SCOTT

Charles P. Duffy, for the petitioner. Gary C. Randall, for the respondent.

Held: 1. that $86,500 sales price of petitioner's mortgage-servicing business was in part for capital assets of the nature of goodwill and in part for its right to future income from servicing fees.

2. On the basis of the evidence $10,000 is allocated as the sales price of the capital assets and the balance of the $86,500 as the sales price of the right to future income.

3. The gain on the sale of the capital assets is taxable to petitioner as long-term capital gain and the gain on the sale of the right to future income is taxable to it as ordinary income.

4. Since both the capital assets and the right to future income are property and the right to future income is not compensation for services, petitioner is entitled to report the entire gain from the sale on the installment method, the other requirements of sec. 453, I.R.C. 1954, having been met by it.

5. The evidence does not show that any amount due by petitioner to another for procuring for it some of the mortgages being serviced at the date of the sale was accrued in 1962 except the amount of $1,100 representing a fee due petitioner in 1962 by the other person on a bond which amount petitioner permitted him to retain.

SCOTT, Judge:

Respondent determined a deficiency in petitioner's income tax for the calendar year 1962 in the amount of $32,474.78.

One of the issues raised by the pleadings has been disposed of by agreements of the parties, leaving for our decision the following:

(1) Whether the amount of $86,500 which Sherwood & Roberts, Inc., agreed to pay to petitioner for its mortgage-servicing business is in whole or in part in payment for the assignment by petitioner of its right to future service fees and therefore ordinary income or in the amount the sales price of a capital asset resulting in long-term capital gain to petitioner.

(2) If any part of the $86,500 is taxable as ordinary income as an amount paid for the right to receive income from future fees, may such portion of the payment be reported on the installment method under section 453(b), I.R.C. 1954,

as income from a ‘casual sale or casual disposition of personal property?’

(3) If any portion of the $86,500 is ordinary income and petitioner is not entitled to use the installment method of reporting this income, is the entire amount of $86,500 accrued income of petitioner in the year 1962?

(4) What is the proper amount of deduction, if any, accrued to petitioner in 1962 because of its agreement to pay to another a portion of the amount received from any sale of servicing of mortgages originated by that other person for it?

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

Realty Loan Corp. (hereinafter referred to as petitioner) is an Oregon corporation organized in 1920. Its principal place of business at the date of the filing of the petition in this case was in Portland, Oreg. During 1962 petitioner's president, Ralph M. Holmes (hereinafter referred to as Holmes), owned all its voting stock.

Petitioner kept its books and reported its income on an accrual basis of accounting. Its Federal corporate income tax return for the calendar year 1962 was filed with the district director of internal revenue at Portland, Oreg.

For a number of years prior to 1962 petitioner had been in the mortgage banking business in the Portland, Oreg., area. When an individual desiring to buy or build a house would make application to petitioner for a loan of funds to be advanced for that purpose, petitioner would process the loan application and in the course thereof would, among other things, confirm the applicant's bank balance, check his credit rating, and procure a report from his employer regarding his employment record and his prospects for continued employment. In those instances in which the loan was to be insured by either the Federal Housing Administration or the Veterans' Administration, petitioner would obtain a commitment from the insuring agency. If petitioner was satisfied that the applicant was qualified for the loan for which he applied, it would make the loan. When the transaction was closed petitioner obtained a promissory note from the purchaser of the property secured by a mortgage on the property. A broker's fee of from 1 to 2 percent was received by petitioner from the mortgagor. Petitioner would have the mortgage recorded in the county in which the property was situated.

Petitioner did not have sufficient capital to carry to maturity all loans which it made and therefore made contractual arrangements with several insurance companies to provide the necessary capital. Such a contract would provide that petitioner would offer for sale to the company the notes and mortgages which it had taken. If the company purchased any such note and mortgage, petitioner would execute an assignment of the note and mortgage to the purchaser upon the purchaser's remitting to it the agreed price. These assignments would be recorded in the public records of the county in which the property was situated.

Under its contractual arrangements with the various insurance companies petitioner agreed to service the mortgages which it sold to them for a service fee payable only out of the interest it collected from the mortgagor. The servicing activities performed by petitioner consisted principally of collecting the mortgage payments from the mortgagor and remitting the same to the insurance company after deducting amounts to cover taxes and insurance on the particular properties involved. On FHA-insured loans the mortgages provided for a 1 1/2-percent additional fee on delinquent payments by the mortgagor and under its contracts with the insurance companies petitioner retained all such delinquent fees.

