Garrow v. Comm'r of Internal Revenue

Full title: RALPH R. GARROW AND EUNICE GARROW, PETITIONERS, v. COMMISSIONER OF…

Court: Tax Court of the United States.

Date published: Mar 25, 1965

43 T.C. 890 (U.S.T.C. 1965)

Opinion

Docket No. 4055-63.

1965-03-25

RALPH R. GARROW AND EUNICE GARROW, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Wareham Seaman and Lee M. Galloway, for the petitioners. David Brennan, for the respondent.

ATKINS

Wareham Seaman and Lee M. Galloway, for the petitioners. David Brennan, for the respondent.

The petitioner, sole stockholder of a corporation, elected under section 333 of the Internal Revenue Code of 1954 to have the gain upon the surrender of his shares in the corporation upon liquidation recognized only to the extend provided in that section. The assets received in liquidation consisted of notes receivable, accounts receivable, a claim for refund of Federal income tax, investment real estate, securities, land, and other assets. Held, that the basis of such assets in the hands of the petitioner, computed under section 334 of the Code, is properly allocable among such assets (including the receivables) in proportion to their net fair market values, pursuant to the provisions of section 1.334-2 of the Income Tax Regulations. Held, that such regulations are not unreasonable and inconsistent with the statute and are therefore valid. Held, further, that the gain realized by the petitioner upon collection of the various receivables is taxable as ordinary income.

OPINION

ATKINS, Judge:

The respondent determined a deficiency in income tax for the taxable year 1961 in the amount of $6,427.35.

The issues presented are: (1) Whether the respondent's allocation of the basis computed under section 334(c) of the Internal Revenue Code of 1954 among the various assets (including notes and accounts receivable and and a claim for income tax refund) received by the petitioner in liquidation of a corporation in proportion to the net fair market values of such assets was proper, and (2) whether the respondent properly treated gain on the collection of the notes receivable, the accounts receivable, and the income tax refund claim as ordinary income, rather than as capital gain.

The facts have been stipulated and the stipulations are incorporated herein by this reference.

Petitioners are husband and wife who reside in Antioch, Calif. They filed a joint Federal income tax return for the taxable year 1961 with the district director of internal revenue at San Francisco, Calif. The petitioner Eunice Garrow is a party only by reason of having filed a joint income tax return with the petitioner Ralph R. Garrow, who hereinafter will be referred to as the petitioner.

In 1961 petitioner owned all the outstanding stock (68 shares) of a California corporation which operated under the name of Diablo Development Co. (hereinafter referred to as Diablo). Diablo adopted a plan of complete liquidation providing for a distribution in complete cancellation or redemption of all of its stock and for the transfer of all its property under the liquidation entirely within the month of June 1961. As the sole shareholder in Diablo, petitioner elected to have the gain realized on the surrender of his stock recognized and taxed in accordance with section 333 of The internal Revenue Code of 1954. On June 8, 1961, pursuant to section 333 of the Code, petitioner executed Form 964 entitled ‘Election of Shareholder Under Section 333 of the Internal Revenue Code of 1954.’

The assets and liabilities received by the petitioner on the liquidation of Diablo, the adjusted bases to Diablo, and the fair market value of such assets, at the date of liquidation, were as follows:

