Summary
In Shannonhouse v. Commissioner, 21 T.C. 422 (1953), the taxpayers purchased real property and buildings which they subsequently sold.
Summary of this case from Boothe v. Comm'r of Internal RevenueOpinion
Docket No. 38718.
1953-12-31
ESTATE OF JAMES M. SHANNONHOUSE, DECEASED, FRANCES W. SHANNONHOUSE, EXECUTRIX, AND FRANCES W. SHANNONHOUSE, SURVIVING WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Bruce Gebhardt, Esq., for the petitioners. George W. Calvert, Esq., for the respondent.
Bruce Gebhardt, Esq., for the petitioners. George W. Calvert, Esq., for the respondent.
Where taxpayers realized capital gains in 1947 on the sale by warranty deed of income-producing reality, deductions for amounts paid to the purchasers in 1949 in discharge of liabilities for breach of covenants of title to the property are subject to the capital loss provisions of section 117 of the Internal Revenue Code. Arrowsmith v. Commissioner, 344 U.S. 6.
Respondent determined a deficiency in the income tax of petitioners for the calendar year 1949 in the amount of $1,239.98. Certain of the adjustments covered by the deficiency notice are not contested and will be reflected in the Rule 50 computation.
The sole issue for decision is whether payments made and legal expenses incurred in discharging liabilities for breach of covenants of title in a warranty deed conveying income-producing real property in a prior year are deductible in full or are limited by the capital loss provisions of section 117 of the Code.
FINDINGS OF FACT.
The petitioners are Estate of James M. Shannonhouse, deceased, Frances W. Shannonhouse, executrix, and Frances W. Shannonhouse, surviving wife. Prior to his death, James M. Shannonhouse, and Frances W. Shannonhouse were husband and wife, residing in Charlotte, North Carolina. James M. Shannonhouse died April 17, 1950, Frances W. Shannonhouse qualified and was appointed executrix on April 24, 1950.
For the taxable year ended December 31, 1949, James M. Shannonhouse and Frances W. Shannonhouse filed a timely joint income tax return on the cash basis with the collector of internal revenue at Greensboro, North Carolina. In March 1951, an amended joint return for 1949 was filed.
On or about February 12, 1938, there was conveyed to Frances W. Shannonhouse Lot 513 in the subdivision known as Sunset Shores in Carteret County, North Carolina. On or about October 16, 1939, Frances W. Shannonhouse acquired the eastern 39 feet of Lot 514 which adjoined Lot 513. All the property was near the beach at Morehead City, North Carolina.
The taxpayers erected a 2-story summer home on the property some time in 1938 or 1939. Another structure was also built which had space for two automobiles as well as two rooms and a bath used for servant's quarters. The property was used as a summer home through 1941. Thereafter it was converted into income-producing property with the actual rental being handled by Frances W. Shannonhouse's mother, Mrs. Graham Woodard.
In April 1947, the property was sold for $23,500 by warranty deed to Romaine C. Woodard of Wilson, North Carolina. The sale resulted in a gain which was reported on the 1947 income tax return of Frances W. Shannonhouse as a long-term capital gain.
Late in 1948 the new owners of the property discovered that the garage and servant's quarters encroached upon the adjoining lot of another owner. Prior to that time Frances W. Shannonhouse had no knowledge of such encroachment.
Romaine C. Woodard and her husband, David W. Woodard, spent $3,331.50 in eliminating the encroachment. They agreed to release James M. and Frances W. Shannonhouse from all claims under the warranty deed upon payment of the $3,331.50 expended by them. This money was paid on or about June 4, 1949, and thereupon James M. and Frances W. Shannonhouse were released by the Woodards from all claims for damages and expenses incurred because of the encroachment.
In addition to the aforesaid payment of $3,331.50, James M. Shannonhouse and Frances W. Shannonhouse paid attorney fees of $950 during 1949 in connection with the relocating and rebuilding of the garage and servant's quarters on the property sold to the Woodards.
The payments of $3,331.50 and $950 made by the petitioners were not compensated for by insurance or otherwise.
On their 1949 income tax return, James M. and Frances W. Shannonhouse claimed deductions for the full amounts paid for the release and as attorney fees.
OPINION.
ARUNDELL, Judge:
Petitioners sold income-producing real property in 1947 by warranty deed and realized on the sale a capital gain which was duly returned. In 1948 it was discovered that one of the building sold encroached on the property of a third person. The purchasers were forced to expend $3,331.50 to relocate the building. Petitioners thereafter in 1949 reimbursed the purchases in the full amount of their outlay and were thereupon released from any further liability for breach of the covenants of title in the warranty deed.
Petitioners contend that the aggregate of $4,281.50 was deductible in full in 1949 either as an ordinary loss under section 23(e)(2)
or as a nonbusiness expense under section 23(a)(2).
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(e) LOSSES BY INDIVIDUALS.— In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—(2) if incurred in any transaction entered into for profit, though not connected with the trade or business;
(a) EXPENSES.—(2) NON-TRADE OR NON-BUSINESS EXPENSES.— In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.
The respondent contends that the expenditures in 1949 were an outgrowth of the sale of the property on which a capital gain had been reported in 1947 and that Arrowsmith v. Commissioner, 344 U.S. 6, requires that the expenditures incident to the warranty be given the same capital gain or loss treatment.
We are constrained to agree with the respondent. The adjustment under the warranty was a part and parcel of the sale of the property. Losses under section 23(e)(2) are deductible if incurred in a transaction entered into for profit and that transaction was completed with the sale of the property. The execution of the covenants of title considered alone did not constitute a transaction entered into for profit.
Petitioners argue in the alternative that the payments are fully deductible as nonbusiness expenses paid or incurred for the production or collection of income or for the management, conservation, or maintenance of property held for the collection of income. In support of that contention, they cite Carl W. Braznell, 16 T.C. 503, and Samuel G. Swaim, 20 T.C. 1022. We think that both these cases are inapplicable to the situation in the case at bar, the liability in the Braznell case having arisen from failure to sell a capital asset and the liability in the Swaim case having been found specifically not to have arisen from the sale of a capital asset. Here, the liability arose from the transaction wherein the realty was sold. The payments in question are deductible only as limited by section 117.
Decision will be entered under Rule 50.