On September 23, 1949, petitioner entered into a ‘Residential Loan Correspondent Agreement’ with Bankers Life Co. of Des Moines, Iowa (hereinafter referred to as Bankers Life). On October 24, 1955, petitioner and Bankers Life entered into a second ‘Residential Loan Correspondent Agreement.’ These agreements provided that petitioner would make diligent effort to procure loans meeting the requirements of Bankers Life, deliver promptly after closing to Bankers Life all loan documents on loans on which Bankers Life had made a commitment, service the loans for Bankers Life for the fee agreed upon in the loan commitment, and in case of the termination of the agreement to deliver to Bankers Life the original or copies of all papers and records pertinent to the loan. Under the agreements Bankers Life was to promptly consider all loans offered it by petitioner, issue written commitments for such loans as it agreed to purchase, make prompt payments of loans previously approved, and allow petitioner to service each loan for the fee provided for in the commitment.

Under petitioner's contract with Bankers Life the entire principal and interest payment from the mortgagor (with the exception of a reserve of $20,000) were forwarded to Bankers Life, Bankers Life would then make the necessary computation and return to petitioner its service fee.

On June 8, 1955, petitioner entered into a ‘Purchasing and Servicing Agreement’ with the Mutual Trust Life Insurance Co. (hereinafter referred to as Mutual Trust). The servicing contract agreement had a supplemental agreement and both these agreements were effective during 1962. The provisions in petitioner's contracts with Mutual Trust were generally comparable to those in its contracts with Bankers Life except that the agreements with Mutual Trust contained no limitation that loans be only on residential properties, made no reference to delivery of papers upon termination of the agreement, and did provide that petitioner deduct its service fee prior to forwarding the balance of principal and interest to Mutual Trust.

Both the agreements between petitioner and Bankers Life and those between petitioner and Mutual Trust provided for termination by either party by written notice delivered to the other. Such a provision is customary in contracts between insurance companies and mortgage-servicing companies. However, as a practical matter if the mortgage-servicing company is functioning effectively, the contract is not canceled.

Petitioner kept files on all mortgage contracts. Contained in these files would be copies of the note and mortgage, correspondence respecting the mortgages, and fire insurance policies. These files and their contents with the exception of the fire insurance policies which were the property of the investor company, were the property of petitioner.

Petitioner performed its work in servicing mortgages without the use of computers. Its cost of servicing a mortgage averaged approximately one-half of the servicing fee. However, the cost of servicing a mortgage contract was approximately the same whether the balance of the principal was large or small. The servicing fee was a percentage, usually one-half of 1 percent a year, of the unpaid balance of the mortgage. Increased volume of mortgages serviced did not substantially reduce petitioner's cost of servicing each mortgage.

Sherwood & Roberts, Inc. (hereinafter referred to as S & R), is a Washington State corporation dealing in mortgage-servicing contracts in much the same manner as petitioner. However, S & R operations were much larger than petitioner's and its servicing operations are carried on primarily by use of computers. Because of its use of computers, its unit cost of servicing mortgages decreases as the volume of mortgages serviced increases.

In 1926 S & R, which represented approximately 36 institutional investors, was serv icing about.$4.5 million in mortgages for about 10 institutional investors in the Portland, Oreg., area. S & R has represented Mutual Trust since 1957 in the State of Washington but never in the Portland area. It had never represented Bankers Life in any area.

In 1962 representatives of S & R contacted Holmes with respect to purchasing petitioner's mortgage-servicing business. Holmes was willing to sell petitioner's mortgage-servicing business only if he also sold the business of a sole proprietorship which he operated under the name of Ladd Insurance Agency and received for the two businesses and any personal services he rendered the purchaser the amount of $175,000. The negotiations culminated in the sale of petitioner's mortgage-servicing business for $86,500 plus $4,000 for its personal property, the sale of the sole proprietorship operated by Holmes for $25,000 (plus $1,000 for furniture), an employment contract for 5 years for Holmes for $60,000 and payment by S & R of $1000 for a term life insurance policy of $60,000 for Holmes. A representative of the purchaser made the allocation of the $176,000 to each part of the ‘package deal.’

The bill of sale with respect to petitioner's mortgage-servicing business, executed on August 3, 1962, provided in part as follows:

1. Subject only to the condition contained in paragraph 9 hereunder, for and in consideration of the sum of Eighty Six Thousand Five Hundred Dollars ($86,500) SELLER hereby grants, bargains, sells, transfers, and delivers unto PURCHASER all of the mortgage servicing business in which SELLER is engaged. SELLER has servicing contracts to manage loan portfolios consisting of outstanding principal mortgage balances owned by investor companies, the companies involved and mortgage balances connected therewith are set forth as at January 31, 1962, in Exhibit A attached hereto and made a part hereof. This is a sale and acquisition of the entire mortgage servicing enterprise of SELLER and, therefore, a complete transfer of all of SELLER's interest in and to the mortgage servicing portfolios heretofore serviced by SELLER.

