PELLAR v. COMMISSIONER Docket No. 51932.

25 T.C. 299 (1955)

FRED PELLAR AND ROSALIE PELLAR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

United States Tax Court.
Filed November 29, 1955.
John E. Owens, Esq., for the respondent.

The respondent determined a deficiency in income tax of the petitioners for the calendar year 1949 in the amount of $45,857.64.

The only issue for decision is whether or not petitioners received income by virtue of the construction of a residence for them where the cost of construction and the fair market value of the residence materially exceeded the agreed price paid to the contractor for such construction.

FINDINGS OF FACT.

Petitioners are husband and wife. They filed a joint income tax return for the calendar year 1949. The return was filed with the collector of internal revenue at Chicago, Illinois. The return was filed on a cash receipts and disbursements basis. Said return disclosed a net income of $63,632.49 and a tax liability of $23,899.66.

In 1948, petitioners, Fred and Rosalie Pellar, desired to acquire a house. Not being able to find one that suited them, they decided to have one built. Accordingly, they approached Sam Briskin, Rosalie Pellar's father, who offered to contact Ragnar Benson to see if he would build a house for them.

Ragnar Benson was president of and (with his family) the dominant stockholder of Ragnar Benson, Inc. Ragnar Benson, Inc., was a building and engineering firm engaged primarily in the construction of business and industrial buildings. Ragnar Benson was a friend of Sam Briskin, and had done construction work for companies with which Sam Briskin was connected.

Sam Briskin telephoned Ragnar Benson and subsequently introduced petitioners to Ragnar Benson at the latter's office. This was about April 1948. Ragnar Benson asked Eric Anderson to take care of the Pellars. Eric Anderson was a young employee working in the architectural department of Ragnar Benson, Inc., but who was not then a licensed architect. Ragnar Benson suggested that petitioners and Eric Anderson get together and work out an acceptable floor plan. Petitioners told Ragnar Benson that they did not want to pay more than $40,000 to $45,000 for the house.

After several conferences with Eric Anderson, the Pellars finally decided upon an acceptable floor plan for the first and second floors. Mr. Anderson said he thought it would cost more than $40,000.

Petitioners thereupon conferred with Ragnar Benson who examined the floor plans or sketches, computed the cubic content at about 77,000 cubic feet and, estimating a cost of 60 cents per cubic foot, said he would build the house for them for $40,000 provided they, the Pellars, would furnish the air conditioning machinery, the kitchen equipment, lighting fixtures, breakfast nook, landscaping, and various other miscellaneous items.

Because of his friendship for and pleasant business relationships with Sam Briskin, and because Briskin had recommended his organization to others, together with his hope of future business stemming from Briskin and his recommendations, it was Ragnar Benson's intention to build the house without profit. He was willing to build it at bare cost, or even to lose something in the neighborhood of $2,000 on the project. He accordingly agreed verbally to build the house for $40,000, but with certain items normally included in a completed house to be furnished by the petitioners. Benson told Anderson to take over, and the latter proceeded to work on plans for the house.

Petitioners had purchased a lot at 6711 South Constance Avenue in Chicago for $8,500. The lot was 50 feet wide.

Sometime in July 1948, excavation was begun. This was before the plans and specifications were drafted and at this time there was no written agreement between petitioners and Ragnar Benson, Inc.

On or about October 4, 1948, Eric Anderson wrote a letter to Fred Pellar stating that the cost of the house would greatly exceed $40,000. The letter was received and opened by Sam Briskin who became angry and tore it up. Mr. Pellar did not see the letter. The figure stated therein was "better than double" the $40,000 price agreed upon.

Petitioners and Briskin contacted Ragnar Benson and ordered that construction be stopped because petitioners did not intend to pay more than the $40,000 which had been agreed upon.

Ragnar Benson informed petitioners that he knew nothing about the Eric Anderson letter, that he had not authorized the writing of the letter, and that he would stand by his verbal agreement. An understanding was reached between Mr. Pellar and Ragnar Benson that the agreement would be confirmed by an exchange of letters.

