Opinion
Docket No. 6692.
1946-04-30
C. C. ROUSE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Escar R. Wren, Esq., and Fred W. Allen, Jr., C.P.A., for the petitioner. Donald P. Chehock, Esq., for the respondent.
Petitioner and his wife, domiciled in Texas, entered into an agreement pending divorce proceedings whereby petitioner acquired for $60,000 the wife's interest in community property having a value of approximately $45,000 and separate property of wife having value of $27,000. Held, the basis to petitioner of the property so acquired is $60,000 and not the original cost to the community. Escar R. Wren, Esq., and Fred W. Allen, Jr., C.P.A., for the petitioner. Donald P. Chehock, Esq., for the respondent.
Respondent determined deficiencies in petitioner's income tax for the calendar years 1940 and 1941 in the amounts, respectively, of $687.83 and $944.78. The deficiencies resulted from an adjustment of the basis claimed by petitioner in the computation of gain on the sale of real estate and of the allowance for depreciation.
FINDINGS OF FACT.
Petitioner is an individual who resides at Houston, Texas, and who filed his income tax returns for 1940 and 1941 with the collector for the first district of Texas.
Petitioner and his former wife, Eleanor Fay Rouse, were married in 1919 and were divorced on April 29, 1940. Petitioner remained unmarried until September 27, 1940, when he married his present wife, Mauderay Rouse. At the times pertinent herein petitioner and his former wife were domiciled in the State of Texas.
Petitioner and his former wife are the parents of two minor children.
At the time of the divorce referred to above, the community property held by petitioner and his then wife consisted of the following classes, of the values indicated:
+-----------------------------------------------------------------------------+ ¦Cash in bank ¦ ¦$3,936.26 ¦ +-----------------------------------------------------+----------+------------¦ ¦Salary account owed C. C. Rouse by Rouse Lumber & ¦ ¦7,920.00 ¦ ¦Bldg. Co ¦ ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Escrow or pooling investment ¦ ¦1,500.00 ¦ +-----------------------------------------------------+----------+------------¦ ¦Notes receivable ¦ ¦7,328.00 ¦ +-----------------------------------------------------+----------+------------¦ ¦379 shares capital stock-Rouse Lumber & Bldg. Co., ¦ ¦ ¦ ¦par value $100 ¦ ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦per share, estimated value ¦ ¦37,070.50 ¦ +-----------------------------------------------------+----------+------------¦ ¦New Ulm State Bank (par value $4,080) appraised value¦ ¦4,000.00 ¦ +-----------------------------------------------------+----------+------------¦ ¦Equity in houses under construction ¦ ¦16,245.62 ¦ +-----------------------------------------------------+----------+------------¦ ¦Real estate investments-values as of ¦ ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Oct. 7, 1939 ¦$45,500.00¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦Subject to liens ¦15,060.88 ¦ ¦ +-----------------------------------------------------+----------+------------¦ ¦ ¦ ¦30,439.12 ¦ +-----------------------------------------------------+----------+------------¦ ¦House, 1511 Waugh Drive ¦ ¦10,000.00 ¦ +-----------------------------------------------------+----------+------------¦ ¦Total ¦ ¦118,439.50 ¦ +-----------------------------------------------------+----------+------------¦ ¦Less ¦ ¦* 27,000.00¦ +-----------------------------------------------------+----------+------------¦ ¦ ¦ ¦91,439.50 ¦ +-----------------------------------------------------------------------------+ FN* Petitioner's former wife owned the sum of $27,000 at the time of her marriage to petitioner. This amount is represented and included in the assets listed above and it was her separate property, so that the net value of the community estate at the time of the divorce was $91,439.50
Petitioner and his former wife each owned, in addition, an amount of separate property which was in the possession of each owner. The property settlement agreement hereinafter referred to confirmed as to each the right to the property so owned and possessed.
Pending the trial of the divorce action, petitioner and Eleanor Fay Rouse entered into an agreement relating to the disposition of their property rights. The agreement set out the fact that petitioner was indebted to his wife in the sum of $27,000, which represented the total amount of her separate property borrowed and used by him, and it further stated that:
* * * The community property (being of the value shown on Exhibit 1, less the said sum of Twenty-seven Thousand ($27,000.00) Dollars owing to the separate estate of Mrs. Rouse) is vested in Mr. Rouse and Mrs. Rouse in equal undivided interests; but settlement of the interest of Mrs. Rouse in the community property shown in Exhibit 1, and of the indebtedness of Twenty-seven Thousand ($27,000.00) Dollars owing to her, as her separate estate, is made for the agreed sum of Sixty Thousand ($60,000.00) Dollars, payable to her in the following manner: * * *
The agreement then set out in detail what may be summarized more concisely here as the payment to her of $5,000 cash and the transfer to her of the house located at 1511 Waugh Drive, and its furnishings, of the agreed value of $10,000 at the time of the execution of the agreement; and within 45 days the selection by Mrs. Rouse from the property constituting the community estate (except the capital stock of Rouse Lumber & Building Co.) of property totaling at least $15,000 in value. The remainder of the $60,000 was to be represented by a promissory note to be executed by petitioner, bearing 5 percent interest, payable in installments of not less than $500 per month, all to be paid within five years. The note was to be secured by all the community property remaining after her selections were made.
