
    EDGAR T. APPLEBY AND FRANCIS S. APPLEBY, INDIVIDUALLY AND AS CO-EXECUTORS OF THE ESTATE OF EDGAR S. APPLEBY, DECEASED v. THE UNITED STATES
    [No. 50156.
    Decided November 3, 1953.
    Plaintiffs’ motion for rehearing overruled January 5, 1954]
    
      
      Mr. John B. Goman for tbe plaintiffs.
    
      Mr. J. W. Hussey, with whom was Mr. Assistant Attorney General H. Brian Holland, for the defendant. Mr. Andrew D. Sharpe was bn the brief.
   Littleton, Judge,

delivered the opinion of the court:

Two issues are presented in this case, the first which is identical with that dealt with in the cases of Francis S. and Eva Lee Appleby v. United States, No. 50155, and Edgar T. Appleby v. United States, No. 50157, ante, p. 91, and the opinion rendered there is equally applicable here. As to this issue, the factual differences between this and the above cited cases are ones of detail and may be briefly summarized.

Plaintiffs, as executors of their father’s estate sue to recover $27,037.69, plus interest alleged to represent an overpayment of income tax paid by the estate for the year 1941, occasioned by the carry-back of an alleged net operating loss incurred in 1943. The claim is based on Sections 23 (s) and 122 of the Internal Revenue Code; 26 U. S. C. (1946 Ed.) §§ 23 (s) and 122. As in Nos. 50155 and 50157, supra, the net loss (here 1943) resulted from the sale of certain realty which, had become unprofitable to operate in plaintiffs’ business of managing and operating real estate for the production of rental income. The loss in question is in the amount of $55,231.94 and resulted from the sale by plaintiffs of the Jolson Theatre in New York during 1943. For the reasons set forth in Francis S. Appleby and Eva Lee Appleby v. United States, supra, we hold that this loss was “not attributable to a trade or business regularly carried on by the taxpayer,” within the meaning of Section 122 (d) (5), and plaintiffs are therefore not entitled to carry such loss back to 1941.

This, however, does not completely dispose of the matter since unlike the other two cases, supra, plaintiffs incurred a net operating loss of $15,671.12 in 1943 quite apart from that which we have disallowed above. It is unquestioned that plaintiffs are entitled to carry that loss of $15,671.12 back to 1941 unless, as defendant contends, the adjustments required by Section 122 (c) and (d) more than absorb the entire amount ($15,671.12) available as a loss carry-back from 1943, and therefore no net operating loss deduction was allowable for 1941. This section provides in substance that in arriving at the amount actually to be deducted from the 1941 net income, the net operating loss carry-back (here $15,671.12) must be reduced by the amount by which the net income for 1941, computed with the exceptions required in Section 122 (d), exceeds the net income computed without such exceptions. In the instant case, whether or not an excess results from this computation depends on the effect of an undisputed long-term capital loss of $75,406.28, incurred by plaintiffs in 1941, as used in computing their income tax for that year. The proper role of this capital loss, in the computations incident to the conversion of the net operating loss carry-back, into a net operating loss deduction is the center around which the controversy between the parties revolves. Inasmuch as several sections of the Internal Revenue Code are involved and their application to the facts tends toward complexity, a fuller summary of those provisions and the relevant facts seems desirable.

As applicable to 1941, Section 122 (c) provides that:

The amount of the net operating loss deduction shall be the aggregate of the net operating loss carry-overs and the net operating loss carry-backs to the taxable year reduced by the amount, if any, by which the net income (computed with the exceptions and limitations provided in subsection (d) (1), (2), (3), and (4)) exceeds, in the case of a taxpayer other than a corporation, the net income (computed without such deduction) * * *.

Subsection (d) (4) is the important limitation involved here. This subsection provides that long-term capital gains and long-term capital losses should be taken into account for the purpose of Section 122, but should not be differently classified by percentages where held for different periods of time as set out in Section 117 (b). It then provides that “as so computed” the amount deductible on account of long-term capital losses should not in any case exceed the amount includible on account of long-term capital gains.

