36 T.C. 22">*22 The respondent determined deficiencies in income tax against the petitioners for the calendar year 1950 as follows:

1961 U.S. Tax Ct. LEXIS 178">*180 The issues for decision are whether, under section 117(m) of the Internal Revenue Code of 1939, the gains realized by petitioners 36 T.C. 22">*23 upon distributions or payments received by them from two corporations and upon the sale of their stock in those corporations in 1950 are to be considered as gain from the sale or exchange of property which is not a capital asset, or, in the alternative, whether the distributions or payments are taxable as compensation under section 22(a). The petitioners have also taken the position that the respondent, by amended answer, has pleaded new matter and for that reason has the burden of proof with respect to the issue under section 117(m).

FINDINGS OF FACT.

Some of the facts and a substantial amount of evidence have been stipulated.

Benjamin Braunstein and Diana Braunstein are husband and wife, and residents of Flushing, New York. Benjamin Neisloss and Julia Neisloss were husband and wife and residents of Forest Hills, New York, during the period here pertinent. Harry Neisloss and Lillian Neisloss are husband and wife, and also residents of Forest Hills. The respective husbands and wives filed joint income tax returns for the taxable year 1950 with1961 U.S. Tax Ct. LEXIS 178">*181 the collector of internal revenue for the first district of New York. The husbands are sometimes hereafter referred to as the petitioners.

Benjamin and Harry Neisloss were brothers and were active in various real estate enterprises from 1919. During the 1920's they, as individuals or through corporate organizations, built and sold one-family homes on Long Island, engaged in construction work for others, purchased several parcels of land for development, and acquired and improved commercial property which was disposed of in 1929.

During the 1930's the Neisloss brothers organized and operated Benhar Holding Corporation, Lawrence Homes, Inc., and Hillburn Holding Corporation, in which they were equal stockholders. The Benhar Holding Corporation built garden-type apartment homes in 1930 and 1931. The brothers sold their stock in that corporation in 1946. The Lawrence Village Homes, Inc., built and sold about 100 houses between 1936 and 1938, constructed a business building as a contractor, and was liquidated about 1939. The Hillburn Holding Corporation built a row of stores in 1938, and the Neisloss brothers sold their stock in that corporation in 1948.

Benjamin Braunstein is an1961 U.S. Tax Ct. LEXIS 178">*182 architect, who met the Neisloss brothers in 1930, when he designed the garden apartments of the Benhar Holding Corporation. In 1938 Braunstein and the Neisloss brothers organized and were equal stockholders of the Henshire Holding Corporation, which erected a large apartment house, sold the property in 1941, and was dissolved. In 1938 they organized Weeks-Woodlands, 36 T.C. 22">*24 Inc., which built and sold about 100 houses, reported its profits as ordinary income, and was liquidated after the houses were sold.

Beginning in 1943, the three petitioners organized and were equal stockholders in seven corporations, which constructed multiple-dwelling garden-type apartments located in New Jersey and in New York and financed under section 608 of the National Housing Act. After the passage of varying periods of time up to 10 years from the dates of completion of these projects, petitioners sold their stock therein. The corporate names of the projects, the years of completion, and the years the stock was sold were as follows:

1961 U.S. Tax Ct. LEXIS 178">*183 The sales were solicited by brokers acting on behalf of the buyers. The 1953 sale of stock in the four corporations was in one transaction. The 1950 sale of stock in the two corporations was in one transaction. The petitioners reported their profits on the 1949, 1950, and 1953 sales as capital gains.

Both the Springfield and Hill projects were constructed on land located in Bayside, Queens County, New York. On April 23 and May 15, 1947, Benjamin Neisloss had entered into contracts with the Queens Valley Development Corporation and Marshall Affiliated, Inc., for the purchase of a tract of land located in Bayside, with a view to the construction of multiple dwellings under section 608 of the National Housing Act. The National Housing Act is and was administered by the Federal Housing Administration, sometimes hereafter referred to as FHA. Under the contracts to purchase, Neisloss had reserved the right to terminate the contracts and secure a refund of deposits, without further liability, in the event the FHA did not make to the purchaser a satisfactory mortgage insurance commitment under section 608.

The FHA forms for applying for mortgage insurance were in two parts. Part I1961 U.S. Tax Ct. LEXIS 178">*184 was for execution by the proposed mortgagee, and part II by the proposed mortgagor. In part I, space was provided for showing the principal amount of the mortgage sought to be insured, the rate of interest, and terms of payment. Part II, being the proposed mortgagor's application, was set up to reflect data on which the application was based. Exhibits showing the description and ownership of the property, zoning requirements, and architectural 36 T.C. 22">*25 plans were to be attached. In one portion of the application the proposed mortgagor was required to give a statement of its resources, the amount of cash working capital, and its estimates of costs of construction, interest, taxes on real estate, and the cost of insurance for the period of construction, title and recording expense, and organization expense. It was specified that organization expense was to include only reasonable expenses not otherwise classified and properly incurred during the organization of the project. The resources to be listed were the amounts represented by land, cash, other equity, and mortgage loan proceeds. The item designated as "cash working capital" was not to be "part of the mortgage security," 1961 U.S. Tax Ct. LEXIS 178">*185 and in amount was to be not less than 1 1/2 percent of the amount of the proposed mortgage. It was to be deposited with the mortgagee to meet the cost of equipping and renting subsequent to completion of construction of the entire project or for certain nonconstruction costs during construction, with any unused balance to be returned to the mortgagor. The form also called for an estimated annual operating statement for the project when completed, to reflect anticipated income, operating expenses, taxes, fixed charges including debt service requirements, and the assumed percentage of vacancies.

In addition, the form included schedules A, B, C, D, and E. Schedule A was entitled "Sources of Equity," and was designed to show the names of the equity participants and to reflect in dollars the cash, land, and "Other Equity" of each participant. Under "Other Equity," both the amount and "Nature" were to be shown, and under "Nature" the "source of the amount such as 'Builder's fee,' 'Architect's fee'" was to be indicated. Schedule B did not relate to new construction. Schedule C was designed to reflect equipment furnished tenants and services included in rent. Schedule D was to reflect1961 U.S. Tax Ct. LEXIS 178">*186 the applicant's estimate of annual operating expense, and schedule E the estimate of rentals.

On June 19, 1947, two applications naming the Trust Company of New Jersey as the proposed mortgagee, Benjamin and Harry Neisloss as sponsors, and Benjamin Braunstein as architect were filed with the FHA for mortgage loan insurance under section 608. In one application the proposed mortgagor was shown as a corporation to be formed under the name of Oakland Gardens, Inc., Sections 2 and 3, and the project was to consist of 480 family units with 1,940 rooms and 302 garages. The total estimated requirements were shown as $ 4,109,664 and the amount of mortgage loan insurance requested was $ 3,670,000. The gross income expectancy was estimated at $ 542,758 and the income, net after operating expenses and fixed charges which included debt service requirements, was estimated at $ 41,529. In the other application the proposed mortgagor was shown as a corporation to be formed under the name of Oakland Gardens, Inc., 36 T.C. 22">*26 Section 4, and was to consist of 224 family units with 904 rooms and 116 garages. The total estimated requirements were shown as $ 1,904,001 and the requested mortgage loan1961 U.S. Tax Ct. LEXIS 178">*187 insurance was for $ 1,702,000. The gross income expectancy was shown as $ 251,172.48 and the income, net after operating expenses and fixed charges, which included debt service requirements, was estimated at $ 18,241.78. The land on which the two projects were to be constructed was land covered by the contracts to purchase entered into by Benjamin Neisloss April 23 and May 15, 1947, with the Queens Valley Development Corporation and Marshall Affiliated, Inc. The applications, however, did not show any amount as representing land but described the land as a leasehold and under fixed charges in the "Estimated Annual Operating Statement," $ 20,000 and $ 9,050 were shown as leasehold rent for the two projects. The amounts shown by the applications as costs for construction represented the estimates of the three petitioners based on the current cost of labor, materials, plumbing, heating, and the like.

The FHA made a project analysis of each application and on October 14, 1947, issued two commitments for mortgage loan insurance. For Oakland Gardens, Inc., Sections 2 and 3, the total estimated cost was $ 4,097,744, and the amount of mortgage loan insurance $ 3,647,500. The gross income1961 U.S. Tax Ct. LEXIS 178">*188 expectancy was estimated at $ 512,422 and the income, net after operating expenses and fixed charges, including debt service requirements, at $ 45,625. For Oakland Gardens, Inc., Section 4, the total estimated requirements were $ 1,911,403 and the amount of mortgage loan insurance $ 1,701,173. The gross income expectancy was estimated at $ 239,382 and the income, net after operating expenses and fixed charges, including debt service requirements, was $ 22,519.

