Opinion
Docket No. 14143.
1948-11-29
W. H. HARRIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
W. H. Harris, pro se. F. L. Van Haaften, Esq., for the respondent.
Petitioner, on the cash basis, in 1918 and 1933 executed two mortgage notes on his individual properties. The proceeds were used to discharge obligations of his father's estate, of which he was executor. Petitioner had personally guaranteed the payment of the estate's obligations. The estate became insolvent and ceased to exist long prior to 1942. In 1942 and 1943, petitioner paid the respective amounts of $10,800 and $375 in discharge of his individual mortgage notes. On his income tax returns for 1942 and 1943, petitioner claimed as deductions the amounts paid in those respective years. Held, the respondent's disallowance of the claimed deductions, either as bad debts or business losses, is sustained. W. H. Harris, pro se. F. L. Van Haaften, Esq., for the respondent.
This proceeding involves income and victory taxes for the calendar year 1943 in the amount of $737.62. The respondent requests an increased deficiency in the sum of $25.90.
The issues are:
(1) Whether the respondent erred in disallowing a claimed loss of $10,800 on petitioner's 1942 income tax return.
(2) If the respondent erred as to issue (1), did the respondent further err in disallowing a claimed loss for 1942 carried forward to petitioner's 1943 income tax return?
(3) Whether respondent erred in allowing as a deduction a claimed loss of $375 in computing petitioner's net income for 1943.
The case was submitted upon oral testimony and exhibits.
FINDINGS OF FACT.
Petitioner is an individual, residing in Fort Valley, Georgia. His income and victory tax returns for the periods involved were filed on a cash basis with the collector of internal revenue for the district of Georgia.
Petitioner is the executor of the estate of his father, H. C. Harris, who died testate in 1894. Decedent left him surviving six children. Decedent's will, inter alia, contained the following provision:
Item 2. I will that my said Executor shall have all the powers and rights with reference to the management of all property left by me that I myself would have if living, that without any order of any Court or Judge whatever, he may sell, incumber, reinvest or purchase any property, real or personal, money, stocks or other property, and that such transaction shall be as valid and binding on my estate as if done by me in person, my purpose being, that for all purposes in the management of my property and business my said Executor shall stand in my place and stead, his judgment being the sole guide and authority for all his actings and doings as my legal representative. And I direct that he be not required to make any returns of his actings and doings as my Executor to any Court.
Among the assets of the estate were a small country bank, a fertilizer factory, a cotton warehouse, some farming interests, and a subdivision in Florida.
Commencing immediately after his father's death, petitioner renewed notes of the estate with his endorsement, or he borrowed money elsewhere and paid off the notes, in this way maintaining the credit of the estate. At that time petitioner had just started the practice of law, which he gave up temporarily to operate the fertilizer factory. The factory was sold in 1897. He resumed the practice of law shortly after 1900. The bank was liquidated and the depositors were paid in full. The result from operating the estate was a considerable loss, which petitioner paid off as best he could. The estate, with the exception of a small parcel of property valued at $500, ceased to exist about ten or twelve years ago.
About 1918 petitioner placed a five-year mortgage of $15,000 on a building and lot owned by him. The mortgage was renewed several times. By 1942 this mortgage had been reduced to $8,800. About 1933 petitioner placed a mortgage of $8,500 on a farm he owned. By 1942 this mortgage had been reduced to $2,375, of which $2,000 was paid in 1942 and $375 in 1943. These funds obtained by petitioner under these two mortgage notes were used to pay notes and other debts of his father's estate.
In 1942 petitioner received a substantial fee and paid $8,800 and $2,000 on the foresaid respective mortgage notes. On his 1942 return petitioner claimed the sum of $10,800 as a bad debt deduction, which respondent disallowed. On his return for the taxable year 1943, petitioner claimed the amount of $375, which he paid in that year on the mortgage on his farm, as a bad debt deduction. The respondent allowed said sum as a bad debt deduction.
In determining his deficiency for the taxable year 1943, the respondent disallowed the amount of $7,103.09 claimed by petitioner as a net operating loss carry-over from the year 1942 to the year 1943.
OPINION.
LEECH, Judge:
The primary question presented is whether the respondent erred in disallowing petitioner a loss deduction in the amount of $10,800 on his income tax return for the year 1942. Petitioner contends that, since he reported his income on a cash basis, and the payments were made in 1942, his loss was sustained in that year. Petitioner on his return for 1942 claimed the deduction of $10,800 as bad debts, deductible under section 23(k) of the Internal Revenue Code. He now contends that the amount is deductible under section 23(e), either as a loss incurred in carrying on a business, or in a transaction entered into for profit. There is no disputing the fact that petitioner sustained a loss of the amount claimed by him. Whether the loss is one deductible under section 23(k) as a bad debt, or under section 23(e) as a business loss, or as one incurred in a transaction entered into for profit, is unimportant here. Alexander County National Bank, 12 B.T.A. 1238.
The controlling factor is whether the ‘debt‘ became worthless in 1942, or whether the ‘loss‘ was sustained in that year. On the basis of this record, we think there is no merit in petitioner's contention that the deductibility is controlled by the fact that the payments were made on the mortgage notes in the year 1942.
Petitioner was the sole executor of his father's estate. The outstanding liabilities of the estate were considerable. In order not to sacrifice the assets by a prompt liquidation, petitioner undertook to administer the estate so as to salvage as much of its assets as possible. In order to secure renewals and extensions of the estate's obligations, petitioner was required to give, and gave, his personal endorsement. Petitioner discharges these estate obligations as best he could. Later, to secure funds to meet the estate obligations, he executed a mortgage note in 1918 and another mortgage note in 1933 in the respective amounts of $15,000 and $8,500. By subsequent payments petitioner reduced the $15,000 note to $8,800 and the $8,500 note to $2,375. In 1942, from the proceeds of a professional fee, he paid off the balance of $8,800 on the $15,000 mortgage note and the sum of $2,000 on the $8,500 note. The balance of $375 on the latter note was paid by petitioner in the taxable year 1943.
We think the transaction disclosed by this record is one whereby petitioner loaned his personal funds to the estate, which it was obligated to repay. The fertilizer factory and the cotton warehouse were disposed of in 1897. The small country bank was liquidated in 1914. The net operation of the estate was a loss. The estate ceased to exist ten or twelve years ago, without assets to repay its indebtedness to petitioner. The debt became worthless at that time. The payment of the remaining balances on the mortgage notes given by petitioner in 1942 and 1943 did not extend his time to claim the bad debt deduction. Even if we assume petitioner was engaged in operating the estate as a business, or for profit, his loss was sustained when the estate became insolvent and ceased to exist.
Petitioner, however, contends that, although he knew prior to 1942 that he would sustain a loss by reason of his personal guaranty, since he was on a cash basis, the payments made in 1942 and 1943 on the mortgage notes, the proceeds of which he had used to discharge the estate's obligations, determine the time of the deductibility of such losses. Eckert v. Burnet, 283 U.S. 140. In that case, a taxpayer on the cash basis gave his note to the bank in settlement of his guaranty of a corporation's note to the bank, and claimed a deduction of a loss in the year the note was given. The note was not paid in that year. It was held that the giving of the note did not constitute a cash payment. The facts in the instant case are clearly distinguishable.
Petitioner, in 1918 and 1933, procured funds by the execution of mortgage notes on his individual properties. He used these funds to discharge the estate obligations he had personally guaranteed. The execution of these mortgage notes was not a mere continuation of the same liability. By that means he borrowed money from a third party for the specific purpose of paying the original liability. That loan was a new and distinct transaction. T. Harvey Ferris, 38 B.T.A. 312. Petitioner sustained a loss when he used these independent funds to discharge the estate's liabilities, thereby releasing his personal guaranty, and not when the mortgage notes were paid. Cf. Samuel Eugene Bramer, 6 T.C. 1027; affd., 161 Fed.(2d) 185; certiorari denied, 332 U.S. 771.
We, therefore, conclude that the respondent did not err in disallowing petitioner a deduction of $10,800 on his income tax return for 1942.
At the trial the respondent requested an increased deficiency resulting from his erroneous allowance of the claimed deduction of $375, which petitioner paid on one of the mortgage notes in the taxable year 1943. Since the 1943 payment is in the same category as the 1942 payment, we conclude, for the reasons stated, that respondent erroneously allowed the claimed deduction of the sum of $375 in 1943. The increased deficiency requested is allowed.
As a result of the disallowance of the claimed deduction of $10,800 in 1942, petitioner had net taxable income in that year. The second issue respecting respondent's disallowance of a claimed net operating loss carry-over to the taxable year 1943 becomes moot.
Decision will be entered under Rule 50.