9 T.C. 930">*930 The respondent determined deficiencies in income tax for 1940 in the amounts of $ 21,923.34 against the estate of William H. Foster and $ 1,480.24 against L. Mae Foster. The estate, petitioner in Docket No. 8936, asks that we determine1947 U.S. Tax Ct. LEXIS 38">*39 that there was an overpayment of $ 5,865.89 by the decedent for 1940. The facts are stipulated. The problem is to determine the basis of certain stock sold in 1940.

FINDINGS OF FACT.

The facts are found as stipulated. They are here summarized for the purpose of this opinion.

William H. Foster on December 6, 1922, was the owner of 4,160 shares of the common capital stock of the Foster Machine Co., an Indiana corporation. These shares had a cost basis to him of $ 23,650. Subsequently he acquired other shares and transferred certain shares. In December 1938 he transferred 80 shares by gift to L. Mae Foster, his wife, which shares he had acquired in 1928 at a cost of $ 4,000 or 9 T.C. 930">*931 $ 50 a share. In November 1940 he sold for cash the 2,059 1/2 shares then owned by him for $ 205,950 and L. Mae Foster sold for $ 8,000 in cash the 80 shares then owned by her which she had received as a gift from her husband.

William H. Foster and L. Mae Foster filed separate income tax returns for the year 1940 with the collector of internal revenue at Indianapolis, Indiana. William H. Foster died, testate, on February 8, 1944. The St. Joseph Valley Bank is the duly qualified executor of his1947 U.S. Tax Ct. LEXIS 38">*40 will.

On December 6, 1922, Foster and Carl D. Greenleaf entered into a written agreement concerning the Foster Machine Co. and its common capital stock, which recited in part:

Whereas, for the purpose of inducing Greenleaf to become associated with the Company as a director and in an advisory capacity and of obtaining additional working capital for the Company, Foster is willing to transfer and assign to Greenleaf twenty-one hundred and eighty (2180) shares of said capital stock for the purposes and upon the terms and conditions hereinafter set forth; and

Whereas, Greenleaf is willing to become associated with the Company in an advisory capacity and as a director, and is willing to purchase twenty-one hundred and eighty (2180) shares of the Company's capital stock only on condition that the amount paid therefor by him in cash be payable to the Company and that the amount credited to Greenleaf as hereinafter set forth shall likewise inure to the benefit of the Company, itself, all such payments and credits to be made as hereinafter set forth.

The agreement provided that Foster would transfer 2,180 shares of common stock of the company to a trustee, that Greenleaf would pay certain 1947 U.S. Tax Ct. LEXIS 38">*41 sums to the company, and that the trustee should deliver to Greenleaf certificates of stock upon presentation of receipts for such sums.

While the 1922 agreement between Foster and Greenleaf was in effect, but before any transfer of the shares to Greenleaf pursuant to its provisions had occurred, Greenleaf and Foster entered into a written agreement, dated February 14, 1927, canceling and terminating the prior agreement. The 1927 agreement provided that in payment of the sum of $ 105,000 Greenleaf had paid to Foster Machine Co. pursuant to the 1922 agreement, Greenleaf would accept 1,050 shares of the common stock of Foster Machine Co. owned by Foster, which shares Foster should transfer to Greenleaf.

The $ 105,000 which Foster Machine Co. had received from Greenleaf, pursuant to the provisions of the agreement of December 6, 1922, was credited on its books to its capital surplus account.

The 1927 agreement also provided that Greenleaf should loan to Foster Machine Co. the sum of $ 89,000, which amount, together with the sum of $ 24,000 then owing Greenleaf by Foster Machine Co. and evidenced by its notes, would make a total indebtedness owing Greenleaf by Foster Machine Co. of $ 1947 U.S. Tax Ct. LEXIS 38">*42 113,000; that the notes of the company in 9 T.C. 930">*932 that amount then held by Greenleaf should be canceled and the company should execute to him new notes payable 2 years after date. The agreement also granted to Greenleaf the option, which he might exercise at the expiration of 2 years from the date of the agreement, of purchasing 1,130 shares of the common stock of Foster Machine Co. owned by Foster, certificates for which were to be deposited with an escrow agent upon the execution of the agreement, upon surrendering to the company for cancellation its notes in the sum of $ 113,000. Greenleaf exercised his option on February 14, 1929, and received 1,130 shares of common stock. The company credited on its books to its capital stock account the sum of $ 113,000.

On October 1, 1935, Foster owned 2,348 shares of the 3,315 shares of preferred stock of Foster Machine Co. then issued and outstanding, for which he had paid $ 234,800.