2. Included in the aforesaid transfer are all of the investors' agreements, files, documents, contracts, supplies, records, accounts, and licenses of SELLER insofar as the same pertain to the mortgage servicing business, together with what is commonly referred to as the mortgage servicing portfolio from which the company has conducted its mortgage affairs. And SELLER hereby sets over unto PURCHASER whatever interest it may have in and to investors' agreements and privileges, and in addition thereto completely relinquishes to PURCHASER that which is best referred to as servicing fees arising from the heretofore mortgage business pursuit to SELLER.

3. In connection herewith and as a part hereof SELLER covenants with PURCHASER that it will not in any form or manner of whatever kind or nature utilize the files and portfolios hereby transferred by SELLER to PURCHASER for business purposes which might in any way be competitive with those in which PURCHASER will now be engaged as a result of this acquisition.

4. It is agreed that included in the properties hereby sold is the name ‘Realty Loan Corporation,‘ or any part thereof, and SELLER hereby covenants to execute whatever additional documents may be involved in the surrender of its name to PURCHASER and the transfer of same in the office of the Oregon State Corporation Commission or whatever other public offices may be involved.

5. As at January 31, 1962, SELLER and PURCHASER determined and agreed upon the servicing balances and figures contained in Exhibit A, and based thereupon the purchase price was established as aforesaid at $86,500. Time has been consumed in the negotiations attendant herewith, and each of the parties hereto agreed that a recomputation will be made as at the date upon which PURCHASER actually takes over that which it acquires hereunder and SELLER no longer has any responsibilities connected therewith. In the event of loss or failure to transfer to PURCHASER of all or any portion of said servicing and loan management accounts reflected in Exhibit A, for reasons other than cause by Purchaser, at any time within two years from the date hereof the consideration as stated herein shall be reduced by 1% of the principal balances of such accounts lost or not transferred.

6. All servicing balances, including loans in process, are to be redetermined as at the date of closing and delivery, and those balances are to be related to those reflected in Exhibit A. If the balances in their aggregate are less than those shown or greater than those shown in Exhibit A, then the aforesaid purchase price of $86,500 is to be adjusted in the following manner. If the servicing balances, including loans in process, differ from the balances reflected in Exhibit A, then and in that event the purchase price shall be adjusted upwards or downwards by amounts equal to 1 1/2% on those accounts on which the annual service fee is 1/2%; and 1 1/8% on those accounts on which the annual service fee is 3/8%. These adjustment percentages shall apply only to the differences between the servicing accounts at the time of closing and servicing account balances reflected in Exhibit A. It is understood and agreed that payment for loans in process is to be made by PURCHASER only if said loans in process have been closed, delivered in the investor, paid for by the investor, and are being serviced under contract for the investor under the terms of the servicing contracts herein purchased.

7. The purchase price hereunder shall be paid to SELLER by PURCHASER in sixty equal monthly installments, together with interest upon unpaid balances of 5% per annum, the first such monthly installment to be paid upon the date of delivery hereunder and based upon the purchase figure established at that time. Subsequently monthly installments shall be increased when, and if as a result of increase in purchase price from loans in process, such increase is finally determined to be due and owing. All such monthly installments shall be first applied to the payment of the aforesaid interest and then applied to principal.

8. For and in consideration of the additional sum of $4,000.00 to be paid by PURCHASER to SELLER at the time PURCHASER takes over hereunder SELLER hereby grants, bargains, sells, transfers, and delivers unto PURCHASER all of the personal property of SELLER now being and situated in Suite 400 Henry Building, Portland, Oregon, with the exception of certain items which have heretofore been marked. * * *

10. This agreement in its entirety is expressly conditioned upon the written consent and approval of the transfer of the mortgage servicing portfolios and mortgage servicing contracts with which this agreement is concerned, both by Mutual Trust Life and Bankers Life Company. * * *

Exhibit A attached to the bill of sale showed balances of active loans of $8,840,784.08 and of loans in process of $614,634.34.

The assignments of the Mutual Trust and Bankers Life servicing agreements to S & R were executed by petitioner and consented to by Mutual Trust and Bankers Life on September 28, 1962. S & R agreed to assume all of the duties and obligations that petitioner had under the agreements with Mutual Trust and Bankers Life.

