Black v. Commissioner , 35 T.C. 90 ( 1960 )

Ethel Black, Petitioner, v. Commissioner of Internal Revenue, Respondent

Black v. Commissioner

Docket No. 77628

United States Tax Court

35 T.C. 90; 1960 U.S. Tax Ct. LEXIS 47;

October 21, 1960, Filed

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Decision will be entered for the respondent.

In August 1955, petitioner exchanged desert land she was holding for investment purposes for residential property, a mortgage, and cash. She painted the house and made some repairs, moving from a place she was renting into the newly acquired residence to do the work. When the work had been completed she listed the house for sale with a real estate agent, and in April 1956, it was sold for $ 7,500, the amount at which it had been included in the exchange. Petitioner claimed nonrecognition of gain to the extent of the value of the residential property. Respondent determined that the entire gain realized by petitioner from the exchange was to be recognized and was taxable income. Held, that the residential property received in exchange for the old property was other property held primarily for sale and did not come within the nonrecognition-of-gain provisions of section 1031(a) of the Internal Revenue Code of 1954.

William McRae, Esq., and John R. Elliott, Esq., for the petitioner.

Earl Gardner, Esq., for the respondent.

Turner, Judge.

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TURNER

The respondent determined a deficiency in income tax against the petitioner for the year 1955 in the amount of $ 687.12. The only question presented is whether residential property received by petitioner as partial consideration in exchange for unimproved desert land was property to be held by her for investment within the meaning of section 1031(a) of the Internal Revenue Code of 1954, to the end that the gain realized on the exchange to the extent represented by the residential property was not to be recognized.

FINDINGS OF FACT.

Petitioner is a single person, and a resident of Phoenix, Arizona. She filed an individual income tax return and two amended returns for the year 1955 with the district director of internal revenue for Arizona.

Prior to July 29, 1955, and from 1940, petitioner owned 200 acres of unimproved desert land situated in Maricopa County, Arizona. She was not employed. She resided in a rented "court" at 2627 North Central Avenue in Phoenix.

On July 29, 1955, petitioner, as seller, and Philo C. Carter, a real estate broker of Glendale, Arizona, as buyer, entered into escrow agreement No. 9248, upon the closing of which she would exchange her desert land for a total consideration of $ 19,500, to consist of residential property at a value of $ 7,500, a purchase money mortgage in the amount of $ 11,000, and $ 1,000 in cash. On the same date, Carter, as seller, and petitioner, as buyer, entered into escrow agreement No. 9247, upon the closing of which petitioner would acquire the residential property at a stated value of $ 7,500 as a "credit by trade" of the property covered by escrow agreement No. 9248. The closing under each escrow agreement was contingent on the concurrent closing of the other. The cost to petitioner of the desert land was $ 2,035 and her cost in making the exchange was $ 147.91, resulting in a net gain to her of $ 17,317.09.

Under escrow agreement No. 9248 covering transfer by petitioner of the desert property, the $ 11,000 purchase money mortgage was payable as follows:

In annual installments of $ 2,200.00 or more on or before the 1st of September of each and every year, beginning 9/1/56, with interest on all unpaid principal at the rate of 5% per annum from 9/1/55, payable annually and in addition to the payments of principal.

On August 10, 1955, Carter authorized and directed the escrow agent to show Arizona Rochester Development Corporation, an Arizona corporation, as nominee. Petitioner had no dealings with that corporation.

The escrows were closed on an undetermined date, probably between August 10 and August 31, 1955. At some undetermined time, either prior to or shortly after the closing of the escrows, the persons who had been occupying the residence vacated it. It appeared to petitioner that the property "needed fixing up," and she wanted to do the work herself. The property was situated about 6 miles from where she was living and to reach it she was required to go by public transportation, make a transfer, and then walk about a mile and a half. The trips back and forth would absorb some substantial portion of the time she desired to devote to the work, and it was more economical as well as more convenient for her to live on the property. Accordingly, on or about August 31, 1955, she moved into the house and had her mailing address changed to that location. Included in the work done was the painting of the outside of the house, which took considerable time. When she had completed the work she listed the property for sale with a real estate agent. She was living in the residence when it was sold in April 1956. She received $ 7,500 for the property. At all times after acquisition of the property she had held it primarily for sale.