In order to improve the financial position of Foster Machine Co., Foster, Carl D. Greenleaf, and the Foster Machine Co. entered into a written agreement dated October 1, 1935, by which Foster agreed to transfer to the company, as a donation to it, 1,848 shares1947 U.S. Tax Ct. LEXIS 38">*43 of its preferred stock then owned by him, and Greenleaf agreed to purchase 800 shares of such stock from the company for $ 80,000, and to pay the purchase price by surrendering to Foster Machine Co. $ 50,000 par value of the bonds of the company owned by Greenleaf and canceling an indebtedness of $ 30,000 owing Greenleaf by the company.

Pursuant to this agreement, Foster assigned and transferred to the company 1,848 shares of its preferred stock and Greenleaf purchased from the company 800 shares thereof. The 1,048 shares of preferred stock donated to the company by Foster and not sold to Greenleaf were retired and canceled by the company.

Foster did not report for income tax purposes, on any return filed by him from 1922 through 1935, any gain or loss resulting from the transfer to Greenleaf and his nominee on March 16, 1927, of 1,050 shares of common stock of Foster Machine Co., or the transfer to Greenleaf on February 14, 1929, of 1,130 shares of common stock of Foster Machine Co., or the transfer to Foster Machine Co. on October 5, 1935, of 1,848 shares of its preferred stock.

In his returns for 1927, 1928, 1929, and 1935 Foster reported the following income and losses:

1947 U.S. Tax Ct. LEXIS 38">*44 Prior to the transfer of common stock to Carl D. Greenleaf in 1927 and 1929, Foster owned 4,160 shares out of the 5,000 shares of common stock outstanding, or 83.2 per cent, and owned or controlled 4,360 9 T.C. 930">*933 shares, or 87.2 per cent. After the transfers, he owned 2,130 shares, or 42.6 per cent, and owned or controlled 2,360 shares, or 47.2 per cent, and Greenleaf owned or controlled 2,180 shares, or 43.6 per cent.

Prior to the agreement of October 1, 1935, there were outstanding 3,315 shares of $ 100 par value of preferred stock. After the surrender by Foster of 1,848 shares under the terms of the agreement of October 1, 1935, there were outstanding 2,267 shares, of which Foster held 500 shares. In 1940 Foster held 400 shares of preferred stock. In 1941 he acquired additional shares. In 1943 he disposed of all his preferred shares. In all transactions by Foster the preferred stock was bought or sold at its par value of $ 100 per share.

In 1938 Foster made a cash contribution of $ 12,000 to the corporation. At that time he owned 2,976.5 shares of common stock. This contribution increased the basis of the shares sold by Foster in 1940 by $ 8,303.04 and of the shares sold1947 U.S. Tax Ct. LEXIS 38">*45 by L. Mae Foster by $ 322.53.

The following tabulation shows the total shares of common stock of the company outstanding, the number of shares owned by Foster and by others, and the cost of Foster's shares:

The basis of the shares in the hands of Foster and his wife is computed as follows:

1947 U.S. Tax Ct. LEXIS 38">*46 9 T.C. 930">*934 OPINION.

The sole issue here is the computation of the basis of stock sold in 1940. The parties are agreed as to part of the computation. They agree as to the basis of the shares owned by Foster on December 6, 1922, and as to the effect of some of the subsequent additions or transfers. They do not agree as to the effect of the transactions between Foster and Greenleaf upon the basis. The petitioners contend that there should be added to the basis as otherwise determined the amounts of $ 218,000 paid by Greenleaf to the corporation for 2,180 shares of common stock transferred to him by Foster, $ 80,000 for 800 shares of preferred stock transferred by Foster to the corporation and resold to Greenleaf, and $ 46,793.20, being part of the cost to Foster of 1,048 shares of preferred stock transferred by him to the corporation and canceled. The respondent contends that the addition to basis should be only the cost to Foster of the common stock transferred to Greenleaf. The respondent in the deficiency notice determined the basis of the 2,059.5 shares sold by William H. Foster to be $ 35,968.93 and of the 80 shares sold by L. Mae Foster to be $ 4,000, the original cost1947 U.S. Tax Ct. LEXIS 38">*47 of such shares to William H. Foster. The parties now agree that, as a result of a cash contribution of $ 12,000 to the company by Foster, the basis of the shares he sold in 1940 should be increased by $ 8,303.04, and the basis of the shares sold by L. Mae Foster should be increased by $ 322.53. The respondent computes the basis of the 2,059.5 shares sold by W. H. Foster in 1940 as $ 43,271.97, and the basis of the 80 shares sold by L. Mae Foster as $ 4,322.53. The respondent concedes that the estate is entitled to deduct the full loss of $ 10,450 sustained in 1940 when two notes of the Elkhart Real Estate & Housing Corporation, totaling that amount and owned by William H. Foster, became worthless, rather than the loss of $ 5,225 allowed in the deficiency notice.