+-----------------------------------------------------------------------------+ ¦ ¦Adjusted basis ¦Fair market ¦ +----------------------------------------------+----------------+-------------¦ ¦Assets ¦to Diablo ¦value ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦Cash ¦$2,747.65 ¦$2,747.65 ¦ +----------------------------------------------+----------------+-------------¦ ¦Notes receivable ¦9,473.16 ¦¹ 9,473.16 ¦ +----------------------------------------------+----------------+-------------¦ ¦Accounts receivable ¦10,817.40 ¦¹ 10,817.40¦ +----------------------------------------------+----------------+-------------¦ ¦Claims receivable (refund of Federal income ¦2,310.13 ¦¹ 2,310.13 ¦ ¦tax) ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦Loan trust fund receivable ¦283.33 ¦283.33 ¦ +----------------------------------------------+----------------+-------------¦ ¦Land ¦5,518.77 ¦10,000.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Equipment less depreciation ¦553.90 ¦600.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Investment real estate: ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦11 lots Cavallo Rd. ext ¦1,100.00 ¦15,000.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Lot—18th and Amber (SW) ¦1,834.67 ¦13,000.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦4-plex—Pittsburg depreciation ¦15,035.01 ¦22,500.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Lot NW Wilber ¦2,512.50 ¦18,000.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Lot SE Wilber ¦2,512.50 ¦18,000.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Stock—Garrow Land Co ¦2,500.00 ¦6,980.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦Stock—R&B Land Co ¦2,500.00 ¦4,930.00 ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦59,699.02 ¦134,641.67 ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦ ¦ ¦ +----------------------------------------------+----------------+-------------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+

Liabilities Accrued interest 53.60 Accounts payable 7,587.31 Mortgage payable 15,133.04 Long-term loan payable 12,190.56 34,964.51

In return for such assets petitioner surrendered all of his stock having a basis to him of $6,800 and realized a gain in the amount of $92,877.16, computed as follows:

+------------------------------------------------------+ ¦Fair market value of assets received ¦$134,641.67¦ +------------------------------------------+-----------¦ ¦Less: Liability assumed ¦34,964.51 ¦ +------------------------------------------+-----------¦ ¦ ¦ ¦ +------------------------------------------+-----------¦ ¦ ¦ ¦ +------------------------------------------+-----------¦ ¦ ¦99,677.16 ¦ +------------------------------------------+-----------¦ ¦Less: Basis of 68 shares of stock canceled¦6,800.00 ¦ +------------------------------------------+-----------¦ ¦ ¦ ¦ +------------------------------------------+-----------¦ ¦ ¦ ¦ +------------------------------------------+-----------¦ ¦Gain realized on liquidation ¦92,877.16 ¦ +------------------------------------------------------+

During 1961 petitioner collected $8,047.80 of the notes receivable, $10,488.89 of the accounts receivable (the amount of notes and accounts receivable distributed has not been reduced by any charge to bad debts), and the total amount of the claim for refund of Federal income tax in the amount of $2,310.13.

On the date of the liquidation of Diablo such corporation had earnings and profits in the amount of $17,934.51.

In the 1961 income tax return petitioners reported no income on account of the $8,047.80 collected on the notes receivable, the $10,488.89 collected on the accounts receivable, and the $2,310.13 tax refund collected.

The respondent in the notice of deficiency for the taxable year 1961 determined that the petitioners were in receipt of ordinary income in the amount of $14,948 representing the excess of the amounts collected on the above three items over the bases of such items as determined by him. He determined the amount of the basis to be allocated to the property received on the liquidation in the following manner:

+---------------------------------------------------------------------------+ ¦Basis of stock canceled ¦$6,800.00¦ +-----------------------------------------------------------------+---------¦ ¦Less: Cash received ¦2,747.65 ¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦ ¦4,052.35 ¦ +-----------------------------------------------------------------+---------¦ ¦Plus: Gain recognized on the liquidation ¦17,934.51¦ +-----------------------------------------------------------------+---------¦ ¦Plus: Unsecured liabilities assumed by petitioner Ralph R. Garrow¦7, 587.31¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦Basis to be allocated among unencumbered assets ¦29,574.17¦ +-----------------------------------------------------------------+---------¦ ¦Specific liens against assets received ¦27,377.20¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦ ¦ ¦ +-----------------------------------------------------------------+---------¦ ¦Total basis to be allocated ¦56,951.37¦ +---------------------------------------------------------------------------+

Respondent then made an allocation of such total basis to the assets received on liquidation as follows:

+------------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Basis ¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦Fair ¦Amount of¦Net fair ¦allocated¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Asset ¦market ¦specific ¦market ¦without ¦Total ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦value ¦lien ¦value ¦regard to¦basis ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦ ¦ ¦specific ¦ ¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦ ¦ ¦liens 1 ¦ ¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Notes receivable ¦$9,473.16 ¦ ¦$9,473.16 ¦$2,680.53¦$2,680.53¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Accounts receivable ¦10,817.40 ¦ ¦10,817.40 ¦3,060.89 ¦3,060.89 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Claims receivable ¦2,310.13 ¦ ¦2,310.13 ¦653.67 ¦653.67 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Loan trust fund receivable¦283.33 ¦$283.33 ¦0 ¦0 ¦283.33 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Land ¦10,000.00 ¦ ¦10,000.00 ¦2,829.60 ¦2,892.60 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Equipment less ¦600.00 ¦ ¦600.00 ¦169.78 ¦169.78 ¦ ¦depreciation ¦ ¦ ¦ ¦ ¦ ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦11 lots—Cavallo ¦15,000.00 ¦ ¦15,000.00 ¦4,244.40 ¦4,244.40 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Lot—18th and Amber ¦13,000.00 ¦ ¦13,000.00 ¦3,678.48 ¦3,678.48 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦4-Plex—Pittsburg ¦22,500.00 ¦14,903.31¦7,596.69 ¦2,149.56 ¦17,052.87¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Lot—NW Wilber ¦18,000.00 ¦ ¦18,000.00 ¦5,093.28 ¦5,093.28 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Lot—SE Wilber ¦18,000.00 ¦12,190.56¦5,809.44 ¦1,643.84 ¦13,834.40¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Stock—Garrow Land Co ¦6,980.00 ¦ ¦6,980.00 ¦1,975.06 ¦1,975.06 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦Stock—R & B Land Co ¦4,930.00 ¦ ¦4,930.00 ¦1,394.99 ¦1,394.99 ¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦131,894.02¦27,377.20¦104,516.82¦29,574.09¦56,951.28¦ +--------------------------+----------+---------+----------+---------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------------------------------¦ ¦$9,473.16 ¦ +------------------------------------------------------------------------------¦ ¦Example: Notes receivable basis=-----------X$29,574.17=$2,680.53 ¦ +------------------------------------------------------------------------------¦ ¦$104,516.82 ¦ +------------------------------------------------------------------------------+

¹These amounts also apparently represent the face amount of these receivables.

1 the basis of the property received in the liquidation is, under section 334(c) of the Code,

¹Each asset receives pro rata share of $29,574.17.

The respondent then computed the amount of gain resulting from the collections on receivables in 1961 as follows (treating such gain as ordinary income):

+-----------------------------------------------------------------------------+ ¦ ¦ ¦ ¦ ¦Portion of ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦allocated ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦Asset ¦Face ¦Allocated¦Collection¦basis ¦Gain 1961¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦value ¦basis ¦1961 ¦applicable ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦to ¦ ¦ ¦ ¦ ¦ ¦ ¦collections¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦in 1961 ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦Notes receivable ¦$9,473.16¦$2,680.53¦$8,047.80 ¦$2,277.21 ¦$5,770.59¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦Accounts receivable ¦10,817.40¦3,060.89 ¦10,488.89 ¦2,967.94 ¦7,520.95 ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦Income tax refund claim ¦2,310.13 ¦653.67 ¦2,310.13 ¦653.67 ¦1,656.46 ¦ ¦receivable ¦ ¦ ¦ ¦ ¦ ¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦Total gain ¦ ¦ ¦ ¦ ¦14,948.00¦ +------------------------+---------+---------+----------+-----------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+

The petitioner having elected to have the gain upon the surrender of his shares of Diablo in the liquidation of that company recognized only to the extent provided in section 333 of the Internal Revenue Code of 1954,