Opinion
Docket No. 76597.
1960-03-31
ARTHUR POMPONIO AND TERESA POMPONIO, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Frederick R. Tansill, Esq., for the petitioners. Neil J. O'Brien, Esq., for the respondent.
Frederick R. Tansill, Esq., for the petitioners. Neil J. O'Brien, Esq., for the respondent.
Petitioner, Arthur Pomponio, was a stockholder in two corporations which had secured loan commitments from the FHA to build multiple-unit apartments. The apartments were completed during the year 1949. During the taxable years 1950, 1951, and 1952, petitioner received cash distributions from the two corporations in excess of the amounts reported by petitioner as dividends and the cost to petitioner of his stock in those corporations. Held, such ‘excess' is taxable to petitioners as ordinary income under section 117(m), I.R.C. 1939, rather than as long-term capital capital gain under section 115(d), I.R.C. 1939.
ARUNDELL, Judge:
Respondent determined deficiencies in income tax for the calendar years 1950, 1951, and 1952 in the amounts of $9,374.40, $5,061.38, and $8,445.06, respectively.
The only issue remaining is whether certain cash distributions made by Donna Lee Corporation and Greenbrier Apartments, Inc., in the taxable years are taxable to petitioners as ordinary income or as long-term capital gains. Petitioners concede that the distribution of $218.84 made by Glebe Apartments, Inc., in the taxable year 1951 is taxable as ordinary income.
Teresa Pomponio is a party here only by reason of having made joint income tax returns with her husband, Arthur Pomponio.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein by this reference.
Petitioners are husband and wife who resided in Arlington, Virginia, during the taxable years. They filed joint income tax returns for those years with the district director of internal revenue at Richmond, Virginia. Arthur Pomponio will be sometimes referred to as petitioner. He was an experienced builder and real estate developer.
Donna Lee Corporation (hereinafter sometimes referred to as Donna Lee) was incorporated on September 14, 1948, in the Commonwealth of Virginia for the purpose of engaging in the construction and operation of multiple-unit apartments. It used an accrual method of accounting and reported on a fiscal year basis ending August 31.
Petitioner was secretary-treasurer, a member of the board of directors, and a stockholder in Donna Lee. Donna Lee issued 100 shares of no-par common stock on or about September 16, 1948, to petitioner and William Bornstein in equal amounts. Bornstein subsequently transferred 14 1/2 shares to Alfred Bornstein, and 14 1/2 shares to Adolph Klein. There has been no subsequent change in the stock ownership. Petitioner had a cost basis of $500 for his 50 shares. Donna Lee had no authorized shares other than the common stock.
On October 21, 1948, Donna Lee purchased from Parkwood, Inc., a parcel of land containing 12 sections, together with certain improvements thereon, in Parkwood subdivision, Fairfax County, Virginia, for a total price of $145,000, allocated $110,289.35 to the land and $34,710.65 to the improvements. The land was originally acquired by Parkwood, Inc., from John N. Campbell for $93,000.
Donna Lee thereafter constructed in the Parkwood subdivision a multiple-apartment development known as the Donna Lee Apartments. Two buildings were erected on each of the 12 sections. Each building contained 12 or 13 apartments. The total number of apartments in the 12 sections was 291.
Donna Lee obtained $2,360,800 through the Federal Housing Authority (hereinafter sometimes referred to as FHA) insured mortgage loans from various commercial lending institutions. Each of the loans bore interest at the rate of 4 per cent per annum and was to be repaid in 391 equal monthly payments, commencing on the first day of the 12th month after each loan was made. Twelve separate applications for FHA insurance were originally made by Jesse Johnson as sponsor for Parkwood, Inc., on or about November 5, 1947. On October 12, 1948, FHA agreed to the substitution of petitioner and Bornstein as sponsors of the Donna Lee project. An FHA project analysis was submitted for each of the 12 commitments on February 9, 1948. On the same day, the FHA agreed to insure the mortgages. The first building loan contract was executed on December 8, 1948, and the first architect's agreement was executed on the same date. The first lump-sum construction contracts were entered into between Donna Lee and M. Pomponio & Sons, Inc., for construction of the apartments on December 9, 1948.