The agreement further provided:
The substance of this agreement shall be embodied in the decree of divorce, if the same be granted, so far as either party may desire; but all terms hereof shall remain in full force and effect whether or not embodied in such decree.
The divorce was granted, and the decree referred to the property settlement in this language:
* * * The parties hereto have made settlement agreement with respect to property and property rights, and other matters set forth in said agreement, and this Decree does not iipair, (sic) affect, nor modify said agreement. * * *
Pursuant to the terms of the agreement, Mrs. Rouse received $5,000 cash on April 29, 1940; the land, house, and furnishings referred to valued at $10,000; and, as of July 1, 1940, there were transferred to her, pursuant to her selection, three notes receivable of the value of $5,451.89; one piece of real estate, valued at $8,750, on which there was a lien of $2,468.18, leaving a net value of $6,281.82; and another piece of real estate valued at $5,500, with a lien of $1,425.28, or a net value of $4,074.72. The total value of all these properties, including the $5,000 cash payment and the house originally received, was $30,808.43. Of the $60,000 for which the agreement provided, $29,191.57 remained unpaid. Payments of this unpaid principal and interest thereon were made during 1940, 1941, 1942, and 1943 in the total amount of $32,079.41, plus $722.39 of income taxes which petitioner paid for Mrs. Rouse.
Petitioner received as a result of the agreement notes receivable of the value of $1,876.11; real estate of the net value (exclusive of encumbrances) of $20,082.58; equity in houses under construction of the value of $16,245.62; stock in Rouse Lumber & Building Co. of the value of $37,070.50; stock in the New Ulm State Bank of the value of $4,000; Escrow Account Investment of $1,500; and balance of cash and salary account, after payment of the $5,000 to Mrs. Rouse at the time of the divorce, of $6,856.26. The total value of these assets was $87,631.07.
After the transfers referred to petitioner sold two of the pieces of real estate so owned by him in 1940 and two others in 1941. In computing his income tax liability on the gains realized from these sales, petitioner claimed as his basis for the properties sold the cost thereof to the community. In computing his deductions for depreciation allowances, he also used the cost to the community.
Respondent allowed, for both purposes, a basis for each property arrived at by adding together petitioner's cost of his half of the community estate and the amount which he paid to his wife for her half of the community property and her separate property.
OPINION.
KERN, Judge:
The ultimate question for our decision herein is with regard to what basis petitioner is entitled to use in computing his income tax liability arising by reason of his ownership and sale of certain real property which had constituted a part of the community estate held by himself and his former wife and was acquired by petitioner in a settlement of their property rights in connection with their divorce. The question arises in connection with both gains realized from the sale of some of the property and the allowable deductions for depreciation.
Petitioner contends that he is entitled to use as his basis the cost of the property to the community. Respondent argues that until the settlement, petitioner and his wife each owned one-half of the community property, that the settlement constituted a taxable event by which petitioner acquired his wife's interest in the community and her separate property for a stipulated consideration, and that his basis, therefore, is that cost, under section 113(a).
Article 4619 of Vernon's Annotated Statutes of the State of Texas provides that:
All property acquired by either the husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife * * *
It has been regarded as firmly settled, since the decision of Hopkins v. Bacon, 282 U.S. 122, following Poe v. Seaborn, 282 U.S. 101, and citing Arnold v. Leonard, 114 Tex. 535; 273 S.W. 799; and Wright v. Hays, 10 Tex. 130; that a husband and wife under Texas law have each a present vested one-half interest in the property of the marital community.
Texas taxpayers have frequently, strenuously, and successfully argued and relied upon this principle in their own courts (see Arnold v. Leonard, supra; Wright v. Hays, supra) and in this Court, G. D. Rigsby, 6 B.T.A. 194; R. W. Ramming, 6 B.T.A. 188, as well as in the Federal District and Circuit Courts and in the Supreme Court of the United States.
