Butler v. Commissioner , 45 B.T.A. 593 ( 1941 )

COOLEY BUTLER AND LA RUE BUTLER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Butler v. Commissioner

Docket No. 101760.

United States Board of Tax Appeals

45 B.T.A. 593; 1941 BTA LEXIS 1097;

November 6, 1941, Promulgated

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The property of the Idaho Copper Co. was sold in 1932 under mortgage foreclosure. Prior to the expiration of the period of redemption and before execution of sheriff's deed, proceedings were instituted attacking the validity of the foreclosure proceedings, which had the effect of postponing finality of the foreclosure and sale until 1937. The evidence indicates that the stock had a substantial potential value at the beginning of the year 1937 which was wiped out during that year. Held that the stock of the company became worthless in 1937.

Joseph D. Brady, Esq., Philip H. Richards, Esq., and Charles M. Walker, Esq., for the petitioners.

E. A. Tonjes, Esq., for the respondent.

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MELLOTT

Respondent determined a deficiency in income tax for the calendar year 1937 in the amount of $22,992.79. Petitioners contend that he erred in failing to allow a deduction in the amount of $134,039.27 as a loss sustained by petitioner Cooley Butler on account of 1,150,238 shares of stock in the Idaho Copper Co. having become worthless in the taxable year. An issue involving the right of petitioners to deduct an amount as a bad debt was raised by the pleadings but abandoned by petitioners at the hearing.

The case was submitted on a stipulation of facts, oral testimony, and documentary evidence. We find the facts to be as stipulated and from the whole record make the following findings of fact.

FINDINGS OF FACT.

Petitioners are husband and wife residing in Los Angeles County, California.

On or before March 15, 1935, they filed a joint income tax return for the calendar year 1937 with the collector of internal revenue at Los Angeles, California, which showed no tax liability but a net loss of $50,770.22. In their return the petitioners deducted an amount of $134,039.27 representing the cost to petitioner Cooley Butler of 1,150,238 shares of the capital stock of the Idaho Copper Co. alleged to have become worthless during the taxable year. (Hereinafter the word "petitioner" will be used to mean Cooley Butler.) The respondent disallowed the claimed deduction for worthless stock on the ground that the claimed loss was not sustained in the taxable year, 1937, and determined the deficiency here in issue.

About 1919 petitioner acquired certain mining property known as the Red Ledge Mine and an additional mining claim for approximately $120,000. These properties were later merged and are referred to hereinafter as the Red Ledge.

The Idaho Copper Co., an Idaho corporation, was organized January 10, 1920, and capitalized at $500,000. In 1925 its capitalization was increased to $10,000,000, represented by 10,000,000 shares of common stock of a par value of $1 each. During all the times material hereto, 9,600,000 shares were outstanding. Of the total number of shares outstanding in the taxable year, petitioner owned 1,150,238 shares, or approximately 12 percent, which he had received in exchange for the Red Ledge property and cash. They had a total cost basis of $134,039.27.

On or about November 25, 1927, the Idaho Copper Co. was placed in receivership in the State Court of Adams County, Idaho. In September 1929 petitioner agreed to lend up to $150,000 to pay off the receivership certificates and claims, and on September 16, 1929, the court approved the loan, to be secured by the Idaho Copper Co. real and personal properties, and the receiver was discharged. The actual loan made by petitioner was $125,000, evidenced by a note of the Idaho Copper Co. dated September 21, 1929, due two years after date. The mortgage, securing the loan, on the Idaho Copper Co. real and personal properties bore the same date. In addition to the secured loan petitioner advanced to the Idaho Copper Co. approximately $183,000 on open account.

No interest or principal was paid on the secured note and petitioner filed foreclosure proceedings about September 21, 1931, resulting in a decree of foreclosure and sale dated February 27, 1932. The sheriff's sale pursuant to the decree was held April 16, 1932, and petitioner, as judgment creditor, became the purchaser. The redemption period expired on April 16, 1933, and a sheriff's deed on foreclosure was issued to petitioner August 14, 1933.