Plaintiffs paid $27,186.69 in income tax for the year 1941. The method of computation in arriving at that amount is important to this issue and is reflected below:

Computation of Alternative Individual Tam Under § 111 (c)
Net income_$19, 503.37
Plus long-term capital loss_ 75,406.28
Ordinary net income_$94,909.65
LESS: Personal exemption_ 750.00
Balance subject to normal tax- 94,159.65
Normal tax at 4 percent-$3,766.39
Surtax_ 46,042.18
Partial tax_ 49, 808.57
Minus 30 percent of net long-term capital loss- 22,621.88
Total normal and surtax under Sections 11 and 12_$4,776.41
Tax liability under Section 117 (c)- 27,186.69

It will be noted that this is an alternative tax computed as required by Section 117 (c) of the Code of 1941. Plaintiff was required to pay the tax as so computed because it resulted in a higher tax than would have resulted from a computation of tax under Sections 11 and 12. Under the latter sections the following method was employed. Plaintiffs’ ordinary net income was $94,909.65. When this amount was reduced by the amount of the allowable capital loss ($75,406.28) the resulting net income was $19,503.37. This amount was further reduced by the personal exemption of $750.00, leaving a balance subject to tax of $18,753.37. The total tax on this amount would have been $4,776.41. However, as noted above, plaintiffs’ situation fell within the provisions of Section 117 (c) and his tax as computed in the above tabulation amounted to $27,186.69, which was paid.

At this point the different manner in which the capital loss was employed in the two computations of the tax should be noted. Under the method provided for in Sections 11 and 12 the capital loss was used to reduce the tax by subtracting the total amount ($75,406.28) from the ordinary net income ($94,909.65) before computing the tax. Under the alternative method the capital loss was used to reduce the amount of the partial tax by subtracting 30 percent ($22,621.88) of the loss from the partial tax itself ($49,808.57), as computed on the ordinary net income unreduced by the capital loss.

In view of the above facts plaintiffs now argue that inasmuch as the alternative tax was computed on the ordinary net income ($94,159.65), unreduced by the capital loss ($75,406.28), their net income is the same (i. e., $94,159.65) whether computed with or without the exceptions and limitations of Section 122 (d) (4), with, the result that there is no excess to be subtracted from the net operating loss carry-back ($15,671.12), and the deduction for 1941 should be in that amount. It is further contended that the fact that 30 percent of the capital loss was subtracted from the partial tax ($49,808.57), thereby allowing a tax benefit on account of the capital loss, is immaterial since Section 122 (c) deals only with readjustments of net income and nothing is said specifically about adjustments which might be allowed on the partial tax. We do not agree.

As we interpret Section 122 (c), the various adjustments required in the conversion of a net operating loss carry-back to a net operating loss deduction, are designed to insure that the deduction represents a true loss and to prevent the combining of various relief allowances in the final computation. Thus it is undisputed that had plaintiffs’ position been such as to have rendered the alternative tax computation unnecessary, the benefit gained by deducting the capital loss from net income would have to be offset before a net operating loss in 1943 could be carried back to 1941 as a deduction. In this respect, the situation before us is not qualitatively distinguishable. In both computations the capital loss is utilized to afford a tax benefit. While in the instant case plaintiffs’ category was such as to require a different method of applying the capital loss to reduce the amount of the tax (i. e., subtracting 30% of the capital loss from the fartial tax rather than subtracting 100% of it from the net income before computing the tax), it is nonetheless true that it was employed and that the taxpayer benefited from the entire $75,406.28 loss involved. Having thus enjoyed the benefit in the initial computation, it must now be offset according to the statute before the allowable carry-back can properly become a net operating loss deduction for the taxable year 1941.