On some undisclosed date thereafter but prior to December 23, 1947, the petitioners represented to the FHA that the cost of labor and materials had increased in the interim, and that they felt they could not go ahead with the projects on the basis of the FHA's estimated costs of construction. The FHA agreed to recompute the estimated costs, if the petitioners would file amended applications for mortgage insurance.

On December 23, 1947, two amended mortgage insurance applications covering the same projects and naming the same proposed mortgagee, sponsors, and architect as in the original applications were filed with the FHA. In one amended application the proposed mortgagor was shown as Springfield Development Co., Inc., 1961 U.S. Tax Ct. LEXIS 178">*189 a corporation yet to be formed. The project was described as Oakland Gardens, Sections 2 and 3, and the mortgage insurance requested was in the amount of $ 4,393,650. In schedule A, entitled "Sources of Equity," the equity participants were shown as Springfield Development Co., Inc., builders 36 T.C. 22">*27 Harry & Benjamin Neisloss, and architect. The indicated participation of Springfield Development Co., Inc., was shown as cash, $ 77,866. For Harry and Benjamin Neisloss as the builders, $ 208,522 was listed as "Other Equity." This was the same amount elsewhere shown in the estimated cost of the project as the amount of the builder's fee. For "Architect," a participation of $ 218,949 was shown also as "Other Equity," which amount was identical with the architect's fee elsewhere shown under estimates of cost of project. These items, namely, the cash of $ 77,866 and the builder's and architect's fees, along with the anticipated mortgage loan proceeds, were listed in the application as the total resources for the construction of the project. The word "Leasehold" was listed as a recourse item under the category "Land," but no amount was shown therefor in dollars.

In the other amended1961 U.S. Tax Ct. LEXIS 178">*190 application filed December 23, 1947, the proposed mortgagor was shown as Hill Development Co., Inc., a corporation yet to be formed. The project was described as Oakland Gardens, Section 4, and the mortgage insurance requested was in the amount of $ 1,940,000. In schedule A, entitled "Sources of Equity," the equity participants were shown as Hill Development Co., Inc., builders Harry & Benjamin Neisloss, and architect. The indicated participation of Hill Development Co., Inc., was shown as cash, $ 33,303. For Harry and Benjamin Neisloss as the builders $ 91,944 was listed as "Other Equity." This was the same amount elsewhere shown in the estimated cost of the project as the amount of the builder's fee. For "Architect," a participation of $ 96,541 was shown also as "Other Equity," which amount was identical with the architect's fee elsewhere shown under estimates of cost of project. These items, namely, the cash and the builder's and architect's fees, along with the anticipated mortgage loan proceeds, were listed in the application as the total resources for the construction of the project. As in the Springfield application, the word "Leasehold" was entered under the category1961 U.S. Tax Ct. LEXIS 178">*191 "Land," but no amount was shown therefor in dollars.

In the meantime, on December 15, 1947, the land covered by the contracts to purchase entered into on April 23 and May 15, 1947, by Benjamin Neisloss with the Queens Valley Development Corporation and Marshall Affiliated, Inc., was conveyed to Julia H. Neisloss, Lillian Neisloss, and Diana R. Braunstein. Of the consideration paid, $ 81,600 was attributable to the land to be used for the Springfield project, and $ 38,400 to the land which was to be used for the Hill project. In the application covering the Springfield project, among the items listed as annual fixed charges in the estimated annual operating statement was $ 16,188, described as ground rent. In the application covering the Hill project, $ 7,636, described as ground rent, was similarly shown.

36 T.C. 22">*28 The FHA completed its analysis of the Springfield project on February 16, 1948. Its total estimated cost, exclusive of land and required construction off-site, was $ 4,683,704, as compared with $ 4,898,987 shown in the application for mortgage insurance. It arrived at a total of $ 4,413,262 as the estimated cost for all improvements, as compared with $ 4,597,923 shown1961 U.S. Tax Ct. LEXIS 178">*192 in the application. The total, in each instance, represented the estimates of cost for improvements to the land, consisting of utilities, landscaping, apartments and garages, plus builder's and architect's fees. In the application, the builder's fee was shown as $ 208,522, and the architect's fee as $ 218,949, as compared with $ 200,148 and $ 210,155 in the FHA analysis. In each instance the builder's fee represented 5 percent of the estimated cost for landscaping and construction of utilities, apartments and garages, and the architect's fee was 5 percent of such estimated cost after it had been increased by the amount of the builder's fee.

Under the FHA analysis, the total for "Carrying Charges; Financing" was estimated at $ 257,442, items such as interest, real estate taxes, and insurance being limited to the estimates of such costs for the period of construction. Making up the total were:

The estimates by petitioners 1961 U.S. Tax Ct. LEXIS 178">*193 of the costs of comparable items, as shown by their application, were shown in a total amount of $ 277,564 and, by items, were as follows:

Estimated legal expenses were shown in the FHA analysis as $ 10,000 and organization expenses at $ 3,000. They had been listed in the application at $ 20,000 and $ 3,500.

In both the FHA analysis and the application annual ground rent in the amount of $ 16,188 was included in estimated operating expenses. In the FHA analysis, the fair market value of the fee of the land to be utilized by the Springfield project was estimated at 50 cents per square foot for 809,461 square feet, but no amount 36 T.C. 22">*29 was included for the land in the estimate of cost of the project, it being noted that the land involved was a leasehold estate.

In the FHA project analysis, the maximum insurable mortgage shown was $ 4,174,800, as compared with $ 4,393,650 applied for. In arriving at the maximum insurable 1961 U.S. Tax Ct. LEXIS 178">*194 mortgage, FHA increased its total estimated cost of $ 4,683,704, exclusive of land, by $ 404,700, to include its estimate of the fair market value of the land in fee, so as to arrive at $ 5,088,404 as its estimate of cost of the property in fee simple. Ninety percent of such estimated cost of the property in fee simple was found to be $ 4,579,564, from which $ 404,700, representing the estimated fair market value of land in fee, was deducted to arrive at $ 4,174,864 as the amount of the maximum insurable mortgage. ³ Eliminating the odd amount of $ 64, the insurable mortgage approved was $ 4,174,800.

After arriving at the amount of the maximum insurable mortgage for the Springfield1961 U.S. Tax Ct. LEXIS 178">*195 project, the FHA, in its project analysis, listed as the "Estimated Requirements for Completion of the Project" the following:

Under additional requirements over and above the total estimated cost, exclusive of land and required off-site construction, the FHA listed $ 62,622 as the amount of "cash working capital" to be deposited with the mortgagee and $ 101,443 as the amount estimated for off-site requirements and for which provision was required to be made.

According to its project analysis the FHA estimated the total income of Springfield at 100 percent occupancy as $ 599,712. In arriving at that figure it used an estimated average rental of $ 97.80 per family unit per month for 480 units and $ 10 per month each for 303 garage spaces. In its estimates of operations it used 93 percent as the estimated occupancy for both apartments and garages1961 U.S. Tax Ct. LEXIS 178">*196 to show $ 557,732 as the estimated gross income expectancy from rents. In its estimate of real estate taxes for the operation it used $ 2,720,000 as its estimate of assessed value for the apartments, $ 15,100 for the garages, and $ 243,000 for the land upon completion of improvements, or a total of $ 2,978,100. To these estimated assessed values it applied 36 T.C. 22">*30 a rate of $ 3.06 per $ 100 to arrive at $ 91,130 as its estimate of real estate taxes. Allowing $ 16,188 for ground rent, $ 127,636 for operating expenses, $ 17,105 as a reserve for replacements, and $ 92,390 for real estate and social security taxes and New York unemployment insurance premiums, or $ 253,319 for total operating expenses, taxes, and ground rent, the FHA arrived at $ 304,413 as the "Estimated Net Income, after Operating Expenses and Taxes and Ground Rent." Included in the $ 127,636 estimated for operating expenses was an item of $ 22,213 for decorating costs of which $ 16,448 was for tenant space, $ 4,480 for exterior of buildings, and the remaining $ 1,285 for public space and accessory buildings. For debt service requirements, which included mortgage insurance, interest, and principal payments on the1961 U.S. Tax Ct. LEXIS 178">*197 mortgage, the FHA arrived at an estimate of $ 250,488, indicating $ 53,925 as the estimated balance remaining for the payment of such items as income and corporate taxes, other unlisted expenses or charges and for corporate purposes.

