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Joseph B. v. Commissioner of Internal Revenue

decided: December 15, 1960.


Author: Staley

Before GOODRICH, MCLAUGHLIN and STALEY, Circuit Judges.

STALEY, Circuit Judge.

Does a recognizable gain accrue to a taxpayer where pursuant to a prearranged plan he mortgages real estate and receives therefor an amount in excess of the property's adjusted basis under Section 111(b) of the Internal Revenue Code of 1939,*fn1 and shortly thereafter transfers the property without consideration but subject to the mortgage?

The facts as found by the Tax Court, stipulated in part, may be summarized as follows:

In 1941 Joseph B. Simon, petitioner,*fn2 purchased the RKO Building ("property") in Philadelphia, Pennsylvania, for $104,220.45. On September 28, 1951, he placed a mortgage on it not involving personal liability and received therefor $120,000. On December 27, 1951, the petitioners conveyed the property subject to the mortgage to Exco Corporation ("Exco"), and shortly thereafter, Exco conveyed the same property to Penn-Liberty Insurance Company ("Penn-Liberty").

The petitioners' joint income tax return for the year 1951 did not show receipt of the mortgaged proceeds or reflect in any way the conveyance of the property to Exco. The Commissioner determined that these transactions constituted a sale from which the petitioner realized a long-term capital gain in the amount of $35,108.33 for the taxable year 1951.*fn3 A tax deficiency in the amount of $10,715.94 was assessed against the petitioners, together with an addition to tax in the amount of $824.41 for substantial underestimation under Section 294(d)(2) of the Internal Revenue Code of 1939.*fn4 The Tax Court sustained the Commissioner's determination, except that it reduced the taxable gain by $901.78, which represented the November and December, 1951, payments towards the mortgage debt, thereby requiring a recomputation of the deficiency.*fn5

In this court the petitioner does not assail the facts, largely stipulated, as found by the Tax Court, but only its ultimate finding that a sale took place, asserting that "there are no facts to support the Court's conclusion that a 'sale', or any other kind of taxable disposition, took place." The Tax Court's conclusion that the mortgage and subsequent conveyance to Exco was a sale is, of course, an ultimate finding of fact which this court can review free of the restraint imposed by the clearly-erroneous rule applicable to ordinary findings of fact. Philber Equipment Corp. v. Commissioner, 3 Cir., 1956, 237 F.2d 129. But that does not end the matter, for as we said in Pennroad Corp. v. Commissioner, 3 Cir., 1958, 261 F.2d 325, 328, certiorari denied sub nom. Madison Fund, Inc. v. Commissioner, 1959, 359 U.S. 958, 79 S. Ct. 797, 3 L. Ed. 2d 766, "where the ultimate fact reasonably flows from the basic facts and especially where the basic facts are persuasive of the ultimate fact so found, this court will not disturb the finding of the trial court." See also Heebner v. Commissioner, 3 Cir., 1960, 280 F.2d 228; August v. Commissioner, 3 Cir., 1959, 267 F.2d 829.

In our evaluation of the evidence before the Tax Court to determine its persuasiveness of that court's conclusion, we are guided in part by what was said in Commissioner of Internal Revenue v. Court Holding Co., 1945, 324 U.S. 331, 334, 65 S. Ct. 707, 708, 89 L. Ed. 981:

"* * * The incidence of taxation depends upon the substance of a transaction. The tax consequences which arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. Rather, the transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant. A sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title. To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress."

During 1951 Penn-Liberty was confronted with a deteriorating financial condition caused by substantial losses arising from claims for hurricane damage which had occurred at the end of 1950. The petitioner, Charles Denby, and officers of Penn-Liberty discussed this situation and agreed to a plan whereby the property in question would be mortgaged and thereafter conveyed, subject to the mortgage, to Penn-Liberty to help maintain its legal reserves. The interest shown by petitioner and Denby in PennLiberty's plight was understandable. Petitioner was president of Exco and treasurer of Penn-Liberty, while Denby served as treasurer of Exco. Together, they owned and controlled Exco, which in turn owned Penn-Liberty.*fn6

The petitioner proceeded to execute the plan. Either because Penn-Liberty did not require a contribution equal to the full value of the property, or because the petitioner was unwilling to make a contribution for that amount, he mortgaged the property on September 28, 1951, for $120,000. The petitioner used $79,587.27 of the mortgage proceeds to satisfy two prior mortgages and pay closing costs, and reduced the principal debt to $119,098.22 by making payments thereon in November and December, 1951, retaining $40,412.73 of the proceeds.

On December 27, 1951, when the property had an adjusted basis of $82,205.17, the petitioners conveyed it to Exco, and immediately thereafter, on December 31, 1951, petitioner, as president of Exco, signed a deed conveying the same property to Penn-Liberty. In both instances the property was conveyed subject to the mortgage for a recited but never paid consideration of $100.

Petitioner testified and he here contends that he intended the conveyance to be a contribution to capital meant to improve Penn-Liberty's financial condition. He also maintains that neither that conveyance nor the placing of the mortgage and retention of part of the proceeds can constitute separately or together a taxable event. However, in determining the true nature of the transaction based on the mortgage and subsequent conveyances, the Tax Court was free to draw its own conclusion from the evidence as a whole, not being bound by the interested though uncontradicted testimony of the taxpayer. Heil Beauty Supplies, Inc. v. Commissioner, 8 Cir., 1952, 199 F.2d 193.*fn7

Taxpayer may very well have intended to and probably did improve Penn-Liberty's financial condition by the method employed, for at the time of the conveyance to Penn-Liberty, the property was entered on its books as an asset with an appraised value of $242,800 (less the unpaid principal on the mortgage and $471.43 accrued interest), which was well in excess of the mortgage for $120,000. It thus appears that these transactions served as a means of fulfilling ...

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