In her original income tax return for 1955, filed on April 16, 1956, petitioner listed her address as 3214 West Northview Avenue, Phoenix, which was the address of the property in question. The only income reported was in the amount of $ 5,926.04, which was shown as long-term capital gain realized from the disposition of her desert property. Attached to the return was a computation reflecting $ 17,317.09 as the amount of gain realized, $ 11,852.09 as the amount of the gain to be recognized, and $ 5,926.04 as "long-term" gain, the amount taken into account for tax purposes. The $ 11,852.09 represented the mortgage of $ 11,000 and cash of $ 852.09 ($ 1,000 cash received less $ 147.91, cost of the exchange). At the bottom of the computation sheet was the following reference: "per Sec. 351, 356, 371, 1031, I.R.C.-1954," followed by "Sec. 112-c I.R.C.-1939." With a standard deduction in the amount of $ 592.60 and a personal exemption of $ 600, the taxable income reported was shown as $ 4,733.44, and the tax thereon as $ 1,030.69.

On June 15, 1956, petitioner filed an amended return for 1955. At that time, her address was given as 4136 North 19th Street, Phoenix. In a computation attached to the return, the market value of the $ 11,000 mortgage was stated to be $ 8,800, which resulted in a showing that there was realized a gain of $ 15,117.09, a recognized gain of $ 9,652.09, and a taxable "long-term" gain of $ 4,826.05. The tax liability was reported as $ 783, and an overpayment of the tax was shown as $ 247.69.

On October 2, 1956, petitioner filed a second amended return for 1955. In this return, she was shown to have elected to report the gain from the sale or exchange on the installment basis, the basis therefor being that the $ 11,000 was payable at the rate of $ 2,200 per year for 5 years, commencing September 1, 1956. The computation showed a realization of long-term capital gain of $ 1,000, an exclusion of long-term capital gain of $ 500 and income of long-term capital gain of $ 500, resulting in the reporting of "No Tax" due and an overpayment, described as "Paid on original return," of $ 40, refund of which was requested.

Respondent determined that the long-term capital gain to be recognized from the exchange was $ 17,317.09, and not $ 11,852.09, as reported by petitioner.

At the time of the exchange petitioner acquired the new property as other property to be held primarily for sale.

OPINION.

The question presented is whether upon the disposition by petitioner of her desert property the gain realized to the extent of the fair market value of the residential property received in exchange is not, under section 1031(b) of the Internal Revenue Code of 1954, ¹ to be recognized. Respondent has determined that the exchange does not meet the statutory requirements for nonrecognition of the gain in question. Both parties have accepted $ 7,500 as the fair market value of the residential property received.

In section 1031(a) of the Code, 1 it is provided that "[no] gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale * * *) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment." If, however, the property received in exchange includes money or property other than property permitted under subsection (a) to be received without recognition of gain, then under subsection (b) the gain is to be recognized to the extent of "the sum of such money and the fair market value of such other property."

According to section 1.1002-1(b) of the Income Tax Regulations, exceptions to the general rule, including the exceptions provided in section 1031 of the Code, "are strictly construed and do not extend either beyond the words or the underlying assumptions and purposes of the exception." According to subsection (c) of that section, "[the] underlying assumption of these exceptions is that the new property is substantially a continuation of the old investment still unliquidated."

Similar language has been used in regulations extending back to those promulgated under the Revenue Act of 1934.

With respect to the exception provided in section 1031 of the Code, the definition of "like kind" is stated in section 1.1031(a)-1(b) of the Income Tax Regulations, as follows:

As used in section 1031(a), the words "like kind" have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale.

"Like kind" has been similarly defined in prior regulations, extending back to the Revenue Act of 1924. Regs. 118, sec. 39.112(b)(1)-1; Regs. 111, sec. 29.112(b)(1)-1; Regs. 103, sec. 19.112(b)(1)-1; Regs. 101, art. 112(b)(1)-1; Regs. 94, art. 112(b)(1)-1; Regs. 86, art. 112 (b)(1)-1; Regs. 77, art. 572 (sec. 112, 1932 Act); Regs. 69, art. 1572(a) (sec. 203, 1926 Act); Regs. 65, art. 1572(a) (sec. 203, 1924 Act).

