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Commissioner of Internal Revenue v. Lowery

decided: August 18, 1964.

COMMISSIONER OF INTERNAL REVENUE, PETITIONER,
v.
SYLVESTER J. LOWERY AND ROSEMARY P. LOWERY, RESPONDENTS.



Author: Kalodner

Before KALODNER, STALEY and HASTIE, Circuit Judges.

KALODNER, Circuit Judge.

The issue presented is whether gains realized by the taxpayer*fn1 in 1951 and 1952 from the sale of his stock in two corporations, Parkway House, Inc. ("Parkway") and Raleigh Construction Company ("Raleigh") were taxable as ordinary income pursuant to section 117 (m) of the Internal Revenue Code of 1939,*fn2 relating to collapsible corporations.

The stipulated facts, found by the Tax Court, may be summarized as follows:

Taxpayer's principal occupation is that of a "Builder". In 1949 he had been associated with E. J. Frankel ("Frankel") in the building of an apartment project in Collingswood, New Jersey. Frankel had supervised the actual construction of that project and taxpayer had arranged for the Federal Housing Administration ("FHA") commitment. Thereafter, in January, 1950, Frankel was instrumental in organizing Parkway for the purpose of constructing a luxury apartment house in Philadelphia, and because of his earlier successful association with taxpayer he permitted taxpayer to participate in this project. On October 18, 1950, taxpayer purchased for $750 a 30% interest in Parkway, receiving 75 shares of $10 par value stock out of the corporation's authorized capital of 250 shares. Parkway was initially financed by means of a conventional mortgage and taxpayer's special ability and knowledge with respect to FHA mortgages was not required.

After the actual construction of the project was approximately 50% completed, Frankel determined that certain improvements in the building were desirable, including complete air-conditioning. He advised taxpayer that the project would cost approximately $700,000 more than the invested capital and mortgage proceeds and an additional investment on the part of the shareholders would therefore be required. Taxpayer was not in a position to advance the additional funds, nor did he desire to do so. Frankel then informed taxpayer that he had contacted two people who were willing to advance a portion of the needed funds on the condition that they obtain an equity interest in the corporation. On August 29, 1951, at about the time the project was 50% complete, taxpayer sold his 75 shares in Parkway for $45,000. Frankel did not sell his interest in Parkway. On his 1951 income tax return taxpayer reported $44,250 gain on the sale of his stock as long-term capital gain.

About one month after the organization of Parkway, Raleigh was organized under the laws of New Jersey with an authorized capital of 100 shares of no par value common stock for the purpose of constructing the Warwick Apartments, another luxury apartment development. All of the authorized shares of Raleigh were issued for $10 per share as follows:

Shareholder No. of Shares Percent

S. J. Lowery 40 40

E. J. Frankel 40 40

Frank Steinberg 13 13

Nate Margolin 7 7

At the time of Raleigh's incorporation, the shareholders also organized a subsidiary corporation known as Raleigh, Inc., which owned the project (Warwick Apartments), and all the stock of Raleigh, Inc., was owned by Raleigh.

Taxpayer successfully undertook to obtain an FHA insurance commitment for this project. Construction loans totalling $2,489,000 were obtained from the Irving Trust Co. of New York, although, as a condition to advancing this sum, the shareholders were required to execute an FHA indemnity agreement of approximately $235,000 to insure compliance with the requirements of the building loan agreement. Construction of the project was begun in the early part of 1950 and it was substantially completed by ...


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