In their application for mortgage loan insurance the petitioners had estimated the rental expectancy at 100 percent occupancy for the Springfield apartments at $ 587,328 and for the garages at $ 36,360 to arrive at a total of $ 623,688. In arriving at that figure they had estimated for 480 family units at $ 101.96 per unit per month and $ 10 per month for 303 garage spaces. Allowing for vacancies of 7 percent they estimated the gross income expectancy from rent at $ 580,030. For real estate taxes they estimated the assessed value of the property at $ 3,811,000 without any breakdown between apartments, garages, and land after completion of improvements. Real estate taxes were estimated at $ 116,617 by applying a rate of $ 3.06 per $ 100 of estimated assessed value. Allowing $ 153,985 for operating expenses, $ 116,617 for estimated real estate taxes, and $ 1,260 for "Social security and other special taxes" and deducting the total thereof, or $ 271,8621961 U.S. Tax Ct. LEXIS 178">*198 from their estimated gross income expectancy, they arrived at $ 308,168 as "Cash available for debt service." Included in the $ 153,985 estimated for operating expenses were $ 25,300 for "Decorating" and $ 18,720 for "Replacement reserve." Under "Annual Fixed Charges" $ 175,746 was shown as interest due for the first year, $ 65,905 as mortgage amortization for the first year, $ 21,968 as mortgage insurance, and $ 16,188 as ground rent, or a total of $ 279,807. Deducting this amount from $ 308,168 described as "Cash available for debt service," the mortgage loan application reflected a remainder of $ 28,361 as "Cash available for income taxes, corporate taxes, dividends and surplus." Neither the mortgage loan insurance application nor the FHA project analysis reflected any allowance for depreciation.

Thereafter, under date of February 18, 1948, the FHA issued a commitment for mortgage insurance with respect to the Springfield 36 T.C. 22">*31 project in an amount not to exceed $ 4,174,800. As a part of the commitment for insurance, certain conditions and requirements were recited. With respect to the land, it was recited that at the closing evidence would be required to show that the mortgagor1961 U.S. Tax Ct. LEXIS 178">*199 was the lessee of the land under a lease for not less than 99 years at an annual ground rental of $ 16,188, and that the lease contain a provision giving the Federal Housing Commissioner under specified circumstances the option to purchase the fee simple title for the sum of $ 404,700. ⁴ $ 62,622 was shown as the amount of "cash working capital." The commitment also provided for the deposit with the mortgagee of an amount representing the excess of the estimated amount required for completion of the project over and above mortgage proceeds, which amount was shown as $ 508,904. It was specified, however, that the said amount to be so deposited might be reduced by so much of the builder's and architect's fees, shown on the analysis as $ 410,303, as the closing documents should show were not to be paid for in cash. The commitment document also specified that the mortgagee's certificate at closing should show an escrow deposit of $ 101,443 to cover off-site improvements and streets. In an attachment to the commitment form, the $ 101,443 was broken down to show the estimated costs for the construction of such items as storm sewer system, curbs, paving, installation of street signs, 1961 U.S. Tax Ct. LEXIS 178">*200 the planting of trees and shrubs, and the like. ⁵

1961 U.S. Tax Ct. LEXIS 178">*201 Under date of February 18, 1948, the FHA's tabulation of financial requirements for closing of the mortgage on the Springfield project was approved by its deputy chief underwriter. As had been the case in the FHA project analysis, the contractor's or builder's fee of $ 200,148 and the architect's fee of $ 210,155, or a total of $ 410,303, were shown as fees to be paid by means other than cash. As a consequence, the $ 4,413,262 theretofore shown as the FHA total estimated cost for all improvements was reduced by $ 410,303 to $ 4,002,959, to represent the estimate of the cash required for construction and fees. To this latter amount, $ 257,442.40 was added to show $ 4,260,401.40 as the estimate of total cash required for fees, construction, carrying charges, and financing. The difference between that amount and $ 4,174,800, the amount of the mortgage loan as approved, or $ 85,601.40, 36 T.C. 22">*32 was shown as the amount of cash to be deposited in escrow by the mortgagor. To this amount, $ 13,000 as representing legal and organization expenses, $ 101,443 as the amount of cash to be deposited for off-site requirements, and $ 62,622 as the amount to be deposited as "cash working capital" 1961 U.S. Tax Ct. LEXIS 178">*202 were added to show the total of the cash required from the mortgagor for all requirements as $ 262,666.40.

On March 17, 1948, the Trust Company of New Jersey, to which as proposed mortgagee the commitment for mortgage loan insurance had been issued on February 18, 1949, transferred the said commitment to the Bank of Manhattan Company, variously referred to herein as Manhattan Company and Bank of Manhattan, as proposed mortgagee, which transfer was approved by the FHA on March 26, 1948.

On March 31, 1948, Springfield Development Co., Inc., sometimes referred to herein as Springfield Co., or Springfield, was incorporated under the laws of New York. Stated purposes, among others, were to improve and operate, and to sell, mortgage, or lease any real estate and any personal property, to borrow money and issue evidences of indebtedness in furtherance of any or all of the objects of its business, and to obtain mortgage insurance from the FHA pursuant to the provisions of the National Housing Act as amended. In that connection, it was provided that so long as any of the property of the corporation should be encumbered by a mortgage insured by the FHA the corporation should engage in no 1961 U.S. Tax Ct. LEXIS 178">*203 business other than the construction and operation of a rental housing project or projects. Its authorized capital stock consisted of 100 shares of preferred stock having a par value of $ 1 per share, 500 shares of no-par-value "common A stock," and 100 shares of no-par-value "common B stock." It was provided that no dividends should be paid upon any of the capital stock, except with the consent of the holders of a majority of the shares of each class of stock outstanding, until all amortization payments due under the mortgage insured by the FHA had been paid.

The preferred stock was issued to FHA pursuant to its rules and regulations, for which on April 26, 1948, Springfield received $ 100 in cash. Ten shares of the common A stock were issued to each of the three petitioners for $ 1 per share, or a total of $ 30. The officers were: Benjamin Neisloss, president, Benjamin Braunstein, vice president, and Harry Neisloss, secretary-treasurer. The investment of petitioners in Springfield Co. never exceeded $ 30, and during the years pertinent the paid-in capital of Springfield was limited to $ 130.

On April 1, 1948, Julia H. Neisloss, Lillian Neisloss, and Diana R. Braunstein leased1961 U.S. Tax Ct. LEXIS 178">*204 to Springfield Development Co., Inc., the land which was to be used for the Springfield project for a term of 99 years from April 1, 1948, at an annual rental of $ 16,188, payable in advance by monthly installments. By the terms of the lease, the 36 T.C. 22">*33 mortgagee of the leasehold or the Federal Housing Commissioner, if the mortgage under the lease was insured under the National Housing Act, had the option to purchase the fee simple title to the land for a cash price of $ 404,700, if either the mortgagee or the Commissioner acquired title to the lease as a result of the mortgage insurance contract.

On April 5, 1948, Springfield Co. entered into a loan agreement with the Manhattan Company, whereunder Manhattan agreed to advance the sum of $ 4,174,800 to be used for the construction of the Springfield project, sometimes referred to as Sections 2 and 3 of Oakland Gardens. Attached to and made a part of the loan agreement was an affidavit of Benjamin Neisloss, reciting that he was president of Springfield and setting forth certain amounts representing various items of expense such as fees, revenue stamps, and the FHA insurance premiums. In listing these expenses, architect's, engineers' 1961 U.S. Tax Ct. LEXIS 178">*205 and surveyors' fees were shown as "None." On the same date Springfield, pursuant to the loan agreement, executed a mortgage bond on its leasehold interest, together with the buildings and structures to be erected on the leasehold, in favor of the Manhattan Company, conditioned on the payment of a mortgage loan of $ 4,174,800 with interest at the rate of 4 percent per annum. From May 1, 1948, to and including September 1949, interest alone was payable. Beginning with October of 1949, monthly installments of $ 19,134.50 were to be paid to cover both interest and principal. These installments were to be applied first to interest on the unpaid balance and then to principal. Also it was provided that prepayment of "the debt in whole or in an amount equal to one or more monthly payments on principal next due," might be made on the first day of any month prior to maturity upon at least 30 days' prior written notice to the holder. By a rider attached it was also provided that such prepayment could be made up to 15 percent of the original principal amount of the mortgage without any additional charge. If, however, prepayment exceeded such 15 percent, additional charges were provided 1961 U.S. Tax Ct. LEXIS 178">*206 for, ranging from 4 percent downward according to the number of remaining years under the mortgage.