The principal purpose of S & R's purchase of petitioner's mortgage-servicing business was to obtain its mortgage-servicing contracts in the amount of approximately.$9.4 million. A.$9.4 million mortgage-servicing business is considered in the industry as a small mortgage-servicing business.

A secondary purpose of S & R's purchase of petitioner's mortgage-servicing business was to obtain a connection with Bankers Life with which S & R had never dealt and the right to represent Mutual Trust in the Portland, Oreg., area. Since S & R had represented Mutual Trust in the State of Washington it considered the obtaining of an additional connection with that company less valuable than the obtaining of its first connection with Bankers Life. In addition to obtaining the services of Holmes which S & R considered to be valuable, the employment of Holmes enabled S & R to maintain relationships with builders and realtors with whom Holmes had dealt for a number of years as well as to obtain the benefit of the good relationship of Holmes to Mutual Trust and Bankers Life.

The contract of employment between S & R and Holmes provided that the $60,000 was to be paid to Holmes at the rate of $1,000 a month for 60 months and that the total amount was to be paid even though the services of Holmes should for any reason no longer be needed by S & R. The contract further provided as additional compensation to Holmes for the retention by him of origination fees on loans he procured for S & R, the payment to him of one-third of new insurance business produced by him for S & R, the payment to him of one-half the commission on new bonds procured for S & R by him, and the payment to him of one-quarter of S & R's commissions on renewal premiums on insurance he had procured. It was specifically provided in the contract that Holmes could for his own account continue in the pursuit of new mortgage, insurance, and bond business provided that during the term of the agreement ‘the same shall never in any form or manner be competitive and contrary to the best interests' of S & R.

The final total amount paid by S & R for the ‘package deal’ was as follows:

+--------------------------------------------------------------------+ ¦Contract price for petitioner's mortgage service business¦$86,500.00¦ +--------------------------------------------------------------------+

Less: Adjustment for loans in process not purchased: (1 1/2% of $136,820.79) 2,052.31

Petitioner's expense paid by S & R for petitioner's employee's vacation salary accrued at time of transaction 128.75

Overhead cost for processing and shipping loans in process ($326,080.75 X 1/2%) 1,630.40 Net price 82,688.54 Personal property of petitioner 4,000.00 Employment contract with Holmes 60,000.00 Contract price for Ladd Insurance Co. 25,000.00 Furniture and equipment of Ladd 1,000.00 Premium for Holmes Life Insurance 1,000.00 Total 173,688.54

Following the formal transfer of the mortgage-servicing business by petitioner to S & R in September 1962, S & R moved into petitioner's offices but placed its name on the door. S & R used petitioner's name only once thereafter. Three of petitioner's employees were retained by S & R. Petitioner remained in existence as a corporate entity but did not continue to engage in the mortgage-servicing business.

National statistics show the average annual cost of servicing a mortgage contract to be approximately 0.3 percent of the remaining principal and that most mortgages are serviced at an annual fee of 0.5 percent of the remaining principal giving an average annual profit of approximately 0.2 percent of the remaining balance. In the mortgage-servicing business in the early part of 1962 it was customary to consider the average life of a long-term mortgage loan to be 8 to 12 years. The loans which petitioner was servicing at the date of the sale of this portion of its business to S & R were long-term loans of 20 to 30 years. After S & R had been servicing the.$9.4 million of mortgages for 2 years it estimated that there would remain unpaid balances of not less than $7.5 million. For the year 1962 up until September 28, when the final transfer of its mortgage-servicing business to S & R was made, petitioner reported mortgage loan servicing fees in the amount of $34,044.89. For an unspecified period after S & R took over the servicing of the mortgages which had been procured by petitioner prior to September 28, 1962, it grossed approximately $40,000 a year in servicing fees from those mortgages.

On January 1, 1959, petitioner and Frank Grimsdell entered into an agreement pertaining to the acquisition and sale of certain loans originated by Grimsdell. This agreement provided for certain payments to be made by petitioner to Grimsdell on mortgages it serviced and that in ‘case the servicing is sold by us or cancelled by the company we represent,‘ Grimsdell was to receive a percentage of the payment received by petitioner. At the time of petitioner's transfer of its mortgage-servicing business to S & R, an unpaid balance of $802,931 remained outstanding on loans originated by Grimsdell. On its 1962 income tax return petitioner did not deduct any amount for an accrual of the remaining balance owed Grimsdell. In a letter to Grimsdell dated January 2, 1968, Holmes computed the amount due Grimsdell as follows:

The total price received from Sherwood and Roberts, including salary paid to me, was $142,688.54 for servicing of $9,318,517, or 1.531%. This percentage multiplied by the $802.931 equals $12,287.67; when divided by one-quarter, $3,071.42 would be your share of the sales price. You have already received $1,100 from the G. H. Jeremiah loan, leaving a balance due of $1,971.42 when and if I ever break even on the Tabor Hill transaction.

