32 T.C. 935 (1959)

When a property owner mortgages a property for an amount exceeding its basis, uses the proceeds to satisfy existing mortgages and retains the balance, then transfers the property subject to the new mortgage to a corporation in which the owner holds a stake, a taxable gain is realized to the extent of the proceeds retained.

Summary

Joseph B. Simon mortgaged a building he owned for $120,000, which exceeded its basis. He used a portion to pay off existing mortgages and kept the remainder. He then transferred the building, subject to the new mortgage, to Exco Corporation, in which he owned 50% of the stock, and the corporation then transferred it to its subsidiary, Penn-Liberty. The Tax Court held that Simon realized a capital gain from the transaction equal to the proceeds he retained because, in substance, the mortgage and transfer constituted a sale. The court rejected Simon’s argument that the transaction was a non-taxable contribution to capital.

Facts

Joseph B. Simon owned the RKO Building. He mortgaged it for $27,000 in 1941 and $80,000 in 1947. In 1951, he was president of Exco Corporation, which owned Penn-Liberty Insurance Company. Penn-Liberty suffered substantial losses, and Simon agreed with his co-stockholder to contribute to the capital of Penn-Liberty. Simon secured a new mortgage on the building for $120,000. He used the proceeds to satisfy existing mortgages, pay settlement costs, and retained the balance of $41,314.51. He transferred the building to Exco for a recited consideration of $100, subject to the new mortgage, and Exco transferred the property to Penn-Liberty for the same consideration. Penn-Liberty recorded the building on its books at an appraised value.

Procedural History

The Commissioner determined a deficiency in Simon’s income tax for 1951. The Tax Court heard the case and ruled in favor of the Commissioner, finding that Simon realized a capital gain on the transaction.

Issue(s)

1. Whether Simon realized income upon transferring property to a corporation in which he was a 50% owner, having previously mortgaged the property for more than its basis and retaining the excess proceeds.

Holding

1. Yes, because the court determined that the series of transactions constituted a sale of the property to Exco, resulting in a realized gain for Simon.

Court’s Reasoning

The court focused on the substance of the transaction. While Simon claimed it was a contribution to capital, the court found that the mortgage, Simon’s retention of the mortgage proceeds, and the transfer of the property, effectively constituted a sale. The court rejected Simon’s argument that the transaction was a non-taxable contribution to capital, as it allowed Simon to realize cash from the property’s financing. The court distinguished this case from those involving transfers to a corporation in exchange for stock, where no gain or loss is recognized, because the transaction was structured as a sale. The court cited *Crane v. Commissioner* to support the idea that the basis of the property includes any existing liens.

Practical Implications

This case highlights that the form of a transaction may be disregarded in favor of its substance when determining tax consequences. If a taxpayer mortgages property, retains proceeds exceeding their basis, and then transfers the property to a controlled corporation, the IRS is likely to view it as a sale, triggering a taxable gain. Tax advisors must carefully structure transactions involving property transfers to avoid unintended tax liabilities. This case underscores the importance of carefully analyzing the economic reality of transactions and their impact on gain recognition.