On or about October 31, 1949, the mortgage was assigned by Manhattan Company to the Prudential Insurance Company of America.

Also on April 5, 1948, Springfield Co. entered into a "Lump Sum" construction contract with N. B. Construction Co., Inc., for the construction work to be done in completing the Springfield project. By the terms of the contract, N. B. Construction Co., Inc., agreed to furnish all materials and perform all work on the project for $ 4,002,959 cash and "in addition thereto, as a fee," 20.0148 shares of Springfield's common B stock. ⁶ The lump-sum figure of $ 4,002,959 36 T.C. 22">*34 was the same in amount as the total of the items of cost for landscape work, utilities, apartments, and garages shown by the FHA therefor in its project analysis. The contract contained schedules showing an allocation of the said $ 4,002,959 to the various units of the project to be constructed according to the nature of the work and the materials to be used. As to time of completion, it was provided that "In no event * * * shall the work to be performed under the Contract be considered 1961 U.S. Tax Ct. LEXIS 178">*207 to be completed until all construction items called for in the Drawings and Specifications have been fully completed and the contract price paid in full."

As to when the final payment of the contract price was to become payable, the contract provided as follows:

Upon completion of the improvements, including all landscape requirements, the balance due the Contractor hereunder shall be payable to the Contractor upon the expiration of 30 days from the date of final completion and acceptance of the project by the Owner with the approval of the Commissioner and the Lender: Provided, however, That this contract shall not be considered complete for purposes of final payment unless and until, all the work requiring inspection by municipal or other governmental authorities having jurisdiction, have been duly inspected and approved by such authorities and by the applicable Board of Fire Underwriters, if any, and all1961 U.S. Tax Ct. LEXIS 178">*208 requisite certificates of occupancy and other approvals have been duly issued: And provided further, That the Owner or Lender may withhold approval of final payment until after the expiration of any period which laborers, subcontractors, and materialmen may have for filing notice of Mechanics' Liens, and until after satisfactory completion of all off-site utilities and streets as required by the Lender and Federal Housing Commissioner.

The fee of 20.0148 shares of common B stock was determined by reference to the amount of $ 200,148 which had been included by the FHA in its project analysis as the builder's fee. It was also recited in the contract that N. B. Construction Co., Inc., thereby subscribed for the said shares and agreed that the services to be rendered by it, when finally completed, should constitute payment therefor, subject, however, to the provision that in no event should Springfield be liable to deliver any of the shares until final payment under the contract was due and payable as therein set forth. On April 19, 1948, N. B. Construction Co., Inc., waived payment of any contractor's fee provided for in the construction contract. At no time was it intended that1961 U.S. Tax Ct. LEXIS 178">*209 the fee should ever be paid as such.

N. B. Construction Co., Inc., had been incorporated on November 25, 1947, under the laws of New York. The stated purposes of the corporation, among others, were to contract for the construction of buildings and generally to carry on the business of builders and general contractors. The capital of the corporation was not stated in any amount. Its authorized capital stock was to consist of 200 shares without par value, which shares the corporation was authorized 36 T.C. 22">*35 to issue and sell for such consideration as might be fixed by its board of directors. The issued and outstanding stock of the corporation was owned equally by Benjamin Neisloss, Harry Neisloss, and Benjamin Braunstein, but the amount of paid-in capital, if any, is not shown.

On April 5, 1948, the same date the "Lump Sum" construction contract was entered into with N.B. Construction Co., Inc., Springfield entered into a contract with Braunstein, under which Braunstein agreed to perform the architectural services for the Springfield project, for which Springfield agreed to pay Braunstein 21.0155 shares of Springfield's common B stock. The number of shares to be so paid was determined1961 U.S. Tax Ct. LEXIS 178">*210 by reference to the amount of $ 210,155 shown in the project analysis as the architect's fee. According to the April 19, 1948, corporate minutes of Springfield Co., Braunstein waived payment for architectural services rendered by him to Springfield. It was never intended that the architect's fees should ever be paid as such.

Also on April 5, 1948, and pursuant to the FHA requirements for closing, Springfield deposited with the Manhattan Company the amount of $ 148,223.40. Of that amount, $ 62,622 represented the "cash working capital" heretofore described. The remainder, or $ 85,601.40, represented the excess of the estimated total cash required for fees, carrying charges and financing, and for cost of construction over the amount of the mortgage loan. Under the building loan agreement, this $ 85,601.40 was to be applied toward the payment of fees and charges relating to the project before any advances were to be made under the loan agreement. If the construction contract and the contract covering architectural services had provided that the builder's fee and architect's fee be paid in cash, instead of common B stock of Springfield, a further deposit of $ 410,303 would have 1961 U.S. Tax Ct. LEXIS 178">*211 been required to cover the estimated total cash for construction, fees, carrying charges, and finances over and above the amount of the mortgage loan.

Also on April 5, 1948, Benjamin and Harry Neisloss and their wives executed an indemnity agreement in the amount of $ 441,326 guaranteeing to the Manhattan Company that Springfield would complete the buildings and improvements in the Springfield project according to specifications. This guarantee was to continue for a period of 2 years from the date of substantial completion of the project. On the same date, April 5, 1948, Benjamin and Harry Neisloss entered into a contract with N. B. Construction Co., Inc., under which contract that corporation was to construct off-site facilities of the Springfield project at a cost of $ 101,443. The off-site facilities included 36 T.C. 22">*36 storm sewers, curbs, pavements, sidewalks, street signs, street trees, and planting strips. ⁷

1961 U.S. Tax Ct. LEXIS 178">*212 On April 6, 1948, the FHA insured the Springfield mortgage of $ 4,174,800 "to the extent of advances approved by" the Federal Housing Commissioner.

The construction of the Springfield project was begun on an undisclosed date in April of 1948. The N. B. Construction Co., Inc., performed the construction work as general contractor under its lump-sum construction contract until some undisclosed date in May 1948, when it ceased to operate. It was succeeded under the contract by N. B. Construction Co., a partnership consisting of Harry Neisloss, Benjamin Neisloss, and Benjamin Braunstein, and sometimes referred to as the N. B. partnership. ⁸ The petitioners formed the N. B. partnership as successor to N. B. Construction Co., Inc., on the recommendation of their attorney that there was no particular need for a corporate contractor which would require the usual corporate formalities and documents. There was no written agreement of partnership. The petitioners had, however, on April 19, 1948, filed a certificate of partnership and a certificate of conducting business under an assumed name in the office of the county clerk, Queens County, New York. The Manhattan Company was informed1961 U.S. Tax Ct. LEXIS 178">*213 that the contractor's work was to be done by N. B. partnership. The partnership filed income tax returns for its fiscal years ending March 31, 1949, and March 31, 1950, reporting its income as "none." In each return, its gross receipts were reported in the same amount as its costs. The Internal Revenue Service examined the return for the fiscal year ended March 31, 1949, and accepted it without change.

As construction proceeded, advances were made under the building loan agreement pursuant to forms and procedures prescribed by the FHA. An FHA inspector on the premises under construction periodically determined on a prescribed form the amount1961 U.S. Tax Ct. LEXIS 178">*214 and percentage of construction completed and approved. This amount was geared to the estimated cost for specified phases of construction as shown by schedules attached to the "Lump Sum" construction contract. The breakdown had been prepared by the FHA, and enabled its inspector to determine the percentage of work completed for each phase of construction and the advances to which the contractor was entitled. The contractor filled out a requisition requesting the advances based on the work completed and on-site materials purchased, less 10 percent, 36 T.C. 22">*37 which was to be retained by the mortgagee until the project was completed. The requisition in each instance was filed with the mortgagee, which then notified the FHA of the sum requested and asked the FHA to approve the amount for mortgage insurance. After approval by the FHA the mortgagee made the advance. The 10 percent retained as indicated was paid in the final advance incident to the request for final endorsement of the credit instrument.

Under date of September 29, 1948, the Department of Housing and Buildings of the Burough of Queens, City of New York, issued a temporary certificate of occupancy reflecting completion, 1961 U.S. Tax Ct. LEXIS 178">*215 for permissible use and occupancy, of 136 of the Springfield apartments. A similar certificate covering 188 apartments was issued November 23, 1948, and a third for 156 apartments, bringing the total up to 480 apartments, was issued in or about May 1949.