On or about September 14, 1932, before the period of redemption on the mortgage foreclosure sale had expired, Maytor Hoppenyan, in behalf of himself and other stockholders of Idaho Copper Co., filed suit in the United States District Court, District of Idaho, Southern Division, against the Idaho Copper Co., alleging that the company's properties were worth upwards of $30,000,000 and that the mortgage foreclosure suit was collusive and fraudulent. A receiver was appointed on the filing of the suit.

On or about April 15, 1933, before the period of redemption on the mortgage foreclosure had expired, William Devlin and Harold Empey, as stockholders and as members of a stockholders' protective committee, for themselves, for other stockholders, and for the company, filed a bill in equity against petitioner in the District Court of the Seventh Judicial District of the State of Idaho, in and for the County of Adams, asking that the court set aside and vacate the foreclosure decree and sale, decree that Butler held the property as trustee for the company, and compel him to return it to the company.

Notice of the pendency of this action, describing all of the real property, was recorded in the county where the property is located, contemporaneously with the commencement of the action. With these two actions attacking the foreclosure decree pending and untried, petitioner received the sheriff's deed above referred to on or about August 14, 1933.

On or about August 17, 1935, petitioner filed an answer and crosscomplaint to the suit filed in the Idaho State Court by William Devlin and Harold Empey against him. By this cross-complaint petitioner brought into the suit, as cross-defendants, Maytor Hoppenyan and Frank T. Wyman, the latter being the receiver appointed in the suit filed by Hoppenyan in the Federal court. Thus the suit in the State Court of Idaho served the purpose of a "clean-up" action, enabling the court to determine in one proceeding all conflicting claims to the mining property.

On August 19, 1935, the Idaho court, in the action referred to in the preceding paragraph, made findings of fact and conclusions of law, one of the findings being that Butler's foreclosure proceedings were in no respect fraudulent or collusive. It concluded that a decree should be entered in accordance with the written stipulation of all the parties. On the same date it entered an interlocutory decree, all the parties to the suit, for themselves or by their attorneys, signing it and consenting thereto, which, among other things, provided that:

Butler should have one year from August 19, 1935, or until within that period he notified the company that he wanted no further time, within which to secure a lessee for the property upon the terms set forth in a lease mutually agreed upon and incorporated in the decree. In the event that he secured a lessee, he was to place in escrow an assignment of the lease and a deed to the property to the Idaho Copper Co., such assignment of lease and deed to be delivered to the company if and when royalty payments under the lease amounting to $510,000 with interest at 6 percent per annum from January 1, 1935, should be paid to him.

In the event that Butler did not secure a lessee within a year, or in the event he notified the Idaho Copper Co. that he desired no further time to find a lessee, then by the terms of the decree the Idaho Copper Co. had eighteen months from the expiration of the one-year period in which Butler could have procured a lessee or from the date of his notification within that year that he desired no further time, whichever period expired first, within which to secure a lessee. If the company secured a lessee Butler was to place an assignment of lease and deed in escrow as above stated, to be deliverable upon the same conditions. If the company found a lessee, the lessee was to have an option to purchase the leased property, and if the option should be exercised, title was to be transferred when Butler had received $650,000 plus interest at 6 percent from January 1, 1935, and return of any advances made after April 1, 1935. In case the lessee exercised the option to purchase when the payments to Butler were made as provided, then he was to execute and deliver a good and sufficient deed conveying to the lessee all his right, title, and interest in and to the property, and also to transfer to the Idaho Copper Co. 1,150,238 shares of its capital stock.

The decree enjoined Butler from disposing of the property during the above periods and provided that if no lessee were secured by either party, then the Idaho Copper Co. and the receiver (in case the company was then in receivership) should quitclaim to him all their interest in the property.