The result of this conclusion as applied to the facts of this case is reflected in the following tabulation:

Net operating loss carry-back-$15,671.12
LESS: Section 122 (c) adjusted net income_$19,503.37
ADD: Long-term capital loss (Section 122
(d) (4))_ 75,406.28
Net income computed with the exceptions and limitations provided in sub-sections (d), (1), (2), (3), and (4)_$94,909.65
Net income computed without net operating ■loss deduction_ 19,503.37
Decrease required by section 122 (c)_$75,406.28
Net operating loss deduction--- none

Since the net income computed with the limitations of Section 122 (d) (4) ($94,159.65) exceeds the net income computed without such limitations ($19,503.37) by $75,406.28, subsection 122 (c) requires that the net operating loss carry-back ($15,671.12) be reduced by that amount in arriving at the net operating loss deduction. The result is a minus quantity, and in the absence of a net loss deduction for 1941 there was no overassessment of plaintiffs’ income tax for that year. It follows that plaintiffs are not entitled to recover here, and the petition is dismissed.

It is so ordered.

Madden, Judge; and Jones, Chief Judge, concur.

Whitaker, Judge,

dissenting in part:

I dissent for the reasons stated in the case of Francis S. Appleby, et al. v. United States, No. 50155, this day decided.

FINDINGS OE FACT

The court, having considered the evidence, the report of Commissioner Bichard H. Akers, and the briefs and argument of counsel, makes findings of fact as follows:

1. The plaintiffs were duly appointed as co-executors of the estate of Edgar S. Appleby on February 5, 1936. The aforementioned Edgar S. Appleby, hereinafter sometimes referred to as the “decedent,” died on January 31, 1936.

2. On March 12, 1942, the plaintiffs, as co-executors, filed an income tax return for the Estate of Edgar S. Appleby for the calendar year 1941 showing an income tax liability of $25,568.65. The tax liability was assessed and it was paid on March 12, 1942. Pursuant to an audit of that income tax return, a deficiency of $1,469.04 was assessed in June 1943 and paid on June 22, 1943, thus making the total tax paid for 1941 $27,037.69.

3. The plaintiffs duly filed an income tax return for the Estate of Edgar S. Appleby for the calendar year 1943. On February 25,1947, they filed an amended income tax return for that year which disclosed a net loss of $63,440.10 and no tax due. The return also showed losses from the sale of capital assets of $16,241.15, $1,000 of which was used in arriving at the net loss of $63,440.10 shown in the return. Nonbusiness income was shown in the return in the amount of $16,883.58.

4. On March 6, 1947, the plaintiffs filed a timely claim for refund for 1941 in the amount of $25,568.65, more or less, plus interest, based on the following grounds:

In 1943, the taxpayer incurred a net operating loss of approximately $62,440.10. Its net operating loss carry-back for 1941 was approximately $62,440.10. The taxpayer is entitled to a refund because of the overpayment of its 1941 income tax attributable to its said net operating loss carry-back.

5. On July 11,1947, the Internal Eevenue Agent in Charge for the Second New York Division notified plaintiffs that he had determined that there was no income tax liability for the estate of the decedent for the calendar year 1943; that the net loss for the year was in the amount shown on the amended return, $63,440.10; and that there was a net operating business loss of $15,671.12. The net operating business loss was computed as follows:

Rental profits as above-$94, 095.95
Less:
Real estate taxes_$40,305.04
Social security taxes- 128.22
Bad debt_ 68,245.94
Insurance_ 484.33
Depreciation_ 603. 54 109,767.07
Business loss_ (15, 671.12)

A further computation appeared in the notice as follows:

(e) Item $52,233.20; to revise loss sustained upon rental property acquired by foreclosure.
Sales price_$150,000.00
Less: Expenses_ 5,404.49
144, 595.51
Fair market value 12/7/43-$150, 000.00
Beal estate taxes paid after fore-closure_ 105, 059.39
- $255,059. 39
Ordinary loss_ 110,463.88
to taxpayer_ 55,231.94
Previously allowed, revenue agent’s report- 2,998.74
Increase in loss_ 52,233.20
(d) Item $68,245.94; to allow deduction for bad debt due to foreclosure on mortgage.
Mortgage_$283,333.33
Foreclosure expense_ 3,158. 55
286,491. 88
Bid in price- 150,000. 00
Bad debt_ 136,491.88
% to taxpayer_ 68,245.94
previously treated as part of carry-over capital loss in revenue agent’s report.