The buildings in the Springfield project were ready for occupancy in 1948 and 1949 according to the dates indicated, and permanent certificates of occupancy were thereafter issued as follows:

1961 U.S. Tax Ct. LEXIS 178">*216 Under date of September 1, 1949, the district director of FHA advised Manhattan Company that all "on-site and off-site work" of the Springfield project had been completed to the satisfaction of the FHA, and that inspection indicated that the buildings were occupied, all utilities were installed and connected, and safe ingress and egress provided. It was suggested that Manhattan contact the FHA legal section relative to the final advance and the FHA requirements concerning request for final endorsement of the credit instrument.

Under date of September 22, 1949, application was made by the Manhattan Company for insurance of $ 443,036.52, representing the 36 T.C. 22">*38 final advances of the mortgage loan proceeds, which amount also included the 10 percent which had been retained under the building loan agreement by the mortgagee from prior advances, and when paid would represent payment in full of the mortgage loan. This application carried Braunstein's certification as architect, likewise dated September 22, 1949, to the effect that he had inspected the work and that "all prior work and the work, labor and materials, to be paid for under this Request for Payment," were satisfactory and1961 U.S. Tax Ct. LEXIS 178">*217 in accordance with the contract drawings. The amount covered by the application was certified for mortgage insurance by the FHA under date of September 26, 1949. Actual payment of the final $ 443,036.52 was made by the Manhattan Company on October 31, 1949, bringing the total payments of loan funds to $ 4,174,800, which was the total amount of the mortgage loan.

Not later than September 12, 1949, and possibly as early as July 29, 1949, Springfield had made payments to or for the account of N. B. partnership to an amount in excess of the total charges against it by the partnership. In addition to the cost of constructing the apartments, garages, and off-site improvements, the total of the charges by the partnership against Springfield also covered certain listed expenditures the partnership had made for Springfield's account. In each month up to and including December of 1949, Springfield continued to make payments to the partnership in amounts ranging from $ 5,000 to $ 100,000. The last payment was for $ 100,000 on December 13, 1949, which payment brought the excess of payments over charges to $ 232,014.41.

By September 22, 1949, the date on which Manhattan applied for insurance1961 U.S. Tax Ct. LEXIS 178">*218 on the final payment of the mortgage loan and Braunstein certified that all work was satisfactory and in accordance with the contract drawings, the payments by Springfield to or for the account of the N. B. partnership had exceeded all charges against it by the partnership by at least $ 43,000, and possibly by as much as $ 95,000.

Except for differences in the amounts involved and some variations in dates, the steps and occurrences in the financing and construction of the Hill project substantially paralleled those of Springfield. The total of the estimates of cost for the project, exclusive of land and required off-site construction, was substantially the same in the application and in the FHA project analysis completed on February 17, 1948, the amount shown in the application being $ 2,161,788 and the amount in the FHA project analysis, $ 2,162,100. The total in each instance, represented the estimates of cost for improvements to land, consisting of utilities, landscaping, apartments, and garages, plus builder's fee and architect's fee. In the application the builder's fee was shown as $ 91,944 and the architect's fee as $ 96,541, as compared with $ 92,409 and $ 97,029 in the1961 U.S. Tax Ct. LEXIS 178">*219 FHA project analysis.

36 T.C. 22">*39 Under the FHA analysis the total for "Carrying Charges; Financing" was estimated at $ 118,886.40, items such as interest, real estate taxes, and insurance being limited to the estimates of such costs for the period of construction. Making up the total were:

The estimates by petitioners of the costs of comparable items, as shown by their application, were in a total amount of $ 122,930, and, by items, were as follows:

Estimated legal expenses were shown in the FHA analysis at $ 4,000 and organization expenses at $ 1,600. They had been listed in the application at $ 10,000 and $ 1,500.

In both the FHA analysis and the application, annual ground rent in the amount of $ 7,636 was included 1961 U.S. Tax Ct. LEXIS 178">*220 in estimated operating expenses. In the FHA analysis, the fair market value of the fee of the land to be utilized by the Hill project was estimated at 50 cents per square foot for 381,909 square feet, but no amount was included for the land in the estimate of cost of the project, it being noted that the land involved was a leasehold estate.

In the FHA project analysis, the maximum insurable mortgage shown was $ 1,926,800, as compared with $ 1,941,000 applied for. In arriving at the maximum insurable mortgage, the FHA increased its total estimated cost of $ 2,162,100, exclusive of land, by $ 190,900, to include its estimate of the fair market value of the land in fee, so as to arrive at $ 2,353,000 as its estimate of the cost of the property in fee simple. Ninety percent of the estimated cost of the property in fee simple was found to be $ 2,117,700, from which $ 190,900, representing the estimated fair market value of the land in fee, was deducted to arrive at $ 1,926,800 as the amount of the maximum insurable mortgage. ⁹

1961 U.S. Tax Ct. LEXIS 178">*221 36 T.C. 22">*40 After arriving at the amount of the maximum insurable mortgage, the FHA in its project analysis listed as the "Estimated Requirements for Completion of the Project," the following:

Under "Additional Requirements" over and above the total estimated costs, exclusive of land and required off-site construction, the FHA listed $ 28,902 as the amount of "cash working capital" to be deposited with the mortgagee and $ 47,339 as the amount estimated for off-site requirements and for which provision was required to be made.

According to its project analysis the FHA estimated the total income of Hill at 100 percent occupancy at $ 278,136. In arriving at that figure it used an estimated average rental of $ 98.25 per family unit per month for the 224 family units and $ 10 per month for each of the 117 garage spaces. In its estimates of operations it 1961 U.S. Tax Ct. LEXIS 178">*222 used 93 percent as the estimated occupancy for both the apartments and garages to show $ 258,666 as its estimated gross income expectancy from rent. Based on such figures, the apartments would produce approximately 95 percent and the garages approximately 5 percent of the total estimated rent. In its estimate of real estate taxes for the operation it used $ 1,272,500 as its estimate of assessed value for the apartments, $ 2,600 for the garages, and $ 115,000 for the land "upon completion of the improvements," or a total of $ 1,390,100. To these estimated assessed values it applied a rate of $ 3.06 per $ 100 to arrive at $ 42,538 as its estimate of real estate taxes. Allowing $ 7,636 for ground rent, $ 59,571 for operating expenses, $ 7,797 as a reserve for replacements, and $ 43,138 for real estate and social security taxes and New York unemployment insurance premiums, and deducting the total thereof or $ 118,142 from its estimated gross income expectancy, the FHA arrived at $ 140,524 as the "Estimated Net Income, After Operating Expenses and Taxes and Ground Rent." Included in the $ 59,571 estimated for operating expenses was an item of $ 10,393 for decorating costs of which $ 1961 U.S. Tax Ct. LEXIS 178">*223 7,695 was for tenants' space, $ 2,096 was for exterior of buildings, and the remainder for public space and accessory buildings. For debt service requirements, which included mortgage insurance, interest, and principal payments on the mortgage, the FHA arrived at an estimate of $ 115,608, indicating $ 24,916 as the estimated balance remaining for the payment 36 T.C. 22">*41 of such items as income and corporate taxes, other unlisted expenses or charges, and for corporate purposes.

In their application for mortgage loan insurance the petitioners had estimated the rental expectancy at 100 percent occupancy for the Hill apartments at $ 272,256 and for garages $ 13,080 to arrive at a total of $ 285,336. For apartments the estimates in the application had likewise been based on 224 family units but at an average monthly rate of $ 101.29 per family unit. In estimating for garages the application took into account 109 garage spaces, whereas the FHA in its project analysis estimated for 117 spaces. Both applied a rate of $ 10 per space per month. Allowing for vacancies of 7 percent each for apartments and garages the gross income expectancy from rents was estimated in the application at $ 265,362. 1961 U.S. Tax Ct. LEXIS 178">*224 For real estate taxes the petitioners had estimated the assessed value of the property at $ 1,699,000 without any breakdown between apartments, garages, and the land after the completion of improvements. Applying a rate of $ 3.06 per $ 100 of estimated assessed value they estimated that real estate taxes would be $ 52,000. Allowing $ 72,095 for operating expenses, $ 52,000 for real estate taxes, and $ 600 for social security and other taxes, and deducting the total thereof, or $ 124,695, from their estimated gross income expectancy, they arrived at $ 140,667 as "Cash available for debt surplus." Included in the $ 72,095 of estimated operating expenses were $ 12,625 for "Decorating," and $ 8,320 for "Replacement reserve." Under "Annual Fixed Charges" $ 77,600 was shown as interest due for the first year, $ 29,100 as mortgage amortization for the first year, $ 9,700 as mortgage insurance, and $ 7,636 as ground rent, or a total of $ 124,036. Deducting this amount from the $ 140,667 described as "Cash available for debt service," the application reflected a remainder of $ 16,631 as "Cash available for income taxes, corporate taxes, dividends, and surplus." Neither the mortgage loan1961 U.S. Tax Ct. LEXIS 178">*225 insurance application nor the FHA project analysis reflected any allowance for depreciation.