Construction of the last two sections of the Donna Lee Apartments was completed on December 19, 1949. The other 10 sections were completed on various dates ranging from June 13, 1949, to November 16, 1949.
The cost to Donna Lee of erecting the Donna Lee Apartments and the cost of the land are as follows:
+------------------------------------------+ ¦Buildings ¦$2,083,875.90¦ +----------------------------+-------------¦ ¦Equipment ¦62,588.96 ¦ +----------------------------+-------------¦ ¦Furnishings ¦10,303.92 ¦ +----------------------------+-------------¦ ¦Total Costs (excluding land)¦2,156,768.78 ¦ +----------------------------+-------------¦ ¦Cost of land ¦110,289.35 ¦ +----------------------------+-------------¦ ¦Total costs (including land)¦2,267,058.13 ¦ +------------------------------------------+
Donna Lee commenced receiving rental income from its various apartments, as each building was completed, on dates ranging from March 21, 1949, to November 4, 1949.
Donna Lee has not dissolved and has continued to operate the Donna Lee Apartments to the present time.
Donna Lee computed depreciation upon the buildings using the declining balance method with an estimated life of 40 years.
Returns of Donna Lee for its fiscal years ending August 31, 1949, 1950, and 1951, showed income and deductions as follows:
+-----------------------------------------------------------------------------+ ¦Item ¦1949 ¦1950 ¦1951 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Income: ¦ ¦ ¦ ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Rents ¦$39,645.41 ¦$300,030.03¦$323,363.91¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Other income ¦5.00 ¦1,170.00 ¦1,884.00 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Total income ¦39,650.41 ¦301,200.03 ¦325,247.91 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Deductions: ¦ ¦ ¦ ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Interest ¦23,834.44 ¦92,266.69 ¦93,045.94 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Depreciation ¦0 ¦85,847.92 ¦83,565.39 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Other deductions ¦36,194.55 ¦119,230.61 ¦137,290.87 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Total deductions ¦60,028.99 ¦297,345.22 ¦313,902.20 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Net income (or loss) before operating ¦(20,378.58)¦3,854.81 ¦11,345.71 ¦ ¦loss deduction ¦ ¦ ¦ ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Less net operating loss deduction ¦0 ¦3,854.81 ¦11,345.71 ¦ +-----------------------------------------+-----------+-----------+-----------¦ ¦Net income (or loss) ¦(20,378.58)¦0 ¦0 ¦ +-----------------------------------------------------------------------------+
Returns of Donna Lee for its fiscal years ending August 31, 1952 and 1953, showed income and deductions as follows:
+-----------------------------------------------------------------------------+ ¦Item ¦1952 ¦1953 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Income: ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Rents ¦$331,694.52¦$334,539.62¦ +-----------------------------------------------------+-----------+-----------¦ ¦Other income ¦2,944.99 ¦3,088.81 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Total income ¦334,639.51 ¦337,628.43 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Deductions: ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Interest ¦91,546.90 ¦89,986.44 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Depreciation ¦80,942.00 ¦78,986.34 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Other deductions ¦161,463.51 ¦172,547.20 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Total deductions ¦333,952.41 ¦341,501.98 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Net income (or loss) before net operating loss ¦687.10 ¦(3,873.55) ¦ ¦deduction ¦ ¦ ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Less net operating loss deduction ¦687.10 ¦0 ¦ +-----------------------------------------------------+-----------+-----------¦ ¦Net income (or loss) ¦0 ¦(3,873.55) ¦ +-----------------------------------------------------------------------------+
Cash distributions received by petitioner from the formation of Donna Lee through the taxable years are as follows:
+----+ ¦¦¦¦¦¦ +----+
Reported Recovery Reported Year as dividends of basis as capital Total 1 gains 1949 0 $500.00 $49,500.00 $50,000 1950 $1,927.40 0 30,822.60 32,750 1951 5,672.85 0 17,777.15 23,450 1952 352.55 0 23,047.45 23,400
Greenbrier Apartments, Inc., (hereinafter sometimes referred to as Greenbrier), was incorporated on May 25, 1948, in the Commonwealth of Virginia for the purpose of engaging in the construction and operation of multiple-unit apartments. It used an accrual method of accounting and reported on a fiscal year basis ending July 31.