Accordingly, on October 7, 1948, Mr. Pellar wrote Ragnar Benson a letter as follows:

OCTOBER 7, 1948 MR. RAGNAR BENSON RAGNAR BENSON, INC. 4744 WEST RICE STREET CHICAGO 15, ILLINOIS

DEAR MR. BENSON:

In re: Job No. 8566

I was shocked to receive your letter dated October 4th and signed by Mr. Anderson, concerning the house which you are building for me. Apparently, Mr. Anderson did not know of the agreement which you made with me several months ago at a meeting at your office of you, me, my wife and my father-in-law, Mr. Sam Briskin.

At that time Mr. Anderson said he thought that the house would cost approximately $45,000 to $50,000. I said I couldn't afford to pay that much for a house. After we had talked for a while you said you would make no charge for architectural or engineering services and would handle the job without a profit, and that you would build the house in accordance with approved plans and specifications for $40,000. This price while including all of the usual items in a house and the duct work for air conditioning does not include the air conditioning machinery. I cannot afford the air conditioning machinery at this time and I hope to put it in the house later.

I am, therefore, returning your bills of August 4th and October 1st (I have lost the September 1st bill), totaling $2,994.80 which are for architectural and engineering services for which I am not to be charged.

I would appreciate your letting me know within the next few days that I have correctly stated our understanding and that you will complete the house according to our agreement.

Very truly yours, (sgd) Fred Pellar

Ragnar Benson then replied by letter to petitioners as follows:

RAGNAR BENSON, INC., ENGINEERS AND BUILDERS CHICAGO 51, ILLINOIS October 13, 1948 MR. & MRS. FRED PELLAR c/o REVERE CAMERA COMPANY 320 EAST 21ST STREET CHICAGO, ILLINOIS

DEAR MR. & MRS. PELLAR:

Wish to acknowledge your letter dated October 7th regarding the home which we are building for you at 6711 Constance Avenue. Your statements in the letter are substantially correct and we do agree to complete this house exclusive of the air conditioning and landscaping and any other furniture such as refrigerator, washing machine and etc., which are not part of a building for the sum of approximately $40,000.00. I have also cancelled out the invoices sent you for Architectural and Engineering services.

When the final working drawings are complete I trust you will study the plans and specifications carefully to make sure it is what you want so that we will not have any changes while work is progressing. These changes have run into considerable money and we want every possible manner to avoid additional costs.

Thanking you for our past pleasant business relationship, I am

Sincerely, (sgd) Ragnar Benson RAGNAR BENSON RB: BMO President

The work on the house, which had been stopped, was then resumed.

The blueprints were completed on or after October 18, 1948, and neither the blueprints nor the plans and specifications had been examined by Fred Pellar prior to the oral and written agreements with Ragnar Benson, Inc.

The work of Ragnar Benson, Inc., on the house was completed in July 1949. Petitioners then had the interior painted and decorated at their own expense. They moved into the house on August 5, 1949, at which time Fred Pellar made the final payment of $20,000 to Ragnar Benson, Inc. The total payments made by petitioners to Ragnar Benson amounted to $40,000.

Petitioners' letter of October 7, 1948, and the letter of Ragnar Benson, Inc., dated October 13, 1948, in reply thereto, which letters incorporated in writing the prior verbal understanding of the parties, evidenced the entire agreement between them.

Neither petitioner had any interest in Ragnar Benson, Inc., either as a stockholder, director, debtor or creditor, or in any other capacity.

The total cost of construction of petitioners' house was $101,936.52. This did not include architectural and engineering costs.

The costs of construction were increased by a number of circumstances, including the following:

(a) When Ragnar Benson first agreed to build the house for $40,000, his calculation of costs was based on 1947 costs of 60 cents a cubic foot. Costs of construction, including labor and material, increased substantially between 1947 and 1949.

(b) Due to an engineering error by Ragnar Benson, Inc., the grade of the house was established too low, so that the basement would have been below a point where there was danger of the sewers backing up. The level of the house had to be raised 18 inches. This was not discovered until after the excavation had been made and the footings had been poured. The change so required was expensive.

(c) Due to faulty installation, the stonework in the wall around the fireplace in the recreation room had to be removed and relaid.

(d) The front of the house was faced with Lannon stone. Lannon stonemasonry is almost a trade by itself. A mason who lays Lannon stone is not an ordinary bricklayer. Ragnar Benson, Inc., could not obtain the services of Lannon stonemasons, and used their regular bricklayers for this purpose. As a result, the job was poorly done and had to be done over when they were able to obtain the services of masons with more experience. This was quite costly and was admittedly the contractor's fault.