That the desert land was held for investment appears to be accepted by both parties, and according to the regulations there is an underlying assumption that residential property received in exchange was substantially a continuation of the old investment still unliquidated. That is not to say, however, that the exceptions are not to be given full force and effect even though they are to be strictly construed and do not extend either beyond the words or the underlying assumptions and purposes of the exceptions. Our inquiry accordingly must be directed to the exceptions, and to whether or not the residential property is covered thereby.

Admittedly, the desert property, the property exchanged, was not property held for productive use, and though at the trial there was some reference to a possible holding of the residential property for rent, the petitioner makes no claim that it was ever so held, but rather, contends that within the meaning of the statute it was property of a like kind to be held for investment.

From a reading of the wording of the exception, it is apparent, we think, that if the exception did cover the property in question it was because it was either stock in trade or other property held primarily for sale. On the facts here, we may pass the stock-in-trade category without any detailed discussion, since it is patent on the record before us that petitioner was not engaged in a business of buying and selling real estate or in any other business during the pertinent period, and thus the residential property acquired could not have been, as to her, stock in trade. We are of the view, however, that on the evidence the property when acquired was "to be held" and was in fact held by petitioner primarily for sale. It was petitioner's testimony that she accepted Carter's offer for her desert property which called for part payment in the residential property because she thought it was the best "deal" she could get. And while on direct testimony she did testify that in acquiring the property she was undecided whether to rent, sell, or just hold it and after acquiring it she had thought of renting it, she later testified on cross-examination that she was at all times attempting to sell the property and when she had finished her painting and other work she placed it in the hands of a real estate agent for sale, the sale being effected very shortly while she was still residing in the house. We are accordingly convinced that petitioner did not acquire the property to be held as an unliquidated continuation of the old property and for investment, but that at all times it was held primarily for sale, and we hold that the gain represented thereby falls within the exception to 1031(a) and must be recognized.

To support her position that the property was not held primarily for sale within the meaning of section 1031(a), petitioner cites and relies on Loughborough Development Corporation, 29 B.T.A. 95">29 B.T.A. 95, and Atlantic Coast Realty Co., 11 B.T.A. 416">11 B.T.A. 416. Neither case is in point. In the Atlantic Coast Realty case, the question was whether a corporation engaged in buying and selling land was entitled to have its income determined by the use of inventories. The question here and the applicable statutory provision are wholly different.

In Loughborough Development Corporation, the question was whether gain from the sale of real estate by a corporation which under its charter was authorized to engage in the real estate business was capital gain under the capital gains provisions of the statute or ordinary income, the basis for the latter being that the gain on the real estate was on the sale of property "held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." It was there found on the evidence that the property sold had not been so held, and it was held that it made no difference that the taxpayer was authorized by its charter to engage in the business of buying and selling real estate and that the particular real estate was not brought within the exception to the capital gains statute if in fact the real estate was not held primarily for sale to customers in the ordinary course of the taxpayer's business.

In the instant case, we are dealing with an entirely different statute, namely, section 1031, and as to that section the words "for sale to customers in the ordinary course of" the taxpayer's trade or business are quite conspicuous by their absence. For the exception in section 1031 to apply, there is no requirement that the taxpayer be conducting a trade or business, or that the property in question be held "for sale to customers in the ordinary course of" a trade or business carried on by the taxpayer. There can be no question, we think, that had it been intended that the scope of the exception in section 1031 should be so limited, language comparable to that used in the capital gains provisions, and which was in question in Loughborough Development Corporation, would likewise have been used in section 1031. The only requirement for applicability of the exception in 1031 is that the property received in exchange be "held primarily for sale." The record shows that the residence was so held, and we accordingly hold that the nonrecognition-of-gain provisions of that section does not apply.

Decision will be entered for the respondent.

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Footnotes

• 1. SEC. 1031. EXCHANGE OF PROPERTY HELD FOR PRODUCTIVE USE OR INVESTMENT.

  (a) Nonrecognition of Gain or Loss From Exchanges Solely in Kind. -- No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment.

  (b) Gain From Exchanges Not Solely in Kind. -- If an exchange would be within the provisions of subsection (a), of section 1035(a), of section 1036(a), or of section 1037(a), if it were not for the fact that the property received in exchange consists not only of property permitted by such provisions to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.↩