1950 U.S. Tax Ct. LEXIS 163">*164 14 T.C. 1221">*1222 This proceeding involves deficiencies in Federal taxes for 1942 as follows:

The deficiencies involved arise from respondent's determination that a loss on construction guarantees claimed by petitioner for 1942 is a capital loss and is not deductible as an ordinary loss as claimed by petitioner.

FINDINGS OF FACT.

The petitioner was incorporated under the laws of the State of Missouri on January 6, 1926, as "Mechin & Voyce Title Company." Later the name was changed to "Ralph C. Becker, Inc.," and then in 1937 to the present name, "Lawyers Title Company of Missouri." Petitioner's principal place of business is in St. Louis, Missouri. Its corporation income, declared value excess profits, and excess profits tax returns for 1942 were filed with the collector of internal revenue for the first district of Missouri.

Petitioner's articles of agreement provided that1950 U.S. Tax Ct. LEXIS 163">*165 it was formed for the following purposes:

To examine, certify and guarantee title to real estate; to make abstracts of public records, documents and files, and to do and perform all other acts which pertain to the transaction of the business of examining, certifying and guaranteeing title to real estate; to own, hold, rent, lease, manage, encumber, improve, exchange, buy and sell real property, collect rents and do a general real estate business; and in general to have and exercise all powers, rights and privileges necessary and incident to carrying out properly the objects above mentioned.

On its tax returns for 1942 petitioner described its business as "Title Examination and Title Insurance on Real Property." Its business activities included acting as escrow agent on construction loans and guaranteeing to lending institutions the completion of construction projects in accordance with specifications, and the issuance of title insurance on deeds of trust held by the lending institutions to secure their first liens.

During the latter part of 1941 and the fore part of 1942 the petitioner entered into thirty-six separate escrow contracts involving construction loans on properties in1950 U.S. Tax Ct. LEXIS 163">*166 Rolla, Missouri. In all of these contracts, which were identical as to the obligations of the parties except for the amounts involved in connection with each of the individual 14 T.C. 1221">*1223 properties, the Huff Construction Co. was designated the contractor; Neal E. Huff, Mabel T. Huff, Raymond S. Huff, and Alice B. Huff were designated the owners, and petitioner was designated the escrowee. The Homesteaders Life Association was designated the mortgagee in ten of the contracts, the Laclede Bond & Mortgage Co. in sixteen, and the Investors Syndicate in ten.

In each of the contracts the contractor agreed to build and fully complete the improvements for a specified sum and according to specifications held by petitioner as escrowee, with all claims for labor and materials paid, and free and clear of all liens; to furnish escrowee the names of all subcontractors and material companies, with the amounts of their contracts or estimates and with the amount of the contractor's anticipated profit; and not to authorize payments for labor and materials in excess of estimated cost or until the labor and materials had become incorporated in the construction of the improvements.

The owners agreed1950 U.S. Tax Ct. LEXIS 163">*167 to deposit with the escrowee funds necessary to complete the improvements; to execute and deliver all necessary deeds of trust or mortgages for notes for the account of the mortgagee; to deposit all payments accruing on the deeds of trust during construction; to supply all necessary funds and to complete the improvements should the contractor fail to complete the improvements in accordance with the terms of the escrow agreement; and to pay any deficit remaining after all costs of the improvements and escrow had been distributed.

The mortgage agreed to lend a specified amount to the owners and to pay the funds as requested to the escrowee for the account of the owners, accepting therefor notes secured by first deeds of trust on the property.

The escrowee agreed to examine title to the properties and to issue interim title insurance binders to the mortgagee, showing title defects to be cured; to issue policies of title insurance after completion of construction without exceptions as to mechanics' and materialmen's liens; and to accept and disburse funds in accordance with the contract. The escrow contracts all specifically provided that:

Escrowee does not undertake to assume or guarantee1950 U.S. Tax Ct. LEXIS 163">*168 to the Owner or Contractor the completion of said improvements, the obligation to complete the same being wholly that of the Owner and Contractor, in accordance with all the terms and conditions hereof.

At the time the escrow agreements, notes, and deeds of trust were executed, the Huffs executed and delivered a quitclaim deed on each of the thirty-six properties to petitioner's nominee to protect petitioner, as escrowee, against loss from any default by the Huff Construction Co. as contractor or the Huffs individually as owners. A 14 T.C. 1221">*1224 bill of sale covering materials to be used in the construction of the houses was executed and delivered by the contractor to petitioner, as trustee for itself and the mortgagees, authorizing the petitioner to reimburse itself and the mortgagees for any accounts due from the contractor under the contracts by selling the materials free of any contractor's lien.

As funds were received from the mortgagees by the petitioner as escrowee under the contracts, petitioner issued its receipts therefor. A typical receipt letter provided as follows:

We acknowledge receipt of the sum of $ 2,500.00 being the 1st disbursement on the above loan.