By the terms of the decree, the court reserved jurisdiction over the cause to order commencement of the eighteen-month period within which the Idaho Copper Co. could secure a lessee at an earlier date than described above; to enter a supplemental or additional decree for the purpose of authorizing an alteration or modification of the lease which Butler and his lessee were to execute, which alteration or modification was to be previously consented to in writing by Butler and the Idaho Copper Co.; to appoint a commissioner for the purpose of executing such instrument or instruments as any party to the cause was ordered or required by the decree to execute but which he should fail or neglect to execute, and to do any other act or thing which any party to the cause was required to do by the decree but which he should fail or neglect to do; to punish as for contempt any disobedience by any party to the cause of any order or direction contained in the decree; and to determine any dispute arising between the Idaho Copper Co. and Butler with respect to the amount of the moneys that might have been advanced by him in the care and protection of the property subsequent to April 1, 1935.

On May 7, 1936, petitioner notified the Idaho Copper Co. that he did not desire further time to find a lessee pursuant to the terms of the decree of August 19, 1935. Thereafter the Idaho Copper Co. or some of its stockholders carried on negotiations in an effort to find a lessee or a purchaser. These negotiations were carried on until the latter part of 1937, but no purchaser was found and no lease was negotiated. Efforts were also made by various interested stockholders to secure further capital for the corporation, but none was obtained.

No lessee or purchaser of the property having been secured by the Idaho Copper Co. within the eighteen-month period provided for in the court decree, petitioner, on December 4, 1937, filed a petition for an order to show cause why the company should not quitclaim the properties to him. On December 8, 1937, the company executed a quitcaim deed to him and his wife. On December 13, 1937, the court which issued the decree and order to show cause entered its final order, stating that on November 7, 1937, the contingency referred to in the decree had happened and that the Idaho Copper Co. had no right, title, or interest in the property described in the decree. The final order further stated that Butler and his wife could thereafter dispose of the property in any manner they saw fit, free and clear of any claim thereto by any other party to the suit. Taking cognizance of the execution of the quitclaim deed to Cooley Butler and LaRue Butler by the Idaho Copper Co., the court approved and confirmed it.

The mining property referred to in the foregoing paragraphs was the only asset of the Idaho Copper Co. of sufficient value to be considered in determining whether the value of the company's assets at any time material hereto exceeded its liabilities.

The liabilities of the Idaho Copper Co. at all times material hereto and prior to August 19, 1935, were in the amount of $519,953.68, comprised of $460,000 owed to petitioner ($125,000 of which was secured by mortgage on all the company's property), $24,505, owed to Cary H. Nixon, $17,525.18 owed to Allen Smith, and $17,923.50 owed to O. H. Griggs. On August 17, 1935, all of the above named creditors entered into an agreement which recited the fact that the litigation referred to above was pending and that a decree was expected soon to be entered therein, the substance of which was known to the contracting parties. By the agreement, and in order to effectuate the compromise settlement embodied in the decree, Nixon, Smith, and Griggs agreed with Butler and his wife to release their claims against the Idaho Copper Co. and thereafter to look solely to the Butlers for payment thereof out of the proceeds, if any, received by them under the terms of the decree.

After August 19, 1935, the liabilities of the Idaho Copper Co. were $510,000, plus interest thereon at 6 percent from January 1, 1935, plus $11,251.13 (additional sum advanced by petitioner after April 1, 1935), with interest from date of such advancement. These amounts were payable out of royalties, in the event the property was leased, before the Idaho Copper Co. could acquire title to its mining properties free from any claim or interest of petitioner.