(e) The window sills throughout the house were made of marble cut to the size of each window. After they were installed, it appeared that the sills, instead of extending over the edge of the inside wall as called for by the blueprints, did not quite reach to the wall, leaving a recess — a "dust catcher." The marble sills on all of the first floor windows were replaced with proper sills. This was an error of the contractor.

(f) The air duct outlets in front of the fireplace were changed to the sides at the request of Mrs. Pellar, resulting not only in a change of the location of the air ducts and the outlets themselves, but also requiring the replacement of the mahogany paneling around the fireplace. Although the plans called for the ducts as originally placed, the effect was disagreeable. The ducts should have been installed on the sides in the first place.

(g) Construction costs were further increased because of the labor shortage in the Chicago area. All types of building labor crafts were very scarce. Ragnar Benson, Inc., had to work some laborers Saturdays and Sundays and pay them overtime in order to get them to work on the job, and some of them would not show up for work on Mondays.

(h) Construction costs were further increased by the extreme cold during the winter. When Ragnar Benson agreed to the $40,000 figure for building the house, he did not take into consideration the extra costs of winter construction. When it was cold it was not practicable to do masonry work and the bricklayers would keep warm in a heated shanty sometimes until 10 or 11 o'clock until it got warmer, but were paid for a full day's work beginning at 8 o'clock. It was also necessary to supply heat in the house when the concrete was poured and to keep the plaster from freezing. The union also required that heat be furnished.

(i) Catch basins were omitted from the basement floor when it was built and had to be installed later.

(j) The concrete floor on the back porch (solarium) originally was poured level. The porch was merely screened in. In order to permit the water to run off, the cement was broken up and relaid so as to have a pitch or slant so the water would run off.

(k) Other smaller items which increased the cost were (1) the small cut-stone sidewalk from the front to the side of the house took two men about a month to lay; (2) the front door was remodeled and glass partitions were installed; (3) the doors throughout the house were exchanged because the doors originally delivered had dark streaks in them; (4) some kitchen cabinets were changed; and (5) some of the tiling on the floors was changed to Koroseal tile.

(l) Another item was a change in the walls of the recreation room. Originally designed and constructed for paneling, it was changed, at petitioners' request to plaster, and then was changed to paneling.

Other changes which increased the cost of construction were made at the direction of petitioners, as indicated below:

(1) The stairway from the first floor to the second floor was changed from a straight stairway to a curved stairway.

(2) The ceilings in the house were raised from 7 to 8 feet.

(3) Changes were made to the heating system.

There were numerous other changes made to suit Mrs. Pellar which added to the cost of construction. Sometimes it was necessary to hold up work on an item until the next day, when the job foreman could come out to the site and discuss the requested change.

Throughout the construction, there were many items changed or constructed differently from the blueprints which were of a nature usually regarded as "extras" for which Ragnar Benson, Inc., made no extra charge. Petitioners did not pay or offer to pay to Ragnar Benson, Inc., any amounts in excess of the $40,000 agreed price, and Ragnar Benson, Inc., made no claim for any amount in excess of such price.

In addition to the $40,000 paid to Ragnar Benson, Inc., petitioners expended the following amounts in purchasing the ground, completing the house, and landscaping and improving the grounds:

Cost of lot --------------------------------------   $8,500.00
Landscaping --------------------------------------    2,073.60
Fencing ------------------------------------------      237.00
Lawn sprinkling system ---------------------------    1,501.00

Painting and decorating --------------------------------    $3,430.00
Air conditioning ---------------------------------------     3,392.00
Basement (maid's) room ---------------------------------     1,015.00
Fixtures, lighting, towel, etc -------------------------       622.29
Breakfast nook -----------------------------------------       550.00
Tiling -------------------------------------------------        63.77
Shelf coverings ----------------------------------------       227.51
Kitchen and laundry equipment --------------------------     1,854.77
                                                           __________
                                                           $23,466.94

The Pellar house consists of a basement and a first and second floor. The first floor has 4 rooms—living room, dining room, recreation room, and kitchen—in addition to a breakfast nook, a solarium, and powder room. The second floor has 4 bedrooms, 4 bathrooms, and a dressing room. The house contained 3 fireplaces. In addition, there was a 1-car garage attached to the house.