The agreement involved here recognized that fact, since it provided: ‘The community property * * * is vested in Mr. Rouse and Mrs. Rouse in equal undivided interests * * * .‘ And, finally, petitioner concedes it in this case.
Accordingly, we may assume it to be a fact that at the time of the execution of the agreement set out in our findings petitioner owned a vested, undivided one-half interest in the community property, and Eleanor Fay Rouse owned the other vested, undivided one-half interest.
The settlement agreement provided that:
* * * settlement of the interest of Mrs. Rouse in the community property * * * and of the indebtedness of Twenty-seven Thousand ($27,000.00) Dollars owing to her, as her separate estate, is made for the agreed sum of Sixty Thousand ($60,000.00) Dollars, payable to her in the following manner: * * *
The value of Mrs. Rouse's one-half interest in the community estate was $45,719.75, and of her separate property, $27,000, or a total of $72,719.75. The conclusion seems inescapable that, as a result of the separation agreement, petitioner acquired from her property of that value in which he had theretofore had no interest whatever. Respondent has allowed as his basis therefor the consideration of $60,000 which he paid for it plus $722.39 which petitioner expended in payment of income tax due from his wife.
Petitioner argues that he did not acquire anything from his wife, but that there was simply a partition of the community property by order of the divorce court in accordance with the Texas law. He suggests that there are other factors inherent in the settlement which may have been considered by the court in awarding to petitioner the greater share of the community property. One is the fact that petitioner agreed to furnish support for the minor children in a greater amount and for a greater length of time than the statute required and assumed substantial amounts of indebtedness against the property which he received. Even if the evidence supported the contention that the property was divided by court order, it may be observed that the care of the children was of as much interest to petitioner as to his wife, so that petitioner's agreement to provide generously for them can not be assumed to have been a concession made for the benefit of his wife, or as a consideration for the later settlement of their community property rights, which is a wholly distinct matter from petitioner's obligation for the support of the children. The answer to the other suggestion would be that the amounts of the liens against the community property were deducted from the gross estate of the community in arriving at the value of the interests of both petitioner and his wife.
The facts disclose that the agreement was voluntarily entered into by the parties, that the agreement expressly provided that its validity should not depend on court action, and that the only reference which the divorce decree made to the property settlement was to observe that it had been made and that ‘this Decree does not impair, affect, nor modify said agreement.‘ We are therefore unable to conclude that the transaction between petitioner and his then wife constituted a partition of their community property by order of the divorce court. To the contrary, it appears that the parties to the agreement chose to settle their property rights by bargain and sale rather than by partition or division.
Even had the court approved and adopted the terms of the contract, no one has suggested that voluntary transfers, sales, and exchanges of property rights and interests are relieved of tax consequences solely because they require or receive the approval of a local court. Respondent does not suggest that the contract now before us was not valid. In fact, he relies on it, and on the transfers effected pursuant to it.
It has been held that property settlements such as this are taxable events. In Johnson v. United States, 135 Fed.(2d) 125, 130 (1943), the taxpayer and his wife were residents of California and they entered into a property settlement agreement whereby the wife transferred to the taxpayer her half interest in the community's claim against his clients for legal services. He transferred to her his interest in certain real and personal property and agreed to pay certain taxes for her. The court held that the transfers were taxable events and that the taxpayer was taxable on the gain admittedly realized by him.
Such property settlements are arm's length transactions, valid in all respects. They result in the transfer of property rights or interests for a consideration, and there is no sufficient reason to distinguish them from any other transactions fundamentally similar. If there were simply a division of the community estate, as petitioner contends, the property would have been equally divided, or at least an attempt would have been made in good faith to achieve an equal division. In that event, where, in exchange for a vested undivided one-half interest in the whole, each party received a vested interest in the whole of one-half, obviously there would be no resulting taxable gain, and no change in the basis of any of the property by reason of the settlement. But where, as here, there results a virtual sale of one interest, whatever tax consequences flow from the amount of the consideration should be given proper effect.
Petitioner cites Frances R. Walz, 32 B.T.A. 718, where there was admittedly an equal division of the property. The only question considered was whether the husband was entitled to take a loss for the amount of the depreciation of certain stock allotted to his wife from its cost to the market value at which it was so allotted. We pointed out in that case that, while the stock in question was awarded to the wife by the property settlement, ‘other property of an equivalent value was awarded to the husband.‘ We concluded that there was no sale or exchange of property, but merely a division.
We are of the opinion that there was no error in the respondent's determination.
Reviewed by the Court.
Decision will be entered for the respondent.