The Red Ledge mining property consists of 60 mining claims (20 acres each), 15 mill sites (5 acres each), and a ranch of 320 acres in the vicinity of the copper property, which had been purchased for the purpose of housing employees. The property is situated on the south edge of the Seven Devils mining district, Adams County, Idaho, and is crossed by a mountain stream capable of developing 20,000 horsepower for power purposes. The west end of the property, called Eagle Bar, is adjacent to the Snake River at a point approximately 17 miles from Homestead, Oregon. The property has been partially developed, exploratory tunnels have been driven, and diamond drilling explorations have been made. Machinery has been installed for these operations and mining camps constructed. A road was built to connect the property with outside roads at a cost of approximately $225,000. The exploratory developments have shown that the property contains large deposits of copper, associated with gold and silver, the approximate value of the ore being $8 per ton, made up of about $5 copper and $3 gold and silver, valuing copper at 10 cents per pound and gold and silver at market. These exploratory examinations were conducted by reputable mining engineers at various times from 1914 to 1937. Based on the results of such examinations, the estimated recoverable ore in sight is approximately 2,500,000 tons.

The expenditures in exploring and developing the Red Ledge mining properties prior to January 1, 1937, were approximately $1,250,000. These expenditures, together with litigation arising from factions among the stockholders, had exhausted the finances of the Idaho Copper Co. and delayed getting the mine in operation. As of January 1, 1937, it would have required several years of development work and an expenditure of approximately $1,000,000 to bring the mine to a production capacity of approximately 1,000 tons of ore a day. The conditions at the mine are favorable for operation of the property. The climate is good, it is in a region of good mining timber, water power is obtainable, and the ore can be extracted by tunnel mining. When developed the property can be operated profitably.

The market price per pound for copper on December 31, 1936, and on January 2, 1937, was 11.775 cents; the average price for February 1937 was 13.427 cents; the average price for March 1937 was 15.775 cents; the average price for the entire year 1937 was in excess of 13 cents. All prices are f.o.b. Atlantic Seaboard.

The Red Ledge mining properties had a value as of January 1, 1937, substantially in excess of the outstanding creditors' claims against the Idaho Copper Co. and the stock of the Idaho Copper Co. had a potential value as of that date.

OPINION.

MELLOTT: The only question before us in whether the stock of the Idaho Copper Co. became worthless in 1937.

The respondent contends in his brief that the stock became worthless prior to January 1, 1937, and that, therefore, no loss was sustained by petitioners on account of such worthlessness in that year. In the examining officer's report, attached to the deficiency notice, it is said: "It is held by the examining officer that all outstanding capital stock of Idaho Copper Company became worthless in 1933, when the sheriff's deed was issued to Cooley Butler, covering all properties of Idaho Copper Company."

Petitioner contends that the stock had some value at all times prior to January 1, 1937, and became worthless when, in that year, the company quitclaimed all of its right, title, and interest in the Red Ledge mining properties as shown in our findings. His contention is grounded primarily on his assertion that the Red Ledge mine, at all times material here, had a value substantially in excess of the amount of creditors' claims against the Idaho Copper Co. He argues that the pending litigation, instituted before the Idaho Copper Co.'s equity of redemption under the foreclosure sale had expired, had the effect of postponing until 1937 the finality of the mortgage foreclosure and sale of the company's property, so that in 1937 the company, having a right to repossess its properties under the conditions of the court's interlocutory decree, had assets substantially in excess of the amount of the creditors' claims against it, which gave its stock some value. Consequently, he says, the stock which he owned did not become worthless until 1937, when the court issued its final decree and the Idaho Copper Co. quitclaimed away all of its interest in the Red Ledge property.

The applicable provisions of the statutes and regulations are set out in the margin. ¹

The statute permits a deduction of losses sustained during the taxable year. Therefore a deduction for worthless stock must be taken in the year in which it becomes worthless and not in a prior or subsequent year. ; . The time when worthlessness occurs is a question of fact which obviously must be determined in the light of all the surrounding circumstances.

Generally there is some event which evidences the destruction of value, ; but in any event actual worthlessness should be the test and the burden of proof is on the taxpayer to show that the loss which he claims was sustained in the taxable year in which he seeks to claim the deduction. ; affd., ; certiorari denied, ; .