6. By letter dated January 13,1948, the Internal Revenue Agent in Charge for the Second New York Division transmitted to the plaintiffs copy of a revenue agent’s report dated September 22, 1947, for the calendar year 1941, which recommended the allowance of a net operating carry-back loss for 1943 of $62,440.10 to 1941 which resulted in a proposed overassessment of $27,037.69 for 1941. The form letter of transmittal contained the following paragraph:

Overassessment: After the overassessment(s) have been certified to the Collector by the Commissioner of Internal Revenue, you will receive a check in payment of the overassessment and interest, provided there are no outstanding taxes against which the amount should be credited.

7. By letter dated December 5,1949, the Internal Revenue Agent in Charge transmitted to the plaintiffs a revenue agent’s report for the calendar year 1941 which showed the tax liability for that year as computed by him in the amount of $27,037.69, that that amount had been assessed, and that there was no deficiency or overassessment. The report further recommended the rejection of the claim for refund referred to in finding 4 on the following ground:

It is now held that the Net Loss for 1948 is not allowed as a carry-back to the year 1941, since the sale of property used in a business does not constitute the operation of a business.

8. On August 7,1950, a representative of the Deputy Commissioner of Internal Revenue in Washington, D. C., after a conference with representatives of the plaintiffs, transmitted a decision letter to the Revenue Agent in Charge in New York with respect to the claim for refund referred to in the preceding finding, in which letter the position of the Bureau of Internal Revenue was stated in part as follows:

It seems apparent, on the basis of all information available, that the taxpayer estate was not engaged in the business of trading or dealing in real estate, mortgages or securities. It was in the process of administration and liquidation. An estate which is merely liquidating cannot have a net operating loss. However, over a period of years the instant estate received substantial amounts of income from its holdings in real estate, mortgages and securities. It is believed that those activities may be held to constitute a business since they were substantially more than would be necessary to liquidate the estate. The loss of $68,245.94 on a mortgage foreclosure in 1943 undoubtedly was necessary to protect the investment and therefore may be allowed as a business deduction.
The loss of $55,231.94 from the sale of property used in the business is not attributable to the operationof the business and is deductible in computing a net operating loss only to the extent of gross income not derived from the business. I. T. 3711,1945, CB Page 162. If the loss on foreclosure is allowed as a business deduction and the loss on the sale of the business property is eliminated from the business deductions the net loss from the business will be $15,671.12. Since nonbusiness gross income does not exceed the nonbusiness deductions the net operating loss for 1943 would then be $15,671.12. This net operating loss is a carry-back to 1941 but the net operating loss deduction in 1941 is limited to the amount computed under the provisions of section 122 (c) of the Code.
Section 122 (c) of the Code provides that the carry-back must be reduced by the amount, if any, by which the net income computed with the exceptions and limitations provided in subsection (d)', (1), (2), (3) and (4) exceeds, in the case of a taxpayer other than a corporation, the net income computed without the net operating loss deduction. The net operating loss deduction for 1941, based on the carry-back from 1943 (there are no other carry-overs or carry-backs to 1941), is computed as follows:
1943 Net operating loss carry-back-$15,671.12
Less: Section 122 (c) adjustment
Net income (revenue agent’s report 4/30/42) _$19,503.37
Add: Long term capital loss (section 122 (d) (4))_ 75,406.28
Net income computed with exceptions and limitations provided in subsections (d), (1), (2), (3), and (4)__ 94,909.65
Net income computed without net operating loss deduction- 19,503.37
Decrease required by section 122 (c)- 75,406.28
Net operating loss deduction- None

9. By letter dated October 23, 1950, the Head of the New York Division of the Technical Staff of the Bureau of Internal Eevenue advised the plaintiffs that their claim for refund would be disallowed for the following reasons:

It has been determined that the foreclosure of the mortgage and the sale of rental property in 1943 constituting the basis for the claimed net operating loss carry-back did not result in losses attributable to the operation of a trade or business regularly carried on by the taxpayer since it does not appear that the taxpayer was in the business of selling real estate or foreclosing mortgages. It is further determined that even if either of the transactions resulted in a loss for the calendar year 1943 and constituted a loss attributable to the operation of a trade or business regularly carried on by the taxpayer within the meaning of Section 122 of the Internal Eevenue Code, no carry-back net operating loss would be available in view of the limitations contained in the above-mentioned section of the Internal Eevenue Code.