In the FHA commitment for mortgage insurance, it was recited that at the closing evidence would be required to show that the mortgagor was lessee of the land under a lease for not less than 99 years, at an annual ground rental of $ 7,636, and that the lease contain a provision giving the Federal Housing Commissioner the option to purchase the fee simple title for the sum of $ 190,900. ¹⁰1961 U.S. Tax Ct. LEXIS 178">*226 The commitment also provided for the deposit with the mortgagee of $ 235,300, as representing the excess of the amount required for completion of the project over and above the mortgage proceeds. It was specified, however, 36 T.C. 22">*42 that the said amount to be so deposited might be reduced by so much of the builder's and architect's fees, shown on the analysis at a total of $ 189,438, as the closing documents should show were not to be paid for in cash. The commitment document also specified that the mortgagee's certificate at closing should show an escrow deposit of $ 47,339 to cover off-site utilities and streets. ¹¹

The tabulation of final requirements for closing the mortgage on the Hill project was approved by the FHA under date of February 18, 1949. As had been the case in the FHA project analysis, the contractor's or builder's fee of $ 92,409 and the architect's fee of $ 97,029, or a total of $ 189,438, were shown as 1961 U.S. Tax Ct. LEXIS 178">*227 fees to be paid by means other than cash. As a consequence, the $ 2,037,614 shown as the FHA total estimated cost for all improvements was reduced by $ 189,438 to $ 1,848,176, to represent the estimated amount of cash required for construction and fees. To this latter amount, $ 118,886.40 was added to show $ 1,967,062.40 as the total cash required for construction, carrying charges, fees, and financing. The difference between that amount and $ 1,926,800, the amount of the mortgage loan as approved, or $ 40,262.40, was shown as the amount of cash to be deposited in escrow by the mortgagor. This amount plus $ 5,600 as representing legal and organization expenses, $ 47,339 as the amount to be deposited for off-site construction, and $ 28,902 as the amount to be deposited as "cash working capital" disclosed the sum of $ 122,103.40 as the total cash required from the mortgagor for all requirements.

On March 17, 1948, the Trust Company of New Jersey, to which as proposed mortgagee the commitment for mortgage loan insurance had been issued, transferred the said commitment to the Manhattan Company as proposed mortgagee, which transfer was approved by the FHA on March 26, 1948.

On March1961 U.S. Tax Ct. LEXIS 178">*228 31, 1948, Hill Development Co., Inc., sometimes referred to herein as Hill Co., or Hill, was incorporated under the laws of New York. The stated purposes were the same as those of Springfield Co., and similarly it was provided that so long as any of the property of the corporation should be encumbered by a mortgage insured by the FHA, the corporation should engage in no business other than the construction and operation of a rental housing project or projects. The authorized capital stock consisted of 100 shares of preferred 36 T.C. 22">*43 stock, having a par value of $ 1 per share, 500 shares of no-par-value common A stock, and 100 shares of no-par-value common B stock. It also provided that no dividends should be paid upon any of the capital stock, except with the consent of the holders of a majority of the shares of each class of stock outstanding, until all amortization payments due under the mortgage insured by FHA had been paid.

The preferred stock was issued to the FHA pursuant to its rules and regulations and for which on April 26, 1948, Hill received $ 100 in cash. Ten shares of the common A stock were issued to each of the three petitioners for $ 1 per share, or a total of1961 U.S. Tax Ct. LEXIS 178">*229 $ 30. The officers were: Benjamin Neisloss, president, Benjamin Braunstein, vice president, and Harry Neisloss, secretary-treasurer. The investment of petitioners in Hill Co. never exceeded $ 30, and during the years here pertinent the paid-in capital of Hill was limited to $ 130.

On May 1, 1948, Julia H. Neisloss, Lillian Neisloss, and Diana R. Braunstein, leased to Hill Development Co., Inc., the land which was to be used for the Hill project for a term of 99 years from May 1, 1948, at a net annual rental of $ 7,636. By the terms of the lease, the mortgagee of the leasehold or the Federal Housing Commissioner, if the mortgage under the lease was insured under the National Housing Act, had the option to purchase the fee title to the land for $ 190,900, if either the mortgagee or the Commissioner acquired title to the lease as a result of the contract of insurance.

On May 7, 1948, Hill Co. entered into a loan agreement with the Manhattan Company whereunder Manhattan agreed to advance the sum of $ 1,926,800 to be used for the construction of the Hill project, sometimes referred to as Section 4, Oakland Gardens. Attached to and made a part of the agreement was an affidavit executed1961 U.S. Tax Ct. LEXIS 178">*230 by Benjamin Neisloss reciting that he was president of Hill and setting forth certain amounts representing various items of expenses such as fees, revenue stamps, and FHA insurance premiums. In listing these expenses, architect's, engineers', and surveyors' fees were shown as "None." On the same date Hill, pursuant to the loan agreement, executed a mortgage bond on its leasehold interest together with the buildings and structures to be erected on the land leased by it, in favor of the Manhattan Company, conditioned on the payment of a mortgage loan of $ 1,926,800 with interest at the rate of 4 percent per annum. From June 1, 1948, to and including October 1949, interest alone was payable. Beginning with November 1949, monthly installments of $ 8,831.17 were to be paid to cover both interest and principal. These installments were to be applied first to interest on the unpaid balance and then to principal. It also was provided that prepayment of "the debt in whole or in an amount equal to one or more monthly payments on principal next due" might be made on the first 36 T.C. 22">*44 day of any month prior to maturity upon at least 30 days prior written notice to the holder. By a rider1961 U.S. Tax Ct. LEXIS 178">*231 attached it was also provided that such prepayment could be made up to 15 percent of the original principal amount of the mortgage without any additional charge. If, however, prepayment exceeded such 15 percent, additional charges were provided for, ranging from 4 percent downward according to the number of remaining years under the mortgage.

On or about October 31, 1949, the mortgage was assigned by the Manhattan Company to the Prudential Insurance Company of America.

Also on May 7, 1948, Hill Co. entered into a "Lump Sum" construction contract with N. B. Construction Co., Inc., for the construction work to be done in completing the Hill project. By the terms of the contract, N. B. Construction Co., Inc., agreed to furnish all materials and perform all work on the project for $ 1,848,176 in cash and "in addition thereto, as a fee," 9.2409 shares of Hill's common B stock. ¹² The lump-sum figure of $ 1,848,176 was the same in amount as the total of the items of cost for landscape work, utilities, apartments, and garages shown by the FHA therefor in its project analysis. The contract contained schedules showing an allocation of the said $ 1,848,176 to the various units of the project1961 U.S. Tax Ct. LEXIS 178">*232 to be constructed according to the nature of the work and the materials to be used. The construction contract was on FHA Form No. 2442-W, and carried the same provisions as in the Springfield contract with respect to the time when the work under the contract should be regarded as completed.

The "Lump Sum" contract of May 7, 1948, provided for the payment of the shares of common B stock of Hill, even though N. B. Construction Co., Inc., previously, on April 19, 1948, at a time when it had no contract for the construction of the Hill project, had waived the payment of any contractor's fee. The fee of 9.2409 shares of common B stock so provided for was determined by reference to the builder's fee of $ 92,409 which had been included by the FHA in its estimate of total cost of the project in determining the amount of the maximum insurable mortgage loan. As in the case of Springfield, the contract also recited1961 U.S. Tax Ct. LEXIS 178">*233 that N. B. Construction Co., Inc., thereby subscribed for the said shares and agreed that the services to be rendered by it, when finally completed, should constitute payment therefor, subject, however, to the provision that in no event should Hill be liable to deliver any of the shares until final payment under the contract was due and payable as therein set forth. At no time was it intended that the fee should ever be paid as such.

