Respecting the respondent's act in restoring to petitioner's income the sum of $2,777.34, claimed as a reserve deduction, the petitioner has offered no proof to establish his right to such deduction and respondent's determination is affirmed.

Reviewed by the Board.

Decision will be entered under Rule 50.

WARD AMES, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 49817. Promulgated January 31, 1933.

1. Where there is a bona fide sale of a chose in action (in this case a debt due to the petitioner for money loaned) for a consideration, and the debt is not in fact worthless, the taxpayer sustained a deductible loss in the amount of the difference between the amount of the debt assigned and the amount of the consideration received.

2. In a prior year the taxpayer exchanged a note receivable of one corporation for the cancellation of his indebtedness to another corporation and an account receivable payable in monthly installments, with interest upon the unpaid balance. Of each monthly payment a portion was deemed to constitute interest on the balance of the account then payable and the balance a payment of the principal of the account. In 1928 the petitioner received $24,000 in monthly installments. Held, that the payments received represented in part a realization of taxable income and in part a return of capital and should be taxed accordingly.

Wendell Davis, Esq., Harry LeRoy Jones, Esq., and George B. Francis, Esq., for the petitioner.

George D. Brabson, Esq., for the respondent.

The Commissioner determined a deficiency of $27,766.81 in the petitioner's income tax for 1928. The petition sets forth the following allegations of error:

(a) The respondent erred in refusing to allow the petitioner to deduct for the year 1928 a loss of $221,688.33 arising from the sale of an indebtedness of Evergreen Mining Company in 1928 for $100.

(b) The respondent erred in including $24,000 interest in line 3 of the return and in not allowing in lieu thereof the item of $3,533.61 as such interest, together with $1,634.02 as profit by way of gain in realization of discount.

FINDINGS OF FACT.

The petitioner is a resident of Duluth, Minnesota.

In 1923 the petitioner, D. R. McLennan (trading as the Empire Securities Company), and Robert M. Adams Company, a copartnership (hereinafter for convenience referred to as Adams), formed a syndicate for the development of certain iron ore mining properties, known as the Evergreen properties, in the Cuyuna Range near Duluth, Minnesota. These properties were acquired by the Evergreen Mining Company and the Minnesota Sintering Company, both Delaware corporations. The stock of each company, consisting of 1,000 shares of no par value, was owned as follows:

Ward Ames, Jr----

D. R. McLennan__.

Robert M. Adams Co--

Shares

4272

4272

145

Pursuant to their agreement for the development of the mining properties, the petitioner and his associates made large cash advances by way of loans to the two companies. Between October 1, 1923, and July 1, 1927, petitioner loaned the companies $709,190.17. In the spring of 1927, Adams, being in default of its agreed advances, the petitioner, being unwilling to continue the large advances he was making, and McLennan, wanting to continue the enterprise, entered into a new agreement, which in substance provided that: (1) Adams should be relieved from all further payments; (2) petitioner should make additional payments sufficient to bring his total investment up to $750,722.76; and (3) that the indebtedness of the mining companies to the three contributors should be divided. into various classes in the following order of priority:

Class A-New advances by McLennan

Class B-Preferences to be given McLennan

Class C-Existing advances of the various parties made subsequent to the default of Robert M. Adams Company

Class D-Certain other preferences to McLennan

Class E-Existíng advances of the three parties made prior to the default of Robert M. Adams Company

Simple interest at 6 per cent accrued on each class of indebtedness from specified times.

Pursuant to this agreement, the petitioner and his associates transferred their stock in the Minnesota Sintering Company to the Evergreen Mining Company, which, under the agreement, was thereafter controlled and operated by McLennan. The classified indebtedness referred to above was thereafter carried on its books as an obligation of the Evergreen Mining Company, and the Minnesota Sintering Company was operated as a subsidiary. The classified indebtedness, in its order of preference, was as follows on the dates indicated:

The summarized balance sheet of the Evergreen Mining Company as of December 31, 1927, is as follows:

In the fall of 1927, the petitioner and his associates inspected the Evergreen properties. The overburden had been removed at a cost of nearly $700,000 and the properties were ready for mining operations, the ore then being at the surface. The sintering plant had a capacity of:

Prior to 1928 the production was only 15,000 to 20,000 tons of ore per year. The first big order for ore was received in December, 1927, from the American Radiator Company for 85,000 tons a year for three years. Prior to that time, the plant had not put through enough ore to pay expenses. Operating losses were incurred in 1925, 1926, 1927, and 1928, during which time the development continued by stripping the land, building railroad tracks, and adding to the equipment of the sintering plant. The company made operating profits, before interest charges on the classified indebtedness, in 1929 and 1930. The mining companies met their current obliga

tions in 1927 and 1928 and their credit was good in both years. Neither company had started dissolution proceedings, no receiver had been appointed, no foreclosure proceedings started, no assignment for the benefit of creditors had been made, and neither company was in any way liquidated at the close of 1927. At that time, the estimated ore reserve was sufficient for operations for 40 years. at a production of 200,000 tons per year, which would have been a profitable basis of operation.