Generally, a payment by a stockholder to the corporation, made to protect and enhance his existing investment and prevent its loss, is a capital contribution, rather than a deductible loss, and should be added to the basis of his stock. He increases his capital investment and the determination of gain or loss is held in abeyance until disposition of some or all of his stock. First National Bank in Wichita v. Commissioner, 46 Fed. (2d) 283,1947 U.S. Tax Ct. LEXIS 38">*48 affirming W. R. Ranney, 16 B. T. A. 1399; B. Estes Vaughan, 17 B. T. A. 620. On the other hand, when a stockholder surrenders a part of his stock to improve the financial condition of the corporation he sustains a deductible loss, measured by the basis of the stock surrendered, less the resulting improvement in value of the stock retained. Commissioner v. Burdick, 59 Fed. (2d) 395, affirming 20 B. T. A. 742; Julius C. Miller, 45 B. T. A. 292; Peabody Coal Co. v. United States, 8 Fed. Supp. 845.

9 T.C. 930">*935 The petitioners say that, as a result of the transactions between Foster and Greenleaf, Foster's holdings of stock were reduced by 2,180 shares of common and 1,848 shares of preferred, Greenleaf acquired 2,180 shares of common and 800 shares of preferred at a cost to him of $ 298,000, and the company's net worth was increased by $ 402,800. As to the common stock transactions, the petitioners contend that the legal effect is the same as if Foster had received $ 218,000 for the 2,180 shares transferred1947 U.S. Tax Ct. LEXIS 38">*49 to Greenleaf and had then donated this amount to the company. This amount, they say, should be added to the basis of the shares remaining in his hands. They assert that had he not transferred these shares to Greenleaf, he could have sold them in 1940 for an additional $ 218,000. Their argument is that the transactions by which these funds were raised for the corporation amounted to an assessment against Foster's stock, the amount of which should be added to his basis.

The error in the petitioners' theory on this point is in assuming that Foster could have sold the 2,180 shares of common stock to Greenleaf, or anyone else, for $ 218,000 payable unconditionally to Foster. Foster was attempting to procure working capital for the corporation and was willing to surrender part of his control in order to get the necessary funds. Greenleaf was willing to invest in the corporation and to build it up financially in order to preserve and increase the value of the interest he was acquiring. He stipulated for equal control with Foster in the management. He was not interested in buying stock from Foster, as an investment in stock, but in investing in the business in which he was acquiring1947 U.S. Tax Ct. LEXIS 38">*50 equal control. The original agreement called for his payment for the stock "only on condition that the amount paid therefor by him in cash be payable to the company." The 1927 agreement made him a creditor of the corporation as to the $ 113,000 advanced, with the option of accepting stock at par in discharge of the debt. These transactions did not resemble purchases from Foster. Although Greenleaf contributed to the corporation $ 218,000 in exchange for 2,180 shares of common stock, it is obvious that he would not have been willing to pay Foster that amount in an unrestricted sale. Foster, therefore, was never in a position to make a contribution of this $ 218,000 to the capital of the corporation. See W. R. Ranney, supra, and B. Estes Vaughan, supra. Therefore, we can not agree that the legal effect of these transactions is the same as if Foster had sold the stock and had himself contributed the proceeds to the company.

In Commissioner v. Burdick, supra, and Julius C. Miller, supra, the taxpayers surrendered part of their stock to the corporation and1947 U.S. Tax Ct. LEXIS 38">*51 were allowed a loss deduction. In the Miller case the evidence established that the taxpayer, by surrendering part of his stock, enhanced the value 9 T.C. 930">*936 of the shares he retained. The Board concluded that the allowable loss should be measured by the cost of the stock surrendered ($ 20,000), less the amount by which the value of the remaining stock was improved ($ 10,178), and then commented:

The $ 10,178 of the $ 20,000 loss which petitioner claims, which is disallowed for the reasons above stated, will of course be added to the cost basis of petitioner's remaining stock in the shoe company and will be recovered by petitioner when his remaining stock is sold or otherwise disposed of.

Had Foster surrendered 2,180 shares to the corporation and the corporation sold them to Greenleaf at par, it appears that the effect of the whole transaction would be to improve the value of Foster's retained shares to the extent that no deductible loss resulted from that surrender. Thus, in accordance with the principle stated, the entire cost of the surrendered shares should properly be added to the basis of the retained shares.

