49 T.C. 333">*333 1968 U.S. Tax Ct. LEXIS 196">*197 The respondent determined deficiencies in the income tax of Leonard Osrow and Gladys Osrow of $ 7,388.47 for the year 1961 and in the income tax of Harold Osrow and Frances Osrow of $ 7,199 for the year 1961. There are two issues for decision. The first 49 T.C. 333">*334 issue involves a determination of the petitioners' basis in stock that they sold in 1961. The second issue is whether the petitioners realized dividend income as a result of the payment by their wholly owned corporation of expenses attributable to them.

FINDINGS OF FACT

Some of the facts were stipulated, and those facts are so found.

The petitioners Harold Osrow (Harold) and Frances Osrow are husband and wife, and the petitioners Leonard Osrow (Leonard) and Gladys Osrow are husband and wife. The legal residence of all the petitioners was Glen Cove, N.Y., at the time their petitions were filed in this case. They filed their joint Federal income tax returns, using the cash receipts and disbursements method of accounting, for the calendar year 1961 with the district director of internal revenue, Brooklyn District, New York.

Harold and Leonard were both stockholders and officers of Osrow Products Co., Inc. (Osrow Products). 1968 U.S. Tax Ct. LEXIS 196">*198 Harold was president of the company, and Leonard was vice president. Osrow Products was incorporated on December 5, 1952, in the State of New York for the manufacture of automobile- and window-washing equipment and household products.

Harold and Leonard were the sole stockholders of Osrow Products from the date of its incorporation to July 17, 1961. Each had initially made a $ 5,000 capital contribution to Osrow Products in return for which received 10 shares of its common stock. As of the close of Osrow Products' fiscal year ending March 31, 1961, it was indebted to Harold and Leonard in the amounts of $ 25,000 each for loans that they had made to it.

During the year 1960, Osrow Products considered offering some of its stock to the public. It was first thought that some of the proceeds of the public offering could be used to pay the loan obligations to Harold and Leonard.

In November of 1960 or January of 1961, General Securities, Inc. (General), an underwriter, agreed to sell stock of Osrow Products to the public. As a condition of the public offering, General required Harold and Leonard to accept Osrow Products stock in payment of the loan obligations to them. It was contemplated1968 U.S. Tax Ct. LEXIS 196">*199 that Harold and Leonard could then offer part of their holdings of Osrow Products stock to the public as a part of the public offering by the company.

On June 15, 1961, the articles of incorporation of Osrow Products were amended to authorize the company to issue 500,000 shares of $ 0.10 par value common stock in place of the then authorized 200 shares of no-par-value common stock. On June 23, 1961, Harold and Leonard received, respectively, stock certificates numbered 1 and 2 from Osrow 49 T.C. 333">*335 Products, representing the issuance to each of them of 85,900 shares of the new common stock in exchange for their 10 shares each of the old common stock. On the same date, Harold and Leonard also received, respectively, stock certificates numbered 3 and 4 from Osrow Products, representing the issuance to each of them of 5,750 shares of the new common stock in payment of the indebtedness due them by the company.

On July 17, 1961, Harold and Leonard each sold, at a price of 1 cent per share, 5,400 shares from their personally held Osrow Products stock to three of the persons assisting in various capacities in the underwriting.

Before the Osrow Products stock could be sold to the public, 1968 U.S. Tax Ct. LEXIS 196">*200 the company had to obtain the authorization of the Securities and Exchange Commission. An offering circular was approved by the Securities and Exchange Commission on November 21, 1961. Under the terms of the public offering, 60,000 shares of Osrow Products common stock were offered for sale to the general public at $ 5 per share. Of the 60,000 shares, 37,500 were to be sold on behalf of Osrow Products, 11,250 shares were to be sold on behalf of Harold, and 11,250 shares were to be sold on behalf of Leonard.

During the calendar year 1961, 37,500 shares of Osrow Products stock were sold on behalf of the company, and 11,675 shares were sold on behalf of both Harold and Leonard, all at $ 5 per share. Osrow Products paid the entire underwriting expense for the sale of the stock to the public, including the expense for the sale of the 22,500 shares sold in 1961 and 1962 on behalf of Harold and Leonard. The parties agree that the total expense attributable to the sales in 1961 on behalf of Harold and Leonard was $ 5,625.

On November 2, 1961, Harold and Leonard wrote identical letters to General instructing it to sell their respective shares offered in the prospectus in the following1968 U.S. Tax Ct. LEXIS 196">*201 order:

First, you are to dispose of 5,750 shares of Osrow Products Company, Inc. stock that I have acquired on June 19, 1961. Then, and only if they are entirely disposed of, you are to sell for my account 5,500 shares of Osrow Products Company, Inc. that I acquired on April 1, 1953.

On January 8, 1962, Osrow Products stock certificates numbered 3 and 4 were sent to the transfer agent of the company for reissue to purchasers in the public offering. On January 9, 1962, other stock certificates of Osrow Products that had been issued to Harold and Leonard were sent to the transfer agent of the company for reissuance to purchasers in the public offering.

49 T.C. 333">*336 On their respective 1961 Federal income tax returns, Harold and Leonard each reported the following sales of Osrow Products stock:

Each return showed a net taxable gain as a result of these sales of $ 271.49 for 1961.