Stock of a distressed corporation may have a potential value, even though it does not have a current liquidating value, if there is reasonable hope and expectation that in the future it may acquire a value through foreseeable operations. While such a potential value exists, the stock can not be said to be worthless. ; affd., . See also . We are satisfied from the facts in this record that the stock of the Idaho Copper Co., at all times material here, had a substantial potential value, which was not wiped out by the foreclosure sale of the Red Ledge mining property and the transfer of the property by sheriff's deed to Butler, but was continued during the pendency of the stockholders' suits attacking its validity and by the interlocutory decree of the state court in 1935 until the final decree of the state court and the consequent quitclaims by the Idaho Copper Co. of all its interest in the property in 1937.

It is true, as contended by the respondent, that the computations in the record as to the value were based largely on estimates. Such estimates, however, were based mostly upon facts in the record which were uncontroverted and which, standing alone, are sufficient ground for attributing to the stock a substantial potential value. It is not disputed that exploratory examinations of the mining property by diamond drilling and tunneling carried on by competent mining engineers had shown vast stores of recoverable copper ore containing valuable deposits of gold and silver; that the ore veins were of substantial size, from 60 to 70 feet thick, and easily mined; that the climatic conditions were favorable; that facilities for mining, such as water power and timber, were available in the vicinity; and that development, preliminary to operation, including a connecting road to within a few miles of the property, had been done at a cost of approximately $1,250,000. In this situation we think the stockholders' hopes and expectations of refinancing the corporation's debts or of obtaining a lessee under the terms and conditions of the interlocutory decree of the state court and liquidating the debts through payment of royalties, thus recovering the Red Ledge property, were reasonable. These hopes and expectations were not abandoned until the state court issued its final decree and the Idaho Copper Co. quitclaimed its interest in the property to Butler in 1937. Not until this event happened could it be definitely determined that there would be a loss or the amount of it. We hold that the stock of the Idaho Copper Co. had a potential value on January 1, 1937, and that it became worthless during that year.

Respondent concedes that petitioner's cost of the 1,150,238 shares of Idaho Copper Co. stock and his basis for the computation of loss, if any, was $134,039.27. Being of the opinion that petitioner sustained a loss in that amount, we hold that respondent erred in denying the claimed deduction.

Decision will be entered under Rule 50.

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Footnotes

• 1. Sec. 23(e), Revenue Act of 1936 -

  (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; or

  (3) of property not connected with the trade or business, if the loss arises from fires, storms, shipwreck, or other casualty, or from theft. No loss shall be allowed as a deduction under this paragraph if at the time of the filing of the return such loss has been claimed as a deduction for estate tax purposes in the estate tax return.

  Art. 23(e), Regulations 94 -

  ART. 23(e)-1. Losses by individuals. - Losses sustained by individual citizens or residents of the United States and not compensated for by insurance or otherwise are fully deductible if (a) incurred in the taxpayer's trade or business, or (b) incurred in any transaction entered into for profit, or (c) arising from fires, storms, shipwreck, or other casualty, or theft, and a deduction therefor has not prior to the filing of the return been claimed for estate tax purposes in the estate tax return, or (d) if not prohibited or limited by any of the following sections of the Act: Section 23(g), relating to wagering losses; section 24(a)(6), relating to losses from sales or exchanges of property between members of a family or between a corporation and its shareholders; section 112, relating to recognition of gain or loss upon sales or exchanges of property; section 117, relating to limitation on losses recognized by section 112 upon the sale or exchange of capital assets; section 118, relating to losses on wash sales of stock or securities; section 251, relating to income from sources within possessions of United States; and section 252, relating to citizens of possessions of United States. See Section 213 as to limitation upon losses sustained by nonresident aliens.

  In general losses for which an amount may be deducted from gross income must be evidenced by closed and completed transactions, fixed by identifiable events, bona fide and actually sustained during the taxable period for which allowed. Substance and not mere form will govern in determining deductible losses. Full consideration must be given to any salvage value and to any insurance or other compensation received in determining the amount of losses actually sustained. See section 113(b).

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