Taking the facts as they are, the respondent has determined1947 U.S. Tax Ct. LEXIS 38">*52 that Foster made a contribution to capital to the exent of the cost basis of the shares transferred to Greenleaf, and has included such contribution in the basis of the stock sold in 1940. We think this action was correct. Basis is, fundamentally, cost, and the cost of Foster's entire investment in common stock has been allocated by the respondent to the shares he retained. The petitioner's assumption that, if Foster has retained the 2,180 shares he could have sold them in 1940 for $ 218,000 more than he then received, is purely conjectural. It is quite as likely that but for Greenleaf's investment the company might not have survived and Foster's stock might have become worthless many years ago. As to the common stock transactions, we sustain the respondent.

The preferred stock transaction occurred in 1935. Foster then held 2,348 shares out of 3,315 preferred shares outstanding. He surrendered 1,848 shares, retaining 500. Of the surrendered shares, 1,048 shares were canceled, reducing the outstanding total to 2,267. The remaining 800 were transferred to Greenleaf and he paid in $ 80,000 to the company by surrendering bonds of $ 50,000 and canceling indebtedness of $ 30,000. 1947 U.S. Tax Ct. LEXIS 38">*53 The surrendered stock had cost Foster $ 184,800. The petitioners contend that there should be added to the basis of the common stock $ 80,000, the cost of the preferred shares sold to Greenleaf, and 2,232.5/5,000 of $ 104,800, or $ 46,793.20 on account of the canceled shares. This fraction represents the number of shares of common stock then held by Foster divided by the number of shares of common stock then outstanding.

The respondent would deny any addition to basis for the surrender by Foster of preferred stock because the petitioners have not shown how much, if any, of the cost of such stock should be added to the basis of the common stock, pointing out that the starting point in determining 9 T.C. 930">*937 enhancement of remaining stock is net worth, and that the record contains no evidence of the net worth of the company on October 5, 1935.

While we have no balance sheets or similar evidence of the worth of the company in 1935 to show the value of the common stock, we have the facts of certain transfers of stock, both common and preferred. Foster bought preferred stock at par value of $ 100 per share in 1928 and 1929 and again in 1941. On October 1, 1935, he purchased 166 shares1947 U.S. Tax Ct. LEXIS 38">*54 of preferred at par. Greenleaf accepted 800 shares of preferred on October 5, 1935, at par value in exchange for bonds and an open account. Foster paid more than par value for some common stock acquired in 1929. He sold 2,059.5 shares of common in 1940 at $ 100 per share. Greenleaf paid the company par value for the common stock he acquired before 1930. While these circumstances can not be taken as establishing the fair market value of the stock, they do, we think, sufficiently show that the common stock had value in October 1935, prior to the preferred stock transaction. The common shares having value, their worth was enhanced as a result of the elimination of $ 184,800 in obligations and preferred stock having priority over the common stock. This $ 184,800 by which the net worth of the corporation was increased amounts to $ 36.96 per share of the common stock outstanding. Under the facts and circumstances here present and in the absence of better evidence, we are of the opinion that as a result of the preferred stock transaction the value of the common stock outstanding was enhanced by $ 36.96 per share.

When Foster surrendered 1,848 shares of the preferred stock he parted1947 U.S. Tax Ct. LEXIS 38">*55 with property which had cost him $ 184,800. Under the principle of the Burdick and Miller cases, supra, he then sustained a loss which would be ascertained by deducting from the cost of the property surrendered the resulting enhancement in the value of the common stock he then held. The enhancement in the value of the 2,232.5 shares he then owned, at $ 36.96 per share, was $ 82,513.20. This part of the cost of the surrendered preferred stock, which was not allowable as a loss deduction because it inured to the benefit of his own common stock, properly becomes a part of the basis of these common shares to be taken into consideration on their final disposition. He disposed of some of these shares before 1940 and the part of this addition to basis allocable to them went with them. The addition resulting from this transaction allocable to the basis of the 2,059.5 shares sold in 1940, at $ 36.96 per share, was $ 76,119.12. The addition allocable to the 80 shares given to L. Mae Foster and sold by her in 1940 was $ 2,956.80.

Accordingly, we have found that the basis of the shares sold in 1940 includes, in addition to the original cost of such shares and the 9 T.C. 930">*938 stipulated1947 U.S. Tax Ct. LEXIS 38">*56 addition resulting from Foster's contribution of $ 12,000, the cost to Foster of the common shares transferred to Greenleaf and the part of the cost of the preferred stock surrendered in 1935 in excess of the amount deductible as a loss at that time.

Decision will be entered under Rule 50.