Lawyers Title1950 U.S. Tax Ct. LEXIS 163">*169 Company of Missouri, on behalf of the Lawyers Title Insurance Corporation of Richmond, Virginia, hereby insures Laclede Bond & Mortgage Company against loss by reason of possible unfiled mechanics' and materialmen's liens in the amount of $ 2,500.00.

Lawyers Title Company of Missouri further guarantees that at all times during the course of construction of the improvements to be erected, there will be sufficient funds in the loan account to complete such improvements.

Lawyers Title Company of Missouri further agrees to complete the building in accordance with approved plans and specifications, subject to minor changes thereof approved by owner, contractor, and mortgagee or mortgagee's duly appointed representative.

The guarantees outlined in the preceding two paragraphs shall be subject to governmental priorities and regulations covering material or labor, the nondelivery of which would affect or delay the completion of the improvements.

Separate ledger accounts were set up for each escrow agreement and the funds received thereon were deposited in an escrow bank account, which was separate from the general bank account of the petitioner.

On July 2, 1942, petitioner was informed 1950 U.S. Tax Ct. LEXIS 163">*170 that the contractor and owners had abandoned the Rolla project. On July 6, 1942, the petitioner received a letter from the Huffs confirming their abandonment of the project. When petitioner first learned that the Huffs had abandoned the project, some of petitioner's employees and an attorney immediately went to Rolla. The only assets of the Huffs which petitioner's employees could find were some personal property and equipment left on the project. Petitioner's employees investigated the records of the project properties and found that the Huffs had not disposed of any of them, with the exception of one completed house which had been sold earlier. On about July 6, 1942, petitioner recorded its thirty-five quitclaim deeds and in the name of its nominee took title to the thirty-five unsold properties remaining in the project.

On July 6, 1942, the status of the escrow account with respect to the thirty-six properties was as follows: 14 T.C. 1221">*1225

When petitioner1950 U.S. Tax Ct. LEXIS 163">*172 took title to the properties, ten of the houses had been completed. One of these had been sold and four or five were being rented. One of the remaining twenty-six properties was never improved and was later deeded back to the seller for no consideration. ¹ The other twenty-five houses were in various stages of construction and were all completed in 1942. Petitioner induced the subcontractors to complete their contracts which had been made with the Huffs and proceeded to complete the construction of the houses.

Petitioner attempted to rent some of the completed houses through real estate agents in Rolla and succeeded in renting three or four 14 T.C. 1221">*1226 additional houses. Demand in Rolla appeared to be for furnished rental houses, but petitioner was unwilling to go to the expense of furnishing the houses and so was unable to rent more of them. Attempts were made to sell the houses as individual units as they were completed. Five houses were sold in this way to individuals1950 U.S. Tax Ct. LEXIS 163">*173 who took them subject to the mortgages. Petitioner received a total of $ 1,532.43 for the five houses and credited that amount to the control account of the Laclede Bond & Mortgage Co. A total of $ 2,082.07 was received from rentals between July and December, 1942. Charges for loan payments and other miscellaneous items were made against the rental accounts. The rental account adjusted balances were appropriately credited or charged to the control account of the Laclede Bond & Mortgage Co.

In November, 1942, it was determined that the remaining twenty-nine houses should be sold as a unit. They were sold on December 11, 1942, to Robert E. Park for $ 4,000, in addition to his assumption of the deeds of trust thereon. The $ 4,000 received was credited to the control account of the Laclede Bond & Mortgage Co.

During 1942 the petitioner had no license from the city or county of St. Louis, Missouri, or from the city of Rolla or Phelps County, Missouri, in which Rolla is located, to engage in the real estate business. It did not have a real estate department in 1942, and it neither acquired nor sold any real estate other than the Rolla properties in that year.

In its income tax return1950 U.S. Tax Ct. LEXIS 163">*174 for 1942 petitioner claimed, among other deductions, an item described as "Loss -- Construction Guarantees $ 36,444.40." Respondent disallowed $ 25,912 of this amount on the ground that:

* * * the loss on so-called construction guarantees, claimed for the year 1942 in the amount of $ 25,912.00, is a capital loss as defined in Section 117 (a) of the Internal Revenue Code no part of which is deductible for income tax purposes under the limitations provided by Section 117 (d) (1) of the Code.

Petitioner's loss on the Rolla project in 1942 was $ 22,725.61. There is no evidence to account for the difference of $ 3,186.39 between that amount and the amount disallowed by respondent. There is no evidence that petitioner realized any capital gains in 1942.

Petitioner did not pay out any money in 1942 on account of losses on title insurance or any construction guarantee. The loss which it incurred on the Rolla project was a loss sustained upon the sale of properties held primarily for sale to customers in the ordinary course of its business.

OPINION.