36 T.C. 22">*45 Also on May 7, 1948, Hill entered into a contract with Braunstein, under which Braunstein agreed to perform the architectural services for the Hill project, for which Hill agreed to pay Braunstein 9.7029 shares of Hill's common B stock. The number of shares to be so paid was determined by reference to the amount of $ 97,029 shown by the FHA as architect's fee in its estimate of total cost of the project for the purpose of determining the amount of the maximum insurable mortgage. According to the April 19, 1948, corporate minutes of Hill Co., Braunstein had waived payment for architectural services rendered by him to Hill. It was not intended that the architect's fee should ever be paid by Hill to Braunstein as such.

Also on May 7, 1948, and1961 U.S. Tax Ct. LEXIS 178">*234 pursuant to the FHA requirements for closing, Hill deposited with the Manhattan Company the amount of $ 69,164.40. Of that amount, $ 28,902 represented "cash working capital," heretofore defined, while the remainder, or $ 40,262.40, represented the excess of the estimated total cash required for construction, carrying charges, fees, and financing over and above the amount of the mortgage loan. Under the loan agreement, this $ 40,262.40 was to be applied to the payment of fees and charges relating to the project before any advances were to be made under the loan agreement. If the construction contract and the contract covering architectural fees had provided that the builder's fee and architect's fee be paid in cash, instead of common B stock of Hill Co., a further deposit in escrow of $ 189,438 would have been required.

Also on May 7, 1948, Benjamin and Harry Neisloss and their wives executed an indemnity agreement in the amount of $ 203,760, guaranteeing to the Manhattan Company that Hill Co. would complete the buildings and improvements in the project according to specifications. This guarantee was to continue for a period of 2 years from the date of substantial completion of1961 U.S. Tax Ct. LEXIS 178">*235 the project. On the same date, May 7, 1948, Benjamin and Harry Neisloss entered into a contract with N. B. Construction Co., Inc., under which contract that corporation was to construct off-site facilities of the Hill project at a cost of $ 47,339. As in the case of Springfield, the off-site facilities included storm sewers, curbs, pavement, sidewalks, street signs, street trees, and planting strips. ¹³

On May 7, 1948, the FHA insured the Hill mortgage of $ 1,926,800 "to the extent of advances approved by" the Federal Housing Commissioner.

The construction of the Hill project was begun in May 1948. And as in the case of the Springfield project, N. B. Construction Co., Inc., performed the construction work under its lump-sum construction 36 T.C. 22">*46 contract until some undisclosed date in May of 1948, when it ceased to operate. ¹⁴ It1961 U.S. Tax Ct. LEXIS 178">*236 was succeeded under the contract by the N. B. partnership, as heretofore set forth with respect to Springfield.

As construction proceeded advances were made under the loan agreement pursuant to forms and procedures prescribed by the FHA. The steps for procuring the advances were taken in the same manner as heretofore described with respect to the Springfield project.

On February 9, 1949, the Department of Housing and Buildings of the Borough of Queens, City of New York, issued a temporary certificate of occupancy reflecting the completion, for permissible use and occupancy, of 224 apartments in the Hill project.

The buildings in the Hill project were ready for occupancy in 1949 according to the dates indicated and permanent certificates of occupancy were thereafter issued as1961 U.S. Tax Ct. LEXIS 178">*237 follows:

Under date of August 24, 1949, the district director of FHA advised the Manhattan Company, by letter, that all "on-site and off-site work" on the Hill project was completed to the satisfaction of the FHA, and that inspection indicated that the buildings were occupied, all utilities were installed and connected, and safe ingress and egress provided. It was suggested that Manhattan contact the FHA legal section relative to the final advance and the FHA requirements concerning request for final endorsement of the credit instrument.

Under date of August 3, 1949, application was made by the Manhattan Company for insurance1961 U.S. Tax Ct. LEXIS 178">*238 of $ 217,974.79, which represented the final advances of the mortgage loan proceeds and included the 10 percent which had been retained under the loan agreement by the 36 T.C. 22">*47 mortgagee in making the prior advances. This application carried a certification dated August 2, 1949, by Braunstein, as architect, to the effect that he had inspected the work and that "all prior work and the work, labor and materials, to be paid for under" the current request, were satisfactory and in accordance with the contract drawings. This amount was certified for mortgage insurance by the FHA under date of September 26, 1949. Actual payment of the $ 217,974.79 was made by the Manhattan Company on October 31, 1949, bringing the total payments of loan funds to $ 1,926,800, which was the total amount of the mortgage loan.

On December 13, 1949, Hill made a payment of $ 100,000 to N. B. partnership thereby bringing its total payments to the partnership to an amount which was $ 23,992.89 in excess of the total charges by the N. B. partnership against Hill. In addition to the cost of construction of the apartments, garages, and off-site improvements the total charges by the N. B. partnership against Hill1961 U.S. Tax Ct. LEXIS 178">*239 also covered certain listed expenses of Hill which had been paid by N. B. partnership.

After December 31, 1948, when Springfield was approximately 82 percent completed and Hill was approximately 72 percent completed, ¹⁵ the N. B. partnership began the construction of a shopping center adjacent to the Springfield and Hill projects. The shopping center was constructed for Oakland Gardens, Inc., a separate corporation, which was owned and controlled by petitioners. Actual construction was completed on some undisclosed date not later than March 31, 1950, but possibly as early as July 31, 1949, the parties having stipulated that the books of N. B. partnership disclosed no "Construction Payroll" disbursements after that date.

The completed costs net to the N. B. partnership, including the expenditures of 1961 U.S. Tax Ct. LEXIS 178">*240 N. B. Construction Co., Inc., during its brief period of operation, for the construction of the Springfield, Hill, and shopping center projects were $ 5,878,703.20. Of that amount, the N. B. partnership allocated on its books $ 3,807,908 as the cost of the Springfield project, $ 1,757,581.62 as the cost of the Hill project, and $ 313,213.58 as the cost of the shopping center. In furnishing the materials and supplies for the Springfield and Hill projects, the N. B. partnership maintained no accounts or records which would reflect separately the costs of materials and supplies used in the Springfield and Hill projects. Neither was there any segregation of labor costs as between the projects. The costs later arrived at, and with which on its books Springfield and Hill were charged, were determined by an 36 T.C. 22">*48 allocation between the two projects on a room basis. ¹⁶ The total completed cost net of $ 3,807,908 for the Springfield project included the full cost of off-site improvements which, according to the FHA commitments, were to be completed by petitioners without cost to Springfield. Similarly, the total completed cost net of $ 1,757,581.62 for the Hill project also included1961 U.S. Tax Ct. LEXIS 178">*241 the cost of off-site improvements.

On April 6, 1948, the day after signing the lump-sum construction contract with N. B. Construction Co., Inc., Springfield made a payment of $ 75,000 to N. B. Construction Co., Inc., and on April 12, 1948, it made a second payment in the amount1961 U.S. Tax Ct. LEXIS 178">*242 of $ 25,000 bringing to $ 100,000 the total of the payments made to that company. After N. B. Construction Co., Inc., was succeeded under the contract by the N. B. partnership, and beginning with a payment of $ 40,000 on May 3, 1948, Springfield made 71 payments to the N. B. partnership, the last payment of $ 100,000 in amount being made on December 13, 1949, and bringing the total of the cash paid by Springfield directly to N. B. Construction Co., Inc., and N. B. partnership to $ 4,081,500. In addition, Springfield made expenditures to third parties for the account of the N. B. partnership amounting in the aggregate to $ 52,453.12, which with the cash payments of $ 4,081,500 brought the total payments made to or for the benefit of the N. B. partnership to $ 4,133,953.12.

From April 1, 1948, the day after it was incorporated, Springfield maintained a checking account with the Bank of Manhattan. All of the mortgage loan funds, when received, were deposited in that account. It opened a second account with the Bayside National Bank in June of 1948, and in this account deposited apartment rents, garage rents, security deposits, being deposits by tenants at the beginning of their leases1961 U.S. Tax Ct. LEXIS 178">*243 as security for the performance of their obligations thereunder, and small amounts described as miscellaneous. Of $ 4,081,500 of cash payments made by Springfield to N. B. partnership, including the payments made to N. B. Construction Co., Inc., $ 3,931,500 was paid from its account with the Bank of Manhattan and $ 150,000 from its account with the Bayside National Bank.

