parties called a great number of witnesses. Included among these witnesses were forest rangers familiar with that section of the country, county or city officials, local business men, and other individuals who had some knowledge of the tract of land involved.

Among the witnesses whose depositions were introduced by the petitioner to establish land values were five individuals who served on the condemnation jury in 1927. This jury, having fixed petitioner's award from the city for the taking of the lands, reassembled at her request on August 24, 1931, to determine by retrospective appraisement the fair market value of the lands in September 1920. At their meeting these former jurymen used as a base for their calculations their 1927 award of $182,709.50, which, by a graduated scale of shrinkage, they reduced to what they believed to be a proper level for the year 1920. By such process they decided that $146,167.60 "would be about right" for the lands in the former year.

Briefly stated, the evidence in the case shows quite clearly that the petitioner's property was rough cut-over mountain land and the portion suitable for farming was negligible. There was no market or demand for it in 1917 for watershed purposes. In fact, there seems to have been very little demand for such property for any purpose except possibly camp purposes. The possible inclusion of the property as a part of the watershed of the city of Asheville had received no serious consideration, and very likely no consideration at all until the drought of 1925. Since its acquisition by the city of Asheville, its water facilities have not been developed and it does not now appear that they will ever be developed unless and until the population of Asheville materially increases. A great many tracts of cut-over mountain land in the Ashville area had sold at a price ranging from $5 per acre to $12 per acre.

Making due allowance for such agricultural land as the tract contained and such timber, mostly second growth, as remained on the land and its suitability in 1917 for any purposes disclosed by the record, we are convinced that the fair market value of the property on October 20, 1917, was not in excess of $36,531.66. The petitioner has not shown that her gain from the property computed on that amount as the basis was in any way excessive.

Of the $17,388.64 claimed by the petitioner as a deduction, representing fees paid for legal services, the record shows that during the taxable year she did expend a total of $10,000 for legal services in connection with the condemnation proceedings. This item of $10,000 so expended should be applied against the gross amount received by her in computing the gain realized as a result of the condemnation of her property. Cf. .

On the remaining issue, affirmatively pleaded by him, the respondent is sustained. It is apparent that in computing the deficiency as originally determined the petitioner's taxable profit was reduced by prorating the amount used in the repurchase of similar lands between the basic cost of the original lands and the tentative profit, computed without regard to the possibility of replacement. This method of computation was proper under section 214(a)(12) of the Revenue Act of 1921. However, under the provisions of section 112(f), supra, of the Revenue Act of 1928, which governs this case, the only limitation on the recognition of the gain in full is that it may not exceed the amount of money remaining after replacement purchases are made.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 112. RECOGNITION OF GAIN OR LOSS.

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  (f) Involuntary conversions.↩ - If property (as a result of its 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) is compulsorily or involuntarily converted into property similar or related in service or use to the property so converted, or into money which is forthwith in good faith, under regulations prescribed by the Commissioner with the approval of the Secretary, expended in the acquisition of other property similar or related in service or use to the property so converted, or in the acquisition of control of a corporation owning such other property, or in the establishment of a replacement fund, no gain or loss shall be recognized. If any part of the money is not so expanded, the gain, if any, shall be recognized, but in an amount not in excess of the money which is not so expended.

• 2. SEC. 113. BASIS FOR DETERMINING GAIN OR LOSS.

  (a) Property acquired after February 28, 1913. - The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -

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  (5) PROPERTY TRANSMITTED AT DEATH. - * * * if real property was acquired by general or specific devise or by intestacy, the basis shall be the fair market value of the property at the time of the death of the decedent. * * * ↩