During 1962 Grimsdell collected a $2,200 loan fee, one-half of which was for the account of petitioner but was not paid to it in 1962. In reporting its 1962 income petitioner did not include in accrued income the $1,100 due it from Grimsdell.

On its 1962 Federal corporate income tax return petitioner reported the transfer of its mortgage-servicing business to S & R as an installment sale of a capital asset. Petitioner reported the total gain on the transaction as $83,559. Petitioner reported payments under the installment method on its income tax returns for the years 1962 through 1967, reporting receipts for the following years in the amounts indicated:

+-----------------+ ¦Year ¦Amount ¦ +------+----------¦ ¦1962 ¦$4,197.11 ¦ +------+----------¦ ¦1963 ¦15,840.59 ¦ +------+----------¦ ¦1964 ¦16,651.03 ¦ +------+----------¦ ¦1965 ¦17,502.93 ¦ +------+----------¦ ¦1966 ¦18,437.22 ¦ +------+----------¦ ¦1967 ¦13,871.12 ¦ +-----------------+

Respondent in his notice of deficiency determined that the $83,559 reported as capital gain was ordinary income and that petitioner was not entitled to report this income on the installment method with the following explanation:

(a) and (c) It has been determined that the gain of $83,559.00 in 1962 from the sale of your mortgage servicing business was an ordinary gain instead of a long-term capital gain, as reported.

Moreover, it has been determined that this gain of $83,559.00 may not be reported by the installment method. Such gain is not from the sale of property as within the scope and meaning of Section 453.

Accordingly, the gain of $83,559.00 is reportable in full as ordinary income in 1962, and the long-term capital gains reported on the installment basis in your returns for the years 1962 and 1963 in the respective amounts of $4,054.41 and $15,302.01 have been eliminated.

OPINION

Petitioner contends that the primary assets of its mortgage-servicing business which it sold to S & R were its mortgage portfolio, its name, its going-concern value, and its contracts with Mutual Trust and Bankers Life. Petitioner argues that these intangible assets are capital assets in the nature of goodwill. Respondent contends that the only asset of any value which petitioner sold to S & R for the $86,500 was the right to receive the future service fees from mortgages which petitioner was servicing at the time of the sale. Respondent contends that petitioner had no intangible assets in the nature of goodwill or going concern value aside from Holmes' relationship with builders and realtors and with Mutual Trust and Bankers Life. It is respondent's position that the employment contract of S & R with Holmes was the consideration for these assets.

Both parties recognize that if all petitioner sold to S & R was its right to receive future service fees from Bankers Life and Mutual Trust the entire gain realized from the sale is ordinary income and that if a substantial portion of the sales price was paid for the right to receive income, the gain applicable to such portion would be ordinary income and not capital gain. Nelson Weaver Realty Co., 35 T.C. 937 (1961), revd. 307 F.2d 897 (C.A.. 5, 1962), the holding of which was specifically rejected and the dissenting opinion of Judge Rives of the Court of Appeals followed in Bisbee-Baldwin Corporation v. Tomlinson, 320 F.2d 929, 930, 934 (C.A. 5, 1963); Bankers Guarantee Title & Trust Co. v. United States, 418 F.2d 1084 (C.A. 6, 1969); General Guaranty Mortgage Co. v. Tomlinson, 335 F.2d 518 (C.A. 5, 1969); and United States v. Eidson, 310 F.2d 111 (C.A. 5, 1962).

In Bisbee-Baldwin Corporation v. Tomlinson, supra, a case dealing with mortgage-servicing contracts, the court stated at 934-935:

Still, some parts of the ‘bundle’ of contractual rights transferred by Bisbee-Baldwin were capital assets. The mortgage correspondent relationships have value in addition to the rights to servicing commissions. It acts as a ‘feeder’ for related businesses, such as insurance and real estate, frequently engaged in by mortgage bankers. The monthly escrow deposits made by the mortgagors considerably enhance the servicing agent's credit standing. Moreover, as the dissenting opinion in Nelson Weaver recognized, there is a sale of ‘good will’. The mortgage portfolio of the mortgage banker tends to increase each year as both the mortgagors and the investors look to the mortgaging servicing agent for further funds and further outlets for investment. * * *

* * * The consideration received for the right to earn future servicing commissions must be regarded as a substitute for such future ordinary income. This important part of the bundle of rights sold or exchanged can be separated from the other parts and should be taxed for what it is * * *

See also Hugh H. Hodges, 50 T.C. 428 (1968), in which we allocated a composite price of an insurance business between the amount paid for commissions on renewal premiums on 5-year policies which constituted ordinary income to the seller and the amount paid for the intangible assets which constituted capital gain.