In August 1949, the fair market value of petitioners' house at 6711 South Constance Avenue (excluding the value of the lot, for which the Pellars paid $8,500) was $70,000.

There were four corporations in which Sam Briskin or relatives of Sam Briskin had interests as stockholders, and for which Ragnar Benson, Inc., had performed construction contracts during the years 1947 through 1950, inclusive, namely, Revere Camera Company, Excel Auto Radiator Company, Mercury Products Company, and Supreme Products, Inc.

The names of the stockholders of Revere Camera Company, the relationship of each to Sam Briskin, and the number of shares owned by each as of January 31, 1947, 1948, 1949, and 1950, were as follows:

-----------------------------------------------------------------------------------------------------------
                                                                        |      Revere Camera Company as
                                                                        |             of January 31
                           Stockholder                                  |----------------------------------
                                                                        |  1947  |  1948  |  1949  |  1950
                                                                        |----------------------------------
                                                                        |               Shares
------------------------------------------------------------------------|----------------------------------
Mrs. Bessie Briskin (wife of Sam Briskin) ----------------------------- |  1,500 |  1,500 |  1,500 |  1,500
Rosalie Briskin (Pellar) (wife of Fred Pellar and daughter of Sam       |        |        |        |
   Briskin) ----------------------------------------------------------- |  2,750 |  2,750 |  2,750 |  2,750
Jack Briskin (son of Sam Briskin) ------------------------------------- |  4,000 |  4,000 |  4,000 |  4,000
Sam Briskin ----------------------------------------------------------- |    500 |    500 |    500 |    500
Sam Briskin and Fred Pellar, Trustees for benefit of James Pellar (son  |        |        |        |
   of Rosalie and Fred Pellar) ---------------------------------------- |    375 |    375 |    375 |    375
Sam Briskin and Fred Pellar, Trustees for benefit of Vicki Pellar       |        |        |        |
   (daughter of Rosalie and Fred Pellar) ------------------------------ |    375 |    375 |    375 |    375
Sam Briskin and Fred Pellar, Trustees for benefit of J. A. Briskin (son |        |        |        |
   of Jack Briskin) --------------------------------------------------- |    500 |    500 |    500 |    500
Phillip Briskin (son of Sam Briskin) ---------------------------------- |  5,000 |  5,000 |  5,000 | ------
Sam Briskin and Continental Illinois National Bank, Trustees under      |        |        |        |
   trust for Phillip Briskin (son of Sam Briskin) --------------------- | ------ | ------ | ------ |  5,000
                                                                        | ______ | ______ | ______ | ------
      Total shares outstanding ---------------------------------------- | 15,000 | 15,000 | 15,000 | 15,000
-----------------------------------------------------------------------------------------------------------

Throughout the years 1947 to 1950, inclusive, the entire outstanding capital stock of Excel Auto Radiator Co. was owned by Sam Briskin.

The names of the stockholders of Mercury Metal Finishing Company, their relationship, if any, to Sam Briskin, and the number of shares owned by each as of December 9, 1947, and November 8, 1948, 1949, and 1950, were as follows:

---------------------------------------------------------------------------------------------------------
                                                                       | December |     November 30
                            Stockholder                                |    9     |
                                                                       |----------|----------------------
                                                                       |   1947   | 1948 |  1949  | 1950
-----------------------------------------------------------------------|---------------------------------
                                                                       |              Shares
                                                                       |---------------------------------
Joseph Prosk (nephew of Mrs. Sam Briskin) ---------------------------- |       50 |    50 |    50 |    50
Theodore Prosk (nephew of Mrs. Sam Briskin) -------------------------- |       40 |    40 |    40 |    40
Max Prosk (nephew of Mrs. Sam Briskin) ------------------------------- |       20 |    20 |    20 |    20
Sam Briskin and Fred Pellar as Trustees, for the benefit of Lindsay    |          |       |       |
  Briskin (daughter of Ted Briskin) ---------------------------------- |       30 |    30 |    30 |    30
Sara Pellar (wife of Louis Pellar) ----------------------------------- |      100 |   100 |   100 |   100
Leo Flick ------------------------------------------------------------ | -------- | ----- |   200 |   200
Mabel Hutton (mother of Betty Briskin) ------------------------------- |      200 |   200 | ----- | -----
M. S. Bell (father-in-law of Jack Briskin) --------------------------- |      100 |   100 |   100 |   100
Anna Wienhouse (sister of Mrs. Sam Briskin) -------------------------- |       70 |    70 |    70 |    70
Hermine Prosk Goldman (niece of Mrs. Sam Briskin) -------------------- |       25 |    25 |    25 |    25
Sam Briskin and Fred Pellar, Trustees for the benefit of Felice Prosk  |          |       |       |
  (niece of Mrs. Sam Briskin) ---------------------------------------- |       25 |    25 |    25 |    25
Max T. Prosk (brother of Mrs. Sam Briskin) --------------------------- |       50 |    50 |    50 |    50
Ruth Prosk Charles (sister of Mrs. Sam Briskin) ---------------------- |      100 |   100 |   100 |   100
Ethel DeKoven (niece of Mrs. Sam Briskin) ---------------------------- |       10 |    10 |    10 |    10
Sidney DeKoven (nephew of Mr. and Mr. and Mrs. Sam Briskin) ---------- |       10 |    10 |    10 |    10
Fred Pellar (son-in-law of Mr. and Mrs. San Briskin) ----------------- |      120 |   120 |   120 |   120
Cyril Briskin (daughter-in-law of Mr. and Mrs. Sam Briskin) ---------- |      100 |   100 |   100 |   100
Ida C. Wald (niece of Mr. Sam Briskin) ------------------------------- |       10 |    10 |    10 |    10
Eve Schippek (niece of Mr. Sam Briskin) ------------------------------ |       20 |    20 |    20 |    20
Gerry Blumberg (niece or sister of Mr. Sam Briskin) ------------------ |       10 |    10 |    10 |    10
Rose Wiesman (niece or sister of Mr. Sam Briskin) -------------------- |       20 |    20 |    20 |    20
Samuel R. Rosenthal -------------------------------------------------- |       50 |    50 |    50 |    50
Abe Prosk (brother of Mrs. Sam Briskin) ------------------------------ |       50 |    50 |    50 |    50
Louis Pellar (brother of Fred Pellar) -------------------------------- |       50 |    50 |    50 |    50
Martin Berzon -------------------------------------------------------- |      150 |   150 |   150 |   100
Benjamin Berzon (brother of Martin Berzon) --------------------------- | -------- | ----- | ----- |    50
                                                                       | ________ | _____ | _____ | _____
      Total shares outstanding --------------------------------------- |    1,410 | 1,410 | 1,410 | 1,410
----------------------------------------------------------------------------------------------------------

Throughout the period beginning March 20, 1946 (the date of its incorporation), and ending March 31, 1950, Supreme Products, Inc., had 750 shares of stock outstanding. Rosalie Pellar (petitioner herein) owned 125 of said shares, and T. Wienhouse, nephew of Mrs. Sam Briskin, owned 10 of said shares. No other stockholders of that company were related to Sam Briskin. Lou Spatz was the dominant personality of Supreme Products, Inc.

During the years 1948 and 1949 Sam Briskin was chairman of the board of Revere Camera Company, Fred Pellar was treasurer and director, and Rosalie Pellar was a director.

During the years 1948 and 1949 Sam Briskin was president and director of Excel Auto Radiator Company, and neither Fred Pellar nor Rosalie Pellar was an officer or director of that company. In 1950, when Sam Briskin resigned as president and director, Fred Pellar became vice president and director.

Neither Sam Briskin, Fred Pellar, nor Rosalie Pellar was an officer or director of Mercury Metal Finishing Company or of Supreme Products, Inc., at any time. Fred Pellar was employed as production manager of Supreme Products, Inc., in 1949.

Petitioners were not involved in the letting of or the payment for the construction contracts which any of the above-named companies had with Ragnar Benson, Inc. The contracts of Revere Camera Company and Excel Auto Radiator Company with Ragnar Benson, Inc., were negotiated by Sam Briskin and Ragnar Benson. The contract of Supreme Products, Inc., with Ragnar Benson, Inc., were negotiated by Lou Spatz and Ragnar Benson.

The total contract price of the contracts entered into between Ragnar Benson, Inc., and Revere Camera Company, Excel Auto Radiator Company, Mercury Metal Products Company, and Supreme Products, Inc., during the years 1947 through 1950, inclusive, was $1,314,344.57.