Petitioner was secretary-treasurer, a member of the board of directors, and a stockholder in Greenbrier. Greenbrier issued 900 shares of no-par common stock and 100 shares of preferred stock with a par value of $1 per share. All of the preferred shares were issued to the FHA for the sum of $100 and the common shares were issued on or about September 12, 1948, to petitioner, Arthur Hirsch, and Louis Pomponio. Each of the three individuals received 300 shares and they each still retain their stock.
The common shares referred to above were issued to the three subscribers in exchange for conveyance of title to Greenbrier of lots 1 to 5, inclusive, of the subdivision of Greenbrier Apartments, Arlington County, Virginia. Petitioner's cost basis in those shares of stock was $8,333.33.
Greenbrier thereafter constructed in the Greenbrier subdivision a multiple-apartment development known as Greenbrier Apartments.
Petitioner made an application for mortgage insurance to the FHA on February 25, 1948, on behalf of Greenbrier. The FHA project analysis was submitted on April 19, 1948, and on the same day the FHA agreed to insure the loans for $894,600. The principal of the loan was to be amortized in 391 equal monthly payments with interest at 4 per cent per annum and the first payment was not to start before the first day of the 18th month after the effective date of the agreement.
A building loan agreement was executed between Greenbrier as borrower and the Chase National Bank of New York as lender on November 30, 1948, providing for a loan of $894,600. Thereafter, Greenbrier entered into a construction contract with Arthur Pomponio & Sons, Inc., contractors, for the construction of the Greenbrier housing project at a contract price of $804,418.
Construction of the housing project by Greenbrier was completed in 1949 and occupancy commenced in the various apartments between April and August of that year. Total construction cost of the Greenbrier Apartments was as follows:
+----------------------------------------+ ¦Buildings ¦$789,331.18¦ +----------------------------+-----------¦ ¦Equipment ¦72,323.86 ¦ +----------------------------+-----------¦ ¦Furnishings ¦3,645.49 ¦ +----------------------------+-----------¦ ¦Total costs (excluding land)¦865,300.53 ¦ +----------------------------+-----------¦ ¦Cost of land ¦25,000.00 ¦ +----------------------------+-----------¦ ¦Total costs (including land)¦890,300.53 ¦ +----------------------------------------+
Returns of Greenbrier for its fiscal years ending July 31, 1949 and 1950, showed income and deductions as follows:
+-----------------------------------------------------------------------------+ ¦Item ¦1949 ¦1950 ¦ +------------------------------------------------------+----------+-----------¦ ¦Income: ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Rents ¦$15,227.24¦$116,504.67¦ +------------------------------------------------------+----------+-----------¦ ¦Other income ¦2.76 ¦222.06 ¦ +------------------------------------------------------+----------+-----------¦ ¦Total income ¦15,230.00 ¦116,726.73 ¦ +------------------------------------------------------+----------+-----------¦ ¦Deductions ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Interest ¦11,746.17 ¦35,335.76 ¦ +------------------------------------------------------+----------+-----------¦ ¦Depreciation ¦0 ¦21,663.08 ¦ +------------------------------------------------------+----------+-----------¦ ¦Other deductions ¦11,047.73 ¦51,568.55 ¦ +------------------------------------------------------+----------+-----------¦ ¦Total deductions ¦22,793.90 ¦108,567.39 ¦ +------------------------------------------------------+----------+-----------¦ ¦Net income (or loss) before net operating loss ¦(7,563.90)¦8,159.34 ¦ ¦deduction ¦ ¦ ¦ +------------------------------------------------------+----------+-----------¦ ¦Less net operating loss deduction ¦0 ¦8,159.34 ¦ +------------------------------------------------------+----------+-----------¦ ¦Net income (or loss) ¦(7,563.90)¦0 ¦ +-----------------------------------------------------------------------------+
Returns of Greenbrier for its fiscal years ending July 31, 1951 and 1952, showed income and deductions as follows:
+--+ ¦¦¦¦ +--+
Item 1951 1952 Income: Rents $113,959.67 $117,919.34 Other income 313.38 622.03 Total income 114,273.05 118,541.37 Deductions: Interest 35,352.09 34,787.78 Depreciation 21,781.00 21,798.15 Other deductions 55,221.32 61,996.15 Total deductions 112,354.41 118,582.08 Net income (or loss) before net operating loss 1,918.64 (40.71) deduction Less net operating loss deduction 1,918.64 (14.86) Net income (or loss) 0 (55.57)
Greenbrier received gross rental income of $122,145 for the fiscal year ended July 31, 1953.