Although S & R was primarily interested in the purchase of the servicing fees to be obtained on mortgages which petitioner was servicing, the evidence shows that it was also desirous of obtaining petitioner's contracts with Mutual Trust and Bankers Life and the goodwill which petitioner had with individual builders and realtors, and the files relating to mortgages procured through such builders and realtors. The bill of sale as well as the other evidence of record supports the conclusion that S & R was primarily interested in the income that would be generated from the mortgage-servicing business and the major portion of the $86,500 was paid for the mortgage-servicing income. The bill of sale provided that if for any reason except S & R's fault, any of the contracts which petitioner was servicing at the date of sale were lost or not transferred to S & R within 2 years of the date of purchase of the mortgage-servicing business, petitioner would pay to S & R 1 percent of the principal balance of such accounts lost or not transferred. Since the remaining balance of the mortgages transferred to S & R at the end of the 2 years would not be less than $7 1/2 million, S & R was granted a protection up to approximately $75,000 on the amount of the $86,500 which is allocable to future income from servicing fees.

S & R purchased petitioner's name but used it only once in connection with a loan in process at the time of purchase. Obviously, therefore the name was of little value to S & R. Included in the assets purchased were petitioner's mortgage files, documents, records, and licenses. These assets had some value to S & R.

On the basis of this record it is difficult to allocate the $86,500 payment between the purchase of future income and the purchase of capital assets. However, since we are of the view that such an allocation is necessary we will make that allocation on the basis of all the evidence of record.

S & R, for an unspecified number of years after the purchase, received gross servicing fees from the mortgages it took over from petitioner of $40,000. Approximately two-fifths of this amount or $16,000 a year would constitute net income according to the estimate of the officer of S & R who negotiated the purchase. The evidence shows that as the mortgages are paid off and the balances decline the servicing fees and net income from such fees decline. It would not be expected that a person would pay the full price of the income it expected to receive over the lives of the mortgages. Under consideration of all the evidence, we conclude that S & R paid petitioner $10,000 for its intangible assets and the portion of the gain from the transaction applicable to this $10,000 is capital gain and the remaining portion of the gain is ordinary income.

Respondent takes the position that petitioner is not entitled to report the portion of the gain from the sale applicable to its sale of its future servicing fees on the installment method.

Petitioner contends that section 453 applies to all sales except for inventory items. Petitioner points out that section 453, dealing with installment sales, does not require that ‘property’ be a capital asset for a taxpayer to be permitted to elect to use the installment method of reporting income. Petitioner argues that its right to future income from servicing the mortgages under its contracts with the owners, primarily Mutual Trust and Bankers Life, was ‘personal property’ as the term is used in section 453.

In Ann Edwards Trust, 20 T.C. 615 (1953), affd. 217 F.2d 952 (C.A. 5, 1955), certiorari denied 349 U.S. 905 (1955), we held that the taxpayer's gain on the sale of fruit on the trees at the time it sold its citrus grove was ordinary income and not capital gain because the fruit was held primarily for sale to customers in the ordinary course of business. We further held that even though the gain was ordinary income petitioner was entitled to report the gain on the installment method, stating at page 618:

The other issue relates only to the trust petitioners who contend that they may return such ordinary income on the installment basis under section 44 of the Internal Revenue Code. (Footnote omitted. Sec. 453, I.R.C. 1954, is substantially the same provision.)

On this issue, we think that the petitioners have met the requirements of the statute. If the fruit be regarded as personal property, the facts show that the sales in question were casual sales and not sales in the ordinary course of the petitioners' trade or business, even though the fruit on the trees at the time of the sale was held primarily for sale to customers in the ordinary course of such trade or business. Furthermore, there can be no question, we think, that a growing crop of citrus fruit would not be ‘property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year.’ * * *

In Ann Edwards Trust, supra, respondent made no contention that the fruit on the trees was not ‘property.’ In the instant case respondent apparently does contend that petitioner's contractual right to the income from the servicing fees on the mortgages was not ‘property’ within the meaning of section 453.