In addition to the $ 3,807,908 which represented the charges by N. B. partnership to Springfield for construction of the apartment project, including the cost of off-site improvements, N. B. partnership made various payments for the account of Springfield in a total amount of $ 94,030.71, thereby bringing N. B. partnership's total charges against Springfield to $ 3,901,938.71 and indicating an overpayment 36 T.C. 22">*49 by Springfield to N. B. partnership of $ 232,014.41, which amount was reflected by N. B. partnership on its books as a net balance in favor of Springfield. ¹⁷

1961 U.S. Tax Ct. LEXIS 178">*244 The total cost to Springfield of its apartment project, including the cost of off-site improvements, was $ 4,069,007.82, shown as follows:

Of the $ 157,636.72 shown as interest paid during construction, the first payment was $ 154.86, paid on May 10, 1948, and the last payment was $ 12,853.35, paid on October 31, 1949. Of the $ 157,636.72 of interest so paid, Springfield, for income tax purposes, capitalized $ 10,281.73 and deducted $ 147,354.99. Of the $ 3,927.95 shown as real estate taxes during construction, $ 1,563.57 was for the last 6 months of 1948, $ 1,563.57 for the first 6 months of 1949, and $ 800.81 represented accrued taxes for the months of July and August 1949. Of the $ 3,927.95, Springfield, for income tax purposes, capitalized $ 1,314.41 and deducted $ 2,613.54.

Upon receipt1961 U.S. Tax Ct. LEXIS 178">*245 by Springfield of the final payment of $ 443,036.52 on October 31, 1949, from the Manhattan Company, Springfield had received a total in mortgage money of $ 4,174,800, which amount exceeded its total cost of $ 4,069,007.82 for the project by $ 105,792.28.

Beginning with a payment of $ 50,000 on July 20, 1948, Hill made a total of 35 payments to N. B. partnership. The last payment of $ 100,000 was made on December 13, 1949, bringing its total payments to N. B. partnership to $ 1,814,000. In addition to the construction cost of the Hill project in the amount of $ 1,757,581.62, including the cost of off-site improvements, N. B. partnership made various expenditures for the account of Hill amounting in the aggregate to $ 32,425.49, thereby bringing the partnership's total charges against Hill to $ 1,790,007.11 and indicating an overpayment by Hill to N. B. partnership of $ 23,992.89, which amount was reflected on the partnership's books as a net balance in favor of Hill.

36 T.C. 22">*50 From May 10, 1948, and beginning with a deposit of $ 66,316.40, Hill maintained a checking account with the Bank of Manhattan. All of the mortgage loan funds, when received, were deposited in that account. 1961 U.S. Tax Ct. LEXIS 178">*246 It opened a second bank account in November of 1948 with the Bayside National Bank, and in this account deposited apartment rents, garage rents, security deposits, being deposits by tenants at the beginning of their leases as security for performance of their obligations thereunder, and small amounts described as miscellaneous. Of the $ 1,814,000 of cash payments made by Hill to N. B. partnership, $ 1,799,000 was paid from its account with the Bank of Manhattan, and $ 35,000 from its account with Bayside National Bank.

The total cost to Hill of its apartment project, including off-site improvements, was $ 1,872,834.53, as follows:

Of the $ 63,328.88 shown as interest paid during construction, the first payment was $ 60.79, paid on June 8, 1948, and the last payment was $ 5,885.98 paid on October 31, 1949. 1961 U.S. Tax Ct. LEXIS 178">*247 Of the interest so paid, Hill, for income tax purposes, capitalized $ 14,825.80 and deducted $ 48,503.08. Of the $ 2,261.23 shown as real estate taxes during construction, $ 746.32 was for the last 6 months of 1948, $ 746.32 for the first 6 months of 1949, and $ 768.59 for the months of July, August, September, and October of 1949. Of the taxes so paid, Hill, for income tax purposes, capitalized $ 657.20 and deducted $ 1,604.03.

With the final payment of $ 217,974.79 on October 31, 1949, from the Manhattan Company, Hill had received a total in mortgage loan money of $ 1,926,800, which amount exceeded its total cost of $ 1,872,834.53 for the project by $ 53,965.47.

Oakland Gardens, Inc., supplied none of the $ 313,213.58 expended in the construction of its shopping center. To the extent of $ 300,000, it executed a mortgage ¹⁸ and under date of January 31, 1950, received credit therefor on the books of the N. B. partnership, its account on the partnership books being debited with $ 313,213.58 as "Cost of buildings" and credited with $ 300,000, described as "Mortgage." It is stipulated that the remaining $ 13,213.58 was paid, 36 T.C. 22">*51 $ 8,543.46 on December 14, 1949, and $ 4,670.121961 U.S. Tax Ct. LEXIS 178">*248 on March 31, 1951. The N. B. partnership had received $ 7,250 from Oakland Gardens on some undisclosed date or dates in February of 1949, but previously on December 27, 1948, a transfer of $ 7,966.50 had been made from N. B. partnership to Oakland Gardens and in February of 1949 two further transfers were made by the partnership, one of $ 14,750 on February 15 and the other of $ 11.20 on February 28.

On some or all of their FHA projects prior to Springfield and Hill, the petitioners had had their plumbing and heating work done by contractors, and in making up their estimates of cost for Springfield and Hill had assumed they would do the same on the Springfield and Hill projects. They had also assumed that they would have the carpentry handled by a contractor or contractors. 1961 U.S. Tax Ct. LEXIS 178">*249 In keeping with that idea, they solicited bids for carpenter work from certain known contractors. Similarly, they solicited bids from plumbing contractors. They regarded the bids as too high, and decided to proceed with the work without contractors. They had in their employ a man who had acted as their superintendent for many years, and decided to put him in charge of the carpentry work. The plumbing and heating work was done under the supervision of a man named Schwartz. Proceeding in this manner, the carpentry work was approximately $ 80,000 less, and the plumbing and heating work approximately $ 85,000 less than the estimates, resulting in savings which had not been expected at the outset.

With respect to lumber, they had anticipated the need for approximately 5 million board feet, and had based their estimates on a price of $ 100 per thousand feet. They were able to make their first lumber purchases at $ 98.50 per thousand feet, and as early as May of 1948, were able to buy lumber at $ 96 per thousand. In June the price was $ 94, in September it was down to $ 92, and before all of the lumber was bought they were able to buy at $ 75 per thousand feet. At those unexpected1961 U.S. Tax Ct. LEXIS 178">*250 prices, the lumber cost was approximately $ 50,000 less than the original estimates.

In the course of their operations, petitioners freely transferred funds back and forth between their controlled or wholly owned projects, incorporated or otherwise. Insofar as appears, there were no formal authorizations of such transfers, nor were there any written evidences of indebtedness. Appropriately designated accounts were maintained on the books of the various projects to which debits and credits were made to reflect the transfers and retransfers of funds and the debit or credit balance, as the case might be.

The paid-in capital of Springfield at no time during any period here pertinent exceeded $ 130 of which $ 100 was supplied by FHA and $ 30 by petitioners. To meet the initial needs of Springfield, $ 175,000 was transferred from Brookside Gardens to Springfield's 36 T.C. 22">*52 Manhattan bank account on April 1, 1948, the day after Springfield was organized. Springfield's next receipt of funds was on April 6, 1948, when $ 143,672.40 was received from its mortgagee, the Manhattan Company, of which $ 85,601.40 represented the excess of estimated cash required for construction costs, fees, 1961 U.S. Tax Ct. LEXIS 178">*251 carrying charges, and financing over the amount of the mortgage loan, and represented that part of $ 148,223.40 which, pursuant to the FHA closing requirements, had been deposited with the Manhattan Company the preceding day. The $ 58,071 balance of the $ 143,672.40 received on April 6, 1948, represented the first advance to Springfield from the mortgage loan funds.

Transfers to Springfield from Hill were made, $ 50,000 on May 6, 1948, $ 1,000 on October 24, 1948, and $ 15,000 on March 23, 1949. ¹⁹

1961 U.S. Tax Ct. LEXIS 178">*252 The only other receipt of funds in any substantial amount by Springfield from sources other than mortgage loan proceeds or receipts from the operation of its apartments was $ 100,000, representing the proceeds of a loan to it by the Bank of Manhattan on July 13, 1948. This loan was repaid at or prior to June 30, 1949.

Aside from $ 811.79 received in December of 1949, $ 8,000 in January of 1950, and $ 235 in June of 1950, the sources of which are not apparent, the only other funds received by Springfield through August 1950, consisted of the mortgage loan funds in a total amount of $ 4,174,800, the last payment thereof being $ 443,036.52 on October 31, 1949, and receipts from apartment operations in the nature of rents, security deposits, and small amounts representing miscellaneous items.

All of the above funds which had been transferred to Springfield from sources controlled or wholly owned by petitioners had been repaid