Cash distributions received by petitioner from the formation of Greenbrier throughout the taxable years were as follows:
+-----------------------------------------------------+ ¦Year¦Reported as¦Recovery of¦Reported as ¦Total 1 ¦ +----+-----------+-----------+-------------+----------¦ ¦ ¦dividends ¦basis ¦capital gains¦ ¦ +----+-----------+-----------+-------------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----+-----------+-----------+-------------+----------¦ ¦1950¦$2,719.78 ¦$8,333.33 ¦$3,175.33 ¦$14,228.44¦ +----+-----------+-----------+-------------+----------¦ ¦1951¦0 ¦0 ¦0 ¦0 ¦ +----+-----------+-----------+-------------+----------¦ ¦1952¦0 ¦0 ¦1,300.00 ¦1,300.00 ¦ +----+-----------+-----------+-------------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----+-----------+-----------+-------------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------+
These amounts are half of the total distributions in each of the years.
and not as long-term capital gain under section 115(d)
1These amounts are one-third of the total distribution in each of the years.
In the statutory notice of deficiency respondent increased the net income disclosed by the joint return of petitioners for each of the taxable years.
The net income for 1950 was increased by $16,998.97 and explained as follows (Note: petitioner's cost of Donna Lee stock of $500 was recovered in 1949 out of the distribution of $50,000 in that year):
It is held that the excess of the distributions received from Donna Lee Corporation and Greenbrier Apartments, Incorporated, over the cost of the stock of said corporations is taxable as ordinary income and not as long-term capital gains as reported on your return. Therefore, taxable income has been increased in the amount of $16,998.97 compu- ted as follows:STBL 4
+-----------------------------------------------------------------------+ ¦Distribution from Donna Lee Corporation¦ ¦$32,750.00¦ ¦ +---------------------------------------+---------+----------+----------¦ ¦Less: Amount reported as dividends ¦ ¦1,927.40 ¦$30,822.60¦ +-------------------------------------------------+----------+----------¦ ¦Distribution from Greenbrier Apartments, Inc ¦14,228.44 ¦ ¦ +-------------------------------------------------+----------+----------¦ ¦Less: Amount reported as dividends ¦$2,719.78¦ ¦ ¦ +---------------------------------------+---------+----------+----------¦ ¦Basis of stock ¦8,333.33 ¦11,053.11 ¦3,175.33 ¦ +---------------------------------------+---------+----------+----------¦ ¦Total ¦ ¦ ¦$33,997.93¦ +-------------------------------------------------+----------+----------¦ ¦Net taxable captial gain reported on your return ¦ ¦16,998.96 ¦ +-------------------------------------------------+----------+----------¦ ¦Adjustment ¦ ¦ ¦$16,998.97¦ +-----------------------------------------------------------------------+
The net income for 1951 and 1952 was increased by $8,998 and $12,173.73, respectively, with the explanations substantially the same as the above explanation given for the increase in net income for 1950.
Petitioners have not shown that they relied on any statement, document, or purported policy of the respondent or of his delegates in causing Donna Lee and Greenbrier to make the cash distributions in the taxable years.
The cash distributions made to petitioner during the taxable years by Donna Lee and Greenbrier in excess of the amounts reported by petitioner as dividends and the cost to petitioner of his stock in those corporations are taxable to petitioners as ordinary income and not as long-term capital gain.
OPINION.
The respondent contends that the ‘cash distributions' made to petitioner during the taxable years by Donna Lee and Greenbrier in excess of the amounts reported by petitioner as dividends and the cost to petitioner of his stock in those corporations are taxable to petitioners as ordinary income under section 117(m) of the Internal Revenue Code of 1939,