Many of the cases holding the gain from the sale of future income to be taxable as ordinary income recognize that the sale is of ‘property’ but hold such ‘property’ not to be a capital asset on the ground that the capital gains provisions should be narrowly construed so as not to apply to a sum which is ‘essentially a substitute for what would otherwise be received at a future time as ordinary income.’ Commissioner v. P. G. Lake, Inc., 356 U.S. 260, 265 (1958). In that case the Court stated that it would proceed on the basis which had been the premise of the Court of Appeals that the oil payments transferred were ‘interests in land.’ See also United States v. Woolsey, 326 F.2d 287 (C.A. 5, 1963), in which a right to future income from commissions under an insurance contract is referred to as ‘property’ but the gain from the sale is held to be ordinary income.

In Commissioner v. Gillette Motor Transport, Inc., 364 US. 130 (1960), the Court held that an amount received by the taxpayer as compensation for the temporary taking of its facilities by the Government during World War II was ordinary income and not capital gain. The taxpayer took the position that the amount was received upon an involuntary conversion of property used in its trade or business and therefore was taxable as capital gain. The Court made the following statement with respect to the contention of the taxpayer at pages 134 and 135:

While a capital asset is defined in Sec. 117(a)(1) as ‘property held by the taxpayer,‘ it is evident that not everything which can be called property in the ordinary sense and which is outside the statutory exclusions qualifies as a capital asset. This Court has long held that the term ‘capital asset’ is to be construed narrowly in accordance with the purpose of Congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time, and thus, to ameliorate the hardship of taxation of the entire gain in one year. Burnet v. Harmel, 287 U.S. 103, 106. Thus the Court has held that an unexpired lease, Hort v. Commissioner, 313 U.S. 28, corn futures, Corn Products Refining Co. v. Commissioner, 350 U.S. 46, and oil payment rights, Commissioner v. P. G. Lake, Inc., 356 U.S. 260, are not capital assets even though they are concededly ‘property’ interests in the ordinary sense. And see Surrey, Definitional Problems in Capital Gains Taxation, 69 Harv.L.Rev. 985, 987-989 and Note 7.

In Hollywood Baseball Association, 42 T.C. 234, 265 (1964), affd. 352 F.2d 350 (C.A. 9, 1965), remanded on another issue 383 U.S. 824 (1966), we held that the intangible contract and property rights which flowed from the exclusive privilege of playing baseball in certain locations as a member of an established league were ‘property’ within the meaning of section 337.

In our view the rights of petitioner to the servicing fees under its contracts with the various insurance companies and particularly its rights under its contracts with Mutual Trust and Bankers Life was ‘property’ in the ‘ordinary sense’ even though these rights were not ‘capital assets' and the gain received from their sale was not capital gains. The fact that petitioner's rights to servicing fees under its various contracts was a form of property is apparent when these rights are compared to the ‘life memberships' which we held not to be ‘personal property’ within the meaning of section 453(a) in Town & Country Food Co., 51 T.C. 1049 (1969). In that case we stated at page 1055:

We agree with the respondent that the sales of life memberships did not constitute sales of personal property within the meaning of the statute. A life membership granted the purchaser a number of rights, principally the right to purchase food from the petitioner at competitive prices and have it delivered, the right to the services of the petitioner under a 3-year service warranty on the customer's own freezer, and the right if he should at any time purchase a freezer from the petitioner, to have the purchase price of the membership applied on the purchase price of the freezer. Thus, a life membership amounted principally to an agreement by the petitioner to render services to the purchaser in the future and to sell property to the purchaser in the future at the purchaser's election. The sale of a life membership did not itself effect the sale by the petitioner of any property whatsoever. And clearly the statute does not relate to the reporting of income arising from an agreement to render services. * * *

Whereas the taxpayer in Town & Country Food Co., supra, was paid by a ‘purchaser’ for agreeing to render services to that ‘purchaser’ in the future, the petitioner in the instant case transferred to S & R for a price its right to receive future income under a contract.

If petitioner's right to receive income from the servicing fees had not been conditional upon the rendition of certain services, which obligation was assumed by S & R, the fact that the right was ‘property’ would be more readily apparent. However, the fact that the income was conditional upon the rendition of services does not cause the contractual right to receive the income for rendering the services not to be a type of ‘property.’ The issue we must resolve is whether this right is ‘personal property’ within the meaning of section 453(b).

Respondent does not contend that the transaction here involved was not a ‘casual sale’ and the facts clearly support the conclusion that it was a ‘casual sale.’ Each party discusses cases claimed to be comparable to the instant case, stating that no case involving the precise issue has been found.

