The opinion of the court was delivered by: SUGARMAN
Plaintiffs sue for the recovery of income taxes claimed to have been erroneously assessed and collected. The refunds claimed are $ 5,603.79, $ 12,808.02, $ 8,184.70 and $ 21,235.12, taxes paid on income earned in the years 1941, 1943, 1944 and 1945.
The issue here is whether certain moneys received by plaintiff Marie P. Campagna were ordinary income or capital gains. The income was paid on a bond secured by a purchase money second mortgage covering a certain building on the corner of West 42nd Street and Seventh Avenue, New York City, and also covering the leasehold estate in the land on which the building was erected.
The parties have stipulated that:
'1. This is an action based upon the laws of Congress and is for the recovery of income taxes in excess of $ 10,000.00 assessed and collected by a Collector of Internal Revenue for the Third District of New York, for the United States, who is not now in office as Collector of Internal Revenue. The jurisdiction of this Court is based upon Title 28, United States Code, Section 1346(a)(1).
'2. The plaintiffs are husband and wife and reside at 600 West 249th Street, Riverdale, Bronx, in the State of New York.
'3. On October 8, 1934 Rialto Times Square, Inc., a New York corporation, hereinafter referred to as Rialto, was organized for the purpose of constructing and operating a building. At all times pertinent hereto, plaintiff Anthony Campagna was the president of said corporation.
'4. On October 3, 1934 Rialto leased from The Gerry Estates, Inc. the premises known as 201-203 West 42nd Street and 1481-3 Broadway, New York City, which premises occupied the northwest corner of 7th Avenue and 42nd Street. Said lease commenced on November 1, 1934, expired on October 31, 1955, and contained two twenty year renewal options. The rentals were as follows:
First 5 Years $75,000 per year
Second 5 Years $85,000 per year
Third 5 Years $95,000 per year
Last 6 Years $105,000 per year
Renewal rentals were 5% of net appraisal value, but not less than $ 105,000 per year. In addition, there was payable each year an additional rent equal to 20% of the amount by which Rialto's gross rentals exceeded $ 500,000.
'5. In 1937 and 1938, the land was assessed for $ 2,750,000 and $ 2,800,000 respectively.
'6. During the period 1934-1935, Rialto constructed a four story commercial building on the aforementioned premises at a cost of $ 511,019.61.
'7. In 1937 and 1938, the building was assessed for $ 250,000 and $ 450,000 respectively.
'8. On December 1, 1935 Rialto mortgaged to The Chase National Bank of the City of New York, as Trustee, the aforementioned building and its leasehold interest in the land. This mortgage was in the principal amount of $ 185,000, and was secured by 5 1/2% Serial Mortgage Bonds, which bonds were issued in twenty series. The first ten bonds were in the principal amount of $ 12,500 each, and the second ten bonds were in the principal amount of $ 6,000 each. The bonds were to mature one at a time at six month intervals commencing June 1, 1936. Interest at 5 1/2% was payable semiannually.
'9. On June 30, 1937, Rialto sold its building and assigned its leasehold interest in the premises to The 1481 Broadway Corporation for a total consideration of $ 1,049,369.00. This sum was composed of the following elements: Cash -- $ 389,369.00; Assumption of balance due on first mortgage -- $ 153,131.00; Second Purchase Money Mortgage -- $ 506,869.00.
'10. This second mortgage, a copy of which is annexed to the complaint, was for a term of eleven years, and payable at the rate of $ 5,000 per month including 5% interest.
'11. In 1937 when Rialto sold its building and leasehold interest to The 1481 Broadway Corporation, it reported in its 1937 income tax return a gain on this transaction of $ 159,498.10.
'12. Said gain was computed as follows:
Assumption of First Mortgage $153,131.00
Second Purchase Money Mortgage $506,869.00
Total Sale Price $1,049,369.00
Cost of Building $511,019.61
Less Depreciation $ 38,648.52 $472,371.09
Legal Fees Deferred $ 9,163.69
Leasing Commission Deferred $ 14,489.78
Discount of Second Mortgage
Bal. due 12/31/37 $492,307.93
Less 20% $ 98,461.59 $393,846.34 $889,870.90
'13. From January 1, 1938 until its dissolution on September 30, 1938, Rialto reported 80% of its principal collections and 100% of its interest collections with respect to the second mortgage as ordinary income.
'14. On September 30, 1938, the plaintiff Marie P. Campagna owned 70% of the stock of Rialto.
'15. On September 30, 1938 Rialto was liquidated. Among other things, it distributed in liquidation the aforesaid second mortgage. Plaintiff Marie P. Campagna received a 70% interest in this mortgage as a result of the liquidation.
'16. The unpaid balance of the second mortgage at the time of liquidation was $ 465,322.85. Plaintiff Marie. P. Campagna's 70% interest had a face value of $ 325,726.00.
'17. Plaintiff Marie P. Campagna had a zero (0) basis for her stock in Rialto.
'18. After Rialto was dissolved, an individual was designated to receive the payments with respect to the second mortgage, and to distribute the moneys so received to the owners of the mortgage according to their respective interests.
'For the period January 1, 1939 to December 31, 1939, said individual received $ 38,059.24 principal on the mortgage, $ 21,940.76 interest on the mortgage, and incurred expenses of $ 2,782.09. Plaintiff Marie P. Campagna was entitled to receive 70% of the principal and interest payments and to deduct 70% of the expenses. In reporting her income for the year 1939, Marie P. Campagna excluded 20% of the share of the principal which she received, and reported the balance of the principal, plus her share of the interest, less her share of the expenses as a capital gain.
'For the period January 1, 1940 to December 31, 1940, said individual received $ 40,006.46 principal, $ 19,993.54 interest and incurred expenses of $ 760.05. In reporting her income for the year 1940, Marie P. Campagna excluded 20% of her share of the principal and reported the balance of her share of the principal ...