OPINION

The first issue1968 U.S. Tax Ct. LEXIS 196">*202 in this case is the determination of the petitioners' basis in the 22,474 shares of Osrow Products stock that they sold in 1961. The respondent contends that each share sold had the same basis of $ 0.325. The petitioners contend that 11,500 of the shares sold had a basis of approximately $ 4.35 per share and the remaining 10,974 shares sold had a basis of just under $ 0.06 per share.

The petitioners argue that there were two exchanges -- in one, they exchanged 20 shares of old common stock in Osrow Products for 171,800 shares of new common stock; in the other, they canceled a $ 50,000 debt owed them by the company in exchange for 11,500 shares of new common stock. The petitioners then say that their basis in the 171,800 shares is $ 10,000, the amount paid for the old 20 shares, and their basis in the 11,500 shares is $ 50,000.

On the other hand, the respondent argues that there was only one exchange -- the petitioners canceled their $ 50,000 debt owed them by the company, thus increasing their basis in the 20 shares of old common stock to $ 60,000, and exchanged the 20 shares of old common stock for 183,300 shares of new common stock. The respondent then states that the basis 1968 U.S. Tax Ct. LEXIS 196">*203 of the 183,300 shares is the basis of the old 20 shares, or $ 60,000.

The parties' contentions are thus based on different views of the same events. We do not agree with the respondent's view. The respondent would have us ignore what actually happened. In one transaction, the petitioners exchanged their old stock for 171,800 shares of new stock represented by stock certificates numbered 1 and 2. In the other transaction, they canceled the corporation's obligation to them in exchange for 11,500 shares represented by stock certificates numbered 3 and 4. They instructed the broker to sell first the shares represented by stock certificates numbered 3 and 4, and those certificates were delivered so that the sale of the shares which they represented could be reflected on the corporate books. Thus, the petitioners adequately identified the stock which they received in exchange 49 T.C. 333">*337 for the cancellation of the corporate debt and which was sold first in 1961.

There is no reason for refusing to accept what the petitioners did. Section 1012 of the Internal Revenue Code of 1954 provides that as a general rule, the basis of property shall be the cost of such property. Section 1.1012-1(c), 1968 U.S. Tax Ct. LEXIS 196">*204 Income Tax Regs., then provides generally that where shares of stock are sold which were acquired on different dates or at different prices, and such shares can be identified as to the date purchased and price at which purchased, then the basis of the shares sold is the actual cost of such shares. On the other hand, when the stock sold cannot be adequately identified, its basis is determined by application of a "first-in, first-out" rule to the stock held by the taxpayer. The petitioners thus argue that their exchange of stock for stock and debt for stock resulted in two different "purchase" prices and that the stock sold in 1961 was adequately identified as to the price at which it had been purchased.

We agree with the petitioners that they have adequately identified the stock sold. In addition, we have found as a fact that such stock was acquired in exchange for the cancellation of the debt. This case is similar to a recapitalization in which a shareholder acquires new stock in exchange for old stock acquired at different times and having different bases. In such a situation, it has long been recognized that the tax consequences to a shareholder on a sale of the new stock should1968 U.S. Tax Ct. LEXIS 196">*205 be the same as on a sale of the old stock. Kraus v. Commissioner, 88 F.2d 616 (C.A. 2, 1937), affirming 33 B.T.A. 1088">33 B.T.A. 1088 (1936). In the case before us, the respondent has not even raised a question as to the bona fide nature of the exchange of the 11,500 shares for the cancellation of the debt. Moreover, the petitioners exchanged a debt in the face amount of $ 50,000 for stock which could be sold, as a part of the public offering, for approximately $ 50,000. Accordingly, what they did appears realistic from an economic standpoint. Cf. Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders 98 (2d ed. 1966). We hold that the stock acquired in exchange for the debt has the same basis as the debt.

The respondent also determined that Osrow Products paid an expense of the petitioners and that such a payment constituted a dividend to them. Osrow Products paid the entire underwriting expenses for the public offering of the stock, including the sale of the 22,500 shares on behalf of the petitioners. The parties agree that the total amount of underwriting expenses attributable to the sale of the petitioners' 1968 U.S. Tax Ct. LEXIS 196">*206 shares in 1961 was $ 5,625. The petitioners argue that Osrow Products had to incur the underwriting expenses, whether or not there were also selling stockholders, and therefore the expenses were incurred for the corporation rather than the stockholders.

49 T.C. 333">*338 We are unable to agree with this argument of the petitioners. There is no evidence in the record indicating that Osrow Products would have incurred the same amount of underwriting expenses if only 37,500 shares were sold on behalf of the company. Without this evidence, we cannot find that the payment of all of the expenses benefited the company.

The petitioners also argue that if Osrow Products had not paid all of the underwriting expenses, they would not have received the $ 50,000 owed them by the company. Nevertheless, the question is whether Osrow Products paid the expense of the petitioners, and not whether the petitioners ultimately netted more or less than $ 50,000. Osrow Products' debt to the petitioners was satisfied by issuing them stock worth approximately $ 50,000; any further payment to or on behalf of the petitioners was not a payment of the debt.

Accordingly, since Osrow Products paid an expense on behalf1968 U.S. Tax Ct. LEXIS 196">*207 of its stockholders, the payment was a dividend to the petitioners. Louis H. Zipp, 28 T.C. 314">28 T.C. 314 (1957), affd. 259 F.2d 119 (C.A. 6, 1958).

Decisions will be entered under Rule 50.