The question presented for our determination is whether a loss of $ 22,725.61 sustained by petitioner upon the sale of 14 T.C. 1221">*1227 real property1950 U.S. Tax Ct. LEXIS 163">*175 in 1942 is deductible by petitioner as an ordinary loss or as a business expense, or whether it is a loss upon the sale of capital assets as defined in section 117 (a) (1), Internal Revenue Code, ²1950 U.S. Tax Ct. LEXIS 163">*176 no part of which is deductible under the limitations of section 117 (d) (1), Internal Revenue Code. ³

Petitioner contends that the properties upon which it sustained the loss are specifically excluded from the definition of capital assets by section 117 (a) (1) as either "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business" or as "property, used in the trade or business, of a character which is subject to the allowance for depreciation." There is no question that the Rolla properties were properties "held" by petitioner, although it did not purchase them. Richards v. Commissioner, 81 Fed. (2d) 369, but "The section * * * must be construed precisely as written and unless the particular property in question was held by petitioner 'primarily for sale to customers in the ordinary course of * * * [its] trade or business' the loss is limited as provided in section 117 (d)." Thompson Lumber Co., 43 B. T. A. 726.1950 U.S. Tax Ct. LEXIS 163">*177

The question of whether the properties were held by petitioner primarily for sale to customers in the ordinary course of its business is primarily a question of fact. Its determination must depend upon a consideration of all the factors and circumstances surrounding the entire transaction in relation to the conduct of petitioner's business in 1942. Guthrie v. Jones, 72 Fed. Supp. 784; Boomhower v. United States, 74 Fed. Supp. 997.

The petitioner originally became involved with the Rolla project in connection with its business of examining and insuring titles to real estate and acting as escrowee between lending institutions and builders. As petitioner received funds from the mortgagees for use in the development it insured the mortgagees against loss on account of unfiled mechanics' and materialmen's liens in the amount advanced and guaranteed completion of the buildings. When the Huffs abandoned the project, petitioner was faced with the choice of either liquidating the properties in their incompleted state and bearing the 14 T.C. 1221">*1228 loss on its guarantee to the mortgagees, or of taking over the properties 1950 U.S. Tax Ct. LEXIS 163">*178 and completing them in the hope of reducing or avoiding the anticipated loss upon their ultimate disposition. That petitioner anticipated such a possibility when it originally contracted to act as escrowee between the mortgagees and the Huffs is evidenced by the precautionary measures it took at that time.

Upon a full consideration of all the facts and circumstances surrounding petitioner's activity in relation to the Rolla project, we are convinced that the properties came into petitioner's possession as a necessary incident to the conduct of its business and that they were held and completed primarily for sale to customers in the ordinary course of its business. Joe B. Fortson, 47 B. T. A. 158. The fact that petitioner had not had occasion to follow this course of action before (so far as our record shows) does not prevent its being in the ordinary course of petitioner's business in the light of the surrounding circumstances. Welch v. Helvering, 290 U.S. 111">290 U.S. 111.

In any event, we think it is clear that the petitioner's activity in relation to the Rolla properties after it took title to them amounted to engaging in the1950 U.S. Tax Ct. LEXIS 163">*179 real estate business. The facts that petitioner had no license to engage in the real estate business and that it apparently had not done so in the past are not determinative of the question of whether petitioner entered the real estate business when it acquired these properties. It took title to the properties, supervised the completion of construction, rented some of the houses, and ultimately sold them all. Petitioner did not merely hold the property for sale as an investment when it acquired them. It actively engaged in improving and completing them, in the meantime deriving such revenue from them as it could until it managed to complete and sell them to such purchasers as it could find. We conclude that petitioner was engaged in the real estate business in the fullest sense from the time it acquired the Rolla properties. Cf. Snell v. Commissioner, 97 Fed. (2d) 891; Ehrman v. Commissioner, 120 Fed. (2d) 607; certiorari denied, 314 U.S. 668">314 U.S. 668. The loss sustained in the amount of $ 22,725.61 upon the sale of the properties was an ordinary loss upon the sale of properties held primarily1950 U.S. Tax Ct. LEXIS 163">*180 for sale to customers in the ordinary course of petitioner's business.

Thompson Lumber Co., supra, upon which respondent's arguments depend heavily, is not applicable to this case, since it is clearly distinguishable upon its facts. We found in that case that the taxpayer lumber company foreclosed on real estate to recover the cost of lumber and materials furnished by it in the course of its lumber business. It did nothing with the properties so acquired other than to list them for sale with real estate agents, and could not be considered to be engaged in the real estate business to any extent.

14 T.C. 1221">*1229 Petitioner claimed a total deduction on its returns for 1942 of $ 36,444.40 for losses on construction guarantees. Of that amount, respondent disallowed $ 25,912. Petitioner has offered no evidence to explain or support the deductibility of any amount in excess of the $ 22,725.61 lost on the Rolla project. Since petitioner has failed to bear its burden of proof with regard to the amount of $ 3,186.39 difference between the amount shown to have been lost on the Rolla project and the amount disallowed by respondent, respondent's disallowance of that1950 U.S. Tax Ct. LEXIS 163">*181 difference is sustained.

Decision will be entered under Rule 50.