Respondent relies primarily on our holding in Charles E. Sorensen, 22 T.C. 321 (1954). In that case we held that certain options to purchase stock received by the taxpayer as compensation had no ascertainable value when received and therefore when they were subsequently sold the proceeds of the sale constituted ordinary income as a substitute for the compensation which would have been realized of the difference in the price paid for the stock and its fair market value at the date the options would have been exercised, had they not been sold. The taxpayer had contended that the receipts from the sale of the options constituted long-term capital gain. The taxpayer contended that even if the receipts constituted ordinary income, he was entitled to use the installment method of reporting the income since it was from a ‘casual sale’ of ‘personal property.’ We stated in this respect at page 342:

The petitioner contends that even if the proceeds from the sale of the options are held not to be gain from the sale of capital assets held for more than 6 months, he, nevertheless, is entitled to report the income from the sales on the basis provided in section 44 of the Code (sec. 44 of the 1939 Code is the predecessor of section 453 of the 1954 Code) for reporting income from sales of property made on the installment plan. Since the sales of the options operated to compensate petitioner for his services, what he received in the form of both cash and notes was income by way of compensation. The provisions of section 44 relate only to the reporting of income arising from the sale of property on the installment basis. Those provisions do not in anywise purport to relate to the reporting of income arising by way of compensation for services. Petitioner is not entitled to have them applied here.

The instant case is factually different from Charles E. Sorenson, supra. Had the taxpayer in the Sorensen case exercised his options, the entire difference in the price he paid for the stock and its fair market value would have been income to him at that time as compensation for services. When he sold the options he received in effect this same difference in the option price of the stock and its fair market value as compensation. The sale could not change the nature of either that for which it substituted or the time at which the amount was includable in income. In the instant case had petitioner not sold its mortgage-servicing business, it would have received income from the mortgages it was servicing at the date of the sale over a period of approximately 8 years and during these 8 years would have serviced the mortgages. The property petitioner sold to S & R was a substitute for its income or profits over a period of years after the sale to S & R. The income petitioner sold was not ‘compensation for services' as in Sorensen but rather the future profit to be realized from the rendition of services, which services after the sale were rendered by another. In Commissioner v. P. G. Lake, Inc., supra, the Supreme court held that the payments received for the transfer of oil payments, although not ‘capital gains,‘ were subject to the depletion allowance as the oil payments would have been had they not been transferred. Similarly, in the instant case even though the amount received is ordinary income, it is a substitute for income which would have been received over a period of years and there is no reason for prohibiting the use of the installment method of reporting that income.

Considering the purpose of section 453(b) which is to permit income from certain sales of personal property to be taxed as it is realized and the facts of the instant case, we conclude that petitioner is entitled to report its entire gain from the sale of its mortgage-servicing business on the installment method even though we have allocated all but $10,000 of the sales price to the sale of future income is ordinary income. In our view the right to future income sold in the instant case was ‘property’ and the sale was a casual one which also complied with the other requirements of section 453(b).

Since we hold that petitioner is entitled to use the installment method it elected in its return, we need not decide whether the entire gain accrued in 1962.

The final issue is whether petitioner is entitled to a deduction or to reduce the gross amount received from S & R by an amount owing to Grimsdell in 1962 as a result of the transfer. The parties stipulated as follows:

The parties agree that the amount actually due and owing to Grimsdell at the time of the transfer of the mortgage servicing business by Realty Loan, to the extent it resulted from the transfer, should reduce the gross amount received by Realty Loan from Sherwood and Roberts.

From the facts stipulated by the parties, we are unable to determine what amount, if any, was actually owing by petitioner to Grimsdell after the sale in 1962 except to the extent that Grimsdell was to retain petitioner's $1,100 share of the loan fee collected by Grimsdell in 1962 as a part payment of the amount owed to him by petitioner as a result of the sale by petitioner of its mortgage-servicing business. Other than the letter of January 2, 1968, there is nothing in the record to indicate what amount of the payment to petitioner by S & R was to be used as a base for computing the amount owed by petitioner to Grimsdell. The statements in the letter give a fair inference that Grimsdell and petitioner might not have been in agreement on this factor. Also, the fair inference from the 1968 letter is that Grimsdell was to be paid no portion of the $1,971.42 remaining after offsetting the $1,100 unless petitioner were to ‘break even on the Tabor Hill transactions.’ The record is barren of information as to the nature of the Tabor Hill transactions. We therefore hold that the record is insufficient to show that petitioner actually owed to Grimsdell in 1962 any amount in excess of the $1,100 due petitioner on a loan collected in 1962 for it by Grimsdell.

Petitioner did not report the $1,100 as income in 1962 and did not accrue any amount as due to Grimsdell. This record does not support making any change in petitioner's method of handling the two items on its 1962 income tax return.

Reviewed by the Court.

Decision will be entered under Rule 50.