Before CLARK, Chief Judge, and HINCKS and LUMBARD, Circuit Judges.
These are appeals from a decision of the Tax Court, 23 T.C. 756, involving alleged income tax deficiencies in excess of $3,000,000 for the years 1948 and 1949. These eleven cases, all involving distributions to various members of the Gross and Morton families, who were common stockholders of certain building corporations, were consolidated both in the Tax Court and for review here. The facts as stipulated by the parties and found by the Tax Court may be summarized as follows:
Alfred Gross, George Gross, and Lawrence Morton were experienced builders who collaborated in the construction of several housing projects. The first such project, located in Baltimore County, Maryland, and completed in 1944, was operated through four Maryland corporations - First Mars Homes, Inc., Second Mars Homes, Inc., Third Mars Homes, Inc., and Fourth Mars Homes, Inc. - which were controlled by these three men and their families. The project was financed through mortgages insured by the Federal Housing Administration (FHA).
The next project developed by the taxpayers was Glen Oaks Village, located in Queens County, New York, and constructed in two parts. Part I, consisting of 576 apartments covering about 25 acres, was erected by Glen Oaks Village, Inc., a New York corporation organized on April 8, 1947, and controlled by the Gross and Morton families. Glen Oaks Village, Inc. rented the land from the Permanent Land Corporation, also controlled by the Gross and Morton families, for an initial term of 50 years at a rental equal to 4 percent of the land value as appraised by the FHA. Temporary financing was obtained under a building loan agreement with the Bank of Mahattan Company; and the resulting mortgage, which finally totaled $4,652,000, was fully insured by the FHA. Upon completion of the project in 1948, the mortgage was taken over by the Prudential Insurance Company of America, which paid a premium of 31/2 per cent of the principal amount of the mortgage to Glen Oaks Village, Inc.
Simultaneously with the development of Part I of Glen Oaks Village, another corporation, Seton Realty Corporation, was organized to develop a shopping center. In 1948 and 1949 this corporation and the Permanent Land Corporation, which owned the land for Part I of Glen Oaks Village, borrowed substantial sums from insurance companies, secured by mortgages on their realty. These corporations had no mortgages insured by the FHA.
Part II of Glen Oaks Village, consisting of 2,352 apartments covering approximately 100 acres, was constructed in a manner substantially similar to Part I. In order to facilitate financing and because the FHA was allowed to insure mortgages only up to $5,000,000 while the cost of Part II was expected to approach $20,000,000, Part II was constructed through ten separate corporations. Again two Gross-Morton corporations which owned the land conveyed separate parcels of realty to Permanent Land Corporations :2, :3, :4, :6, :7, :9, :11, :12, :13, and :15. Each of these corporations gave a lease on its realty to a correspondingly numbered Glen Oaks Village Corporation, and each Glen Oaks Village Corporation secured temporary financing from the Bank of Manhattan Company and permanent financing from the Prudential Insurance Company or (in the case of Corporations :12, :13, and :15) from the New York State Employees' Retirement System. Each mortgage was fully insured by the FHA.
On October 19, 1949 each of the Permanent Land Corporations executed bonds secured by first mortgages on its land in favor of the Teachers Insurance and Annuity Association of America and received mortgage proceeds. The Permanent Land Corporations had no mortgages insured by the FHA.
Glen Oaks Shopping Center, Inc., is a New York corporation organized in 1948 to develop a shopping center for Part II of Glen Oaks Village. It had no transactions with the FHA.
George Gross, the president, Alfred Gross, the secretary, and Lawrence Morton, the treasurer, of each of the Glen Oaks Village and Permanent Land Corporations, directed the planning, financing, and building of Glen Oaks Village. None of the three devoted his entire time to the project. None of them received salaries from any of these corporations during 1948 or 1949. In 1950 each received compensation of $25,000 from Glen Oaks Shopping Center, Inc.
In 1948 and 1949 the four Mars Home Corporations, the eleven Glen Oaks Village and eleven Permanent Land Corporations, and the Seton Realty Corporation, made pro-rata cash distributions in excess of $6,000,000 to their common stockholders, the eleven members of the Gross and Morton families here concerned.*fn1 Prior to making these distributions each of the corporations wrote up on its books the value of its real estate by an amount equal to or in excess of its distribution. The amounts of the write-ups were credited to a "Surplus Arising from Realty Appreciation."
To the very substantial extent that these distributions were not out of normal earnings and profits of the corporations they came from the following sources:
In the case of the four Mars Home Corporations, from cash resulting from the build-up of depreciation reserves. In the case of the eleven Permanent Land Corporations, from mortgage moneys, i.e., moneys borrowed by the corporations secured by mortgages on their land. In the case of the eleven Glen Oaks Village Corporations and Seton Realty Corporation, from (1) current gross rentals from tenants, (2) premiums received on bonds issued by the corporations to Prudential Insurance Company and New York State Employees' Retirement System, and (3) the excess of moneys borrowed for construction purposes, secured by FHA-insured mortgages, over the cost of construction.
The reasons for the surplus of mortgage moneys received by each of the Glen Oaks Village operating companies over the cost of construction and development were set forth in the following letter of October 27, 1949, from Glen Oaks Village, ...