10. On November 28,1950, the plaintiffs’ claim for refund of $25,568.65 for the calendar year 1941, referred to in finding 4, was formally disallowed by the Commissioner.

11. The Estate of Edgar S. Appleby came into being with the decedent’s death on January 31,1936, and its administration was not concluded until December 31,1943. The estate contained originally a substantial number of investment securities and extensive real estate interests which were producing rental income. During the administration the real estate was retained for rental purposes but the securities were disposed of whenever it was necessary to raise money, the greater part of the securities having been disposed of during the period of administration of the estate. Through an arrangement with the Government the estate tax was paid off over a period of eight years. Funds for that purpose were obtained from the income from rental properties and securities and from the sale of investment securities. At the conclusion of the administration of the estate, the real estate passed to the heirs of the decedent who have continued to manage and operate it in the same manner as when they were acting as co-executors of the estate. The real estate owned by the estate is more particularly described in the findings which follow.

12. The estate owned seven parcels of realty, each of substantial size and value and each located in the City of New York: (1) a garage building on 58th Street; (2) another garage building on 63rd Street; (3) a parcel on 67th Street; (4) a building on 66th Street; (5) the Tremont Theatre; (6) a garage building on Claremont Parkway; and (7) an apartment building on Pitt Street. These seven parcels had an assessed value of $512,000.

13. The estate also owned a 50 percent interest in parcels constituting four city blocks in the City of New York: (1) the entire block bounded by 58th and 57th Streets on the north and south and by 11th and 12th Avenues on the east and west; (2) two-thirds of the block bounded by 57th and 56th Streets on the north and south and by 11th and 12th Avenues on the east and west; (3) the entire block bounded by 41st and 40th Streets on the north and south and by 11th and 12th Avenues on the east and west; and (4) two-thirds of the block bounded by 40th and 39th Streets on the north and south and by 11th and 12th Avenues on the east and west. The tenants in these commercial properties included the General Motors Corporation, the Pennsylvania Railroad, General Tire & Rubber Company, Goodyear Tire Company, United Parcel Service and the New York Butchers Dressed Meat Corporation. This property had an assessed value of $3,825,000.

14. The estate also owned a 50 percent interest in a loft building on Church Street, in the City of New York, and substantial acreage with tenants at Glen Cove, Long Island. The approximate value of these properties was $296,000.

15. The numerous, extensive, and valuable parcels of real property in which the estate had interests, varying from 50 to 100 percent, were located principally in New York City. The plaintiff-executors operated and managed these properties. Francis S. Appleby devoted 75 to 80 percent of his time and Edgar T. Appleby devoted all of his time to the management of these properties and the administration of the estate. They took full and active charge, personally, of all phases of the properties’ operation, the co-owners leaving the operation entirely to them.

16. The executors received approximately $100,000 annually in rents from the real property and paid out substantial sums in taxes and expenses. Only occasional sales of any of the real properties were made during the period of administration and those sales which were made were made because the properties had become unprofitable to operate and the executors decided to dispose of them as a part of the prudent management of the properties. The operation and management of these properties included not only making repairs but also the rehabilitation and renovation of the buildings. In performing their work, they hired architects, negotiated with builders, and drew contracts. In addition they negotiated and prepared leases, including in some cases long-term leases affecting the property. All the properties were held for rental purposes and the plaintiffs performed the duties of rental agents in connection therewith. In the performance of their work they maintained an office and employed a secretary for typing and filing. In addition to the business of managing and operating these properties, the executors carried out the usual administration activities during the period of the administration of the estate.