In December, 1927, the petitioner sold to John R. Washburn for $500 one half of the Class E indebtedness owed to him by the Evergreen Mining Company and on his income tax return for the taxable year 1927 claimed a loss of $221,288.33 arising from the sale of $221,788.33 of the Class E indebtedness for $500. The Commissioner allowed the claimed deduction.

In December 1928, the petitioner sold the remaining one half of the Class E indebtedness of the Evergreen Mining Company for the sum of $100, and upon his income tax return for the taxable year 1928 claimed a loss of $221,688.33 upon the sale of $221,788.33 of the Class E indebtedness for $100. The Commissioner has disallowed the claimed deduction. In the statement attached to the deficiency notice is the following explanation:

The loss claimed for the year 1928 has been disallowed for the reason that the entire account under the class E indebtedness became worthless in 1927 and the sale of one-half of this account in 1928 for a nominal sum does not have the effect of transferring the right to the deduction from 1927 to 1928.

In each of the taxable years 1927 and 1928, the petitioner reported large gains from the sale of securities.

rugs

Prior to the year 1926 the petitioner, with his business partner, Julius H. Barnes, had promoted the Klearflax Linen Looms Company, a corporation engaged in the development and manufacture of and carpets from flax straw. Up to some date in 1926 the petitioner had advanced to this company $165,819.75, which was on that date represented by a note of the company bearing interest at 6 per cent. Unpaid interest on September 3, 1926, amounted to $50,765.51.

In 1926 the petitioner and Barnes were operating a grain commission business through Barnes-Ames Company and each owned approximately one-half of the capital stock of that company. On September 3, 1926, the petitioner was indebted to the Barnes-Ames Company in the amount of $110,121.18.

A stipulation of the parties reads in part as follows:

On or about September 3, 1926, the petitioner sold the Klearflax Linen Looms Company note to Barnes-Ames Company, receiving in payment therefor the cancellation of petitioner's debit balance on the books of Barnes

Ames Company in the sum of $110,121.18, and an unsecured account receivable against Barnes-Ames Company, in the amount of $106,464.08 bearing interest at 5%, for the balance of the principal and accrued interest on the note, payable to the petitioner $2,000 per month, beginning September 1, 1926, of which payment a portion was deemed to constitute interest on the balance of the account then payable and the balance a payment of the principal of the account.

That for the purpose of settlement of income taxes for the year 1929, the Income Tax Unit and the petitioner have agreed that the value of said unsecured account receivable as of September 3, 1926 was its face amount less a discount of $8,500., and that of a payment of $24,000. made by Barnes-Ames Company to the petitioner in 1929, $2,406.32 represented interest on the balance of the account, $1,719.71 represented realization of the discount, and the balance of $19,873.97 represented a return of the principal and, therefore, did not constitute taxable income. This settlement for the year 1929 was made upon the basis of auditors' computations of the profit of the petitioner on the sale of said Klearflax Linen Looms Company note, which are annexed hereto and marked Exhibits 8 and 9.

For the taxable year 1928 the taxpayer received from Barnes-Ames Company, pursuant to his agreement with it, the sum of $24,000., all of which he included in Item 3 (c) of his income tax return for the year 1928, as interest received upon said note of Klearflax Linen Looms Company. That upon the basis on which the taxes for 1929 were settled the amount received by the petitioner in 1928 as interest from said unsecured account receivable was $3,533.61, and the amount received in realization of discount was $1,634.02. [Sic.]

The petitioner kept no books of account, but reported his income on the basis of cash receipts and disbursements.

OPINION.

SMITH: The first issue is the deductibility of the claimed loss upon the sale of the balance of petitioner's Class E indebtedness in the amount of $221,788.33 for $100. A similar sale was made in 1927, and a similar deduction allowed. The respondent has disallowed the deduction claimed in 1928 on the ground that the debt was worthless in 1927. The bona fides of neither the 1927 nor 1928 sale is questioned, and the fact that the sales were made to offset gains upon the sales of securities does not make the transaction illegal or warrant the disallowance of the claimed deduction if the taxpayer has in fact sustained a loss upon the sale of his assets. Cf. James S. McCandless, 5 B. T. A. 1; George N. Crouse, 26 B. T. A. 477.

The record shows that the mining properties were in the process of development up to and including 1927, that most of the indebtedness was incurred for development purposes, which was largely a matter of stripping the overburden of soil from the ore, which then being exposed could be mined more easily and economically. The company had spent nearly $700,000 in this development and its