The total contract price, the net profit, and the percentage of net profit to total contract price, for each of the contracts included in the above total of $1,314,344.57, were as follows:

-----------------------------------------------------------------------------------------------------
                         |                                   |                |            | Per cent
      Job number         |              Company              | Total contract | Net profit |  of net
                         |                                   |      price     |            |  profit
-------------------------|-----------------------------------|----------------|------------|---------
7520 ------------------- | Revere Camera Co ---------------- |    $106,497.73 |  $9,000.00 |     .085
7521 ------------------- | Revere Camera Co ---------------- |     158,143.77 |  13,250.00 |     .084
7685 ------------------- | Excel Auto Rad. Co -------------- |     461,742.37 |  34,466.61 |     .075
7832 ------------------- | Mercury Metal Fin. Co ----------- |      94,458.31 | ---------- | --------
7923 ------------------- | Supreme Products, Inc ----------- |     320,802.70 |  23,788.32 |     .074
9629 ------------------- | Revere Camera Co ---------------- |      58,775.72 |   4,760.48 |     .081
9652 ------------------- | Revere Camera Co ---------------- |      36,611.70 |   2,523.77 |     .069
9765 ------------------- | Excel Auto Rad. Co -------------- |      77,312.27 |   6,505.45 |     .084
                         |                                   | ______________ | __________ | ________
                         |    Totals ----------------------- |  $1,314,344.57 | $94,194.63 |     .072
-----------------------------------------------------------------------------------------------------

All of the above contracts were oral contracts.

The first 5 contracts referred to above were entered into prior to the arrangement to build the Pellar house and the last 3 contracts were entered into subsequent thereto. Subsequent to 1950, Ragnar Benson, Inc., continued to do construction work for one or more of the companies above referred to.

There was no understanding either with Sam Briskin or Fred Pellar or Rosalie Pellar, or any other person, that Ragnar Benson, Inc., was to receive any compensation, direct or indirect, for the building of the Pellar house, other than the $40,000 contract price.

There was no agreement that Briskin or Pellar would do anything (other than pay the agreed price for construction of the Pellar dwelling) for Ragnar Benson, Inc., as consideration for the construction of the Pellar house.

There was no agreement that Ragnar Benson, Inc., was to receive or had received any consideration for the construction of the Pellar house from or by reason of its past or future contracts with Revere Camera Company, Excel Auto Radiator Company, Mercury Metal Finishing Company, or Supreme Products, Inc.

OPINION.

FISHER, Judge:

Respondent appears to have based his statutory notice of deficiency upon the theory that petitioners received income by virtue of the construction of their home in an amount measured by the excess of the total cost to Ragnar Benson, Inc., for constructing the dwelling over the amount paid to Ragnar Benson, Inc., by the Pellars. At the time of the trial of the case, and subsequently in respondent's brief, this view was revised to some extent, and respondent's position is stated in his brief as follows:

Respondent * * * seeks only to recover the amount of tax lawfully due from the taxpayer. It was stated in Court that the petitioners are taxable only on the income they received; respondent is not contending that increased costs which resulted from errors of Ragnar Benson, Inc. and which did not enhance the market value of the house are income to the petitioners.

In view of the foregoing, and in the light of our conclusion, for the reasons hereinafter set forth, that the Pellars realized no taxable income from the transaction in question, we see no reason to determine the precise amount of the cost of construction attributable to the mistakes and miscalculations of Ragnar Benson, Inc., as distinguished from the costs due to changes made at the request of petitioners. For practical purposes, and as background for our discussion, we think we need only discuss whether or not the excess of the fair market value of the property (excluding land) over cost constituted income to the Pellars. We have found as an ultimate fact, upon consideration of the entire record, that such fair market value, on completion, was $70,000. The agreed price paid by the Pellars to Ragnar Benson, Inc., was $40,000. The Pellars likewise paid $23,466.94 in purchasing the ground, completing the house, and landscaping and improving the grounds. Eliminating $8,500 paid for the land, we have the net sum of $14,966.94, which, when added to the $40,000 paid to Ragnar Benson, Inc., gives a total of approximately $55,000 paid by the Pellars for a house worth $70,000.