The estate regularly carried on the business of managing and operating real property for the production of rental income at all times material herein.

17. In 1943 the estate foreclosed a purchase money mortgage held by it on the Jolson Theatre located at 59th Street and 7th Avenue in New York City, with a resulting loss on the foreclosure of $68,245.94. The estate bought in the theater for $150,000 at the foreclosure sale.

18. In 1943, after acquiring title through foreclosure as shown in the preceding finding, the estate sold the Jolson Theatre to an outside party with a resulting loss on the sale of $55,231.94. It was the only sale of real estate made by the estate in 1943. The sale of the theater was made by the executors for the reason that its operations were unprofitable. Both the foreclosure and subsequent sale were dictated by the management’s policy of trying to operate the real estate profitably. They were not carried out for the purpose of liquidating the estate.

19. The real estate in the Estate of Edgar S. Appleby was jointly managed by Edgar T. Appleby and Francis S. Ap-pleby, the decedent’s sons, for the purpose of obtaining rental income therefrom. These sons still retain for the same purpose substantially all the properties which they inherited from their father. No sales of any of the properties have been made at any time except when the properties became unprofitable to operate as rental properties.

20. On January 4,1950, the plaintiffs instituted an action against the United States in the District Court for the Southern District of New York, Civil Action File No. 55-13, claiming an income tax refund to the Estate of Edgar S. Appleby in the amount of $58,010.63 for the calendar year 1942 on account of an alleged right to carry back to that year a net operating loss of $62,440.10 from 1943. That case is still pending.

CONCLUSION OF LAW

Upon the foregoing findings of fact which are made a part of the judgment herein, the court concludes that as a matter of law the plaintiff is not entitled to recover, and the petition is dismissed. 
      
       Francis S. and Edgar T. Appleby, suing here, as executors, were also individual plaintiffs in the cases numbered 50155 and 50157, supra, respectively. As is apparent from our findings of fact, each of these three cases merely presents slightly different facets of the same business, i. e., the management of the property in their father’s estate. This management by plaintiffs has been continuous since 1936 and the instant case deals with transactions prior to, while the other two cases are concerned with those subsequent to, the distribution of the property to the heirs.
     
      
       See findings 11, 12, 13 and 14 for detailed, statement of the property involved.
     
      
       $75,406.28 Is 50% of the actual loss suffered In 1941 upon the sale of securities held for more than 24 months.
     
      
       26 U. S. C. 122 (c) [as amended by Sec. 153 (b), Revenue Act of 1942, 56 Stat, 79811
     
      
       (d) Mmceptions, Additions, and Limitations. — Tbe exceptions, additions, and limitations referred to in subsections (a), (b), and (c) shall be as follows :
      (4) Long-term capital gains and long-term capital losses shall be taken Into account without regard to the provisions of section 117 (b). As so computed the amount deductible on account of long-term capital losses shall not exceed the amount includible on account of long-term capital gains, and the amount deductible on account of short-term capital losses shall not exceed the amount includible on account of short-term capital gains;
     
      
       26 U. S. C. (1946 Ed.), Sec. 117 (b).
     
      
       As applicable to 1941 this section (Sec. 117 (c) (2), Internal Revenue Code of 1939, 53 Stat. 51) provides :
      Sec. 1.17. CAPITAL GAINS AND LOSSES.
      (c) Alternative Tames.
      
      (2) In Case of Net Long-Term Capital Loss.- — -If for any taxable year a taxpayer (other than a corporation) sustains a net long-term capital loss, there shall be levied, collected, and paid, in lieu of the tax imposed by sections 11 and 12, a tax determined as follows, if and only if such tax is greater than the tax imposed by such sections :
      A partial tax shall first be computed upon the net income increased by the amount of the net long-term capital loss, at the rates and in the manner as if this subsection had not been enacted, and the total tax shall be the partial tax minus 30 percentum of the net long-term capital loss.
     