The substantial issue is, therefore, whether the differential of approximately $15,000 was income to the Pellars. We realize that respondent still contends that the expense of various changes made at the request of the Pellars (other than items due to the errors of the contractor) for which the contractor made no charge, and which were not substantially reflected in the value of the house, should serve to increase this differential. As indicated above, however, in view of our ultimate conclusions, it is unnecessary to consider this view or to attribute a specific total amount thereto.

For the purpose of our discussion, therefore, we limit the issue to the question of whether the fact that, as Ragnar Benson put it, petitioners got $15,000 more house than they paid for, resulted in the realization by petitioners of taxable income.

We think there can be no doubt that the general rule is that the purchase of property for less than its value does not, of itself, give rise to the realization of taxable income. Such realization normally arises, and is taxed, upon sale or other disposition.

In Palmer v. Commissioner, 302 U.S. 63 (1937), the Supreme Court said (pp. 68, 69):

In §§ 111, 112 and 113 of the Revenue Act of 1928, [26 U. S. C. A. Pars. 111, 112 and notes, 113 note], profits derived from the purchase of property, as distinguished from exchanges of property, are ascertained and taxed as of the date of its sale or other disposition by the purchaser. Profit, if any, accrues to him only upon sale or disposition, and the taxable income is the difference between the amount thus realized and its cost, less allowed deductions. It follows that one does not subject himself to income tax by the mere purchase of property, even if at less than its true value, and that taxable gain does not accrue to him before he sells or otherwise disposes of it. Specific provisions establishing this basis for the taxation of gains derived from purchased property were included in the 1916 and each subsequent revenue Act and accompanying regulations.

In 1 Mertens, Law of Federal Income Taxation, page 227, paragraph 5.25, we find the following:

5.25. Income Realized Through Purchase. No taxable income results from the purchase of property assuming that the transaction is one at arm's length and that the relationship of the parties does not introduce into the transaction other elements indicating that the transaction is not simply a purchase but involves an exchange of other considerations. It requires strong evidence to rebut the presumption that what appears in good faith to be a purchase is not such. The fact that the property may be acquired at a bargain price or one below its "fair market value" does not require a departure from this rule.

Taxable gain does not accrue to the purchaser of property until he sells or otherwise disposes of it. This concept is specifically incorporated in the statute in the provisions providing for the recognition of gain or loss on the sale or other disposition of property.

As indicated above, acquisitions of property may result in taxable income where they do not represent purchases or where some other purpose is consummated by the acquisition of the property. There are many instances where this is true. For example, property acquired in connection with a "bargain purchase" may represent compensation where the seller and the purchaser bear the relationship of employer and employee, or a dividend distribution, or a gift. The purchase by a corporation of its own bonds at a price below their issuing price is another frequent example of a purchase giving rise to taxable income.

See also Delbert B. Geeseman, 38 B. T. A. 258 (1938).

While the facts before us are obviously unusual, we fail to find any circumstances on the basis of which we may determine that petitioners realized taxable income upon the principles announced by the authorities cited above. In the instant case, there was no employer-employee relationship from which we might infer that the $15,000 differential was compensatory. It is clear, likewise, that the elements of a dividend are not present. Nor is there any other theory brought to our attention from which we may hold that income was realized.

The Pellars did receive more value than that paid for. This opportunity was afforded them because Ragnar Benson wanted Briskin's goodwill, any future business controlled by Briskin, and a continuation in the future of Briskin's favorable recommendations. Nevertheless, there was no obligation for Briskin (or petitioners) to favor Benson, in the future, in any of such respects.

We add that we do not think Benson himself had any idea, when he agreed to build the house, that his voluntary investment in goodwill would be so costly. Once the project was in motion, however, he adhered to his agreement as a matter of policy. We need not consider whether it was enforcible. Whether he will gain or lose in the end is no more before us than the question of petitioners' ultimate realization of gain upon future sale or exchange of the property.

We think that Benson's actions were akin to lavish expenditures for presents or entertaining. We think no more was intended by him, and that, in all events, petitioners were not obligated, in any legal sense, for services or other affirmative response.

Respondent's substantial reliance is upon Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 75 S.Ct. 473 (1955). It is necessary only to point out, in distinguishing the Glenshaw case, that it involved the taxation of exemplary damages for fraud and punitive treble damages for antitrust violations.

We hold, upon the foregoing discussion, that petitioners, under the circumstances discussed, realized no taxable income.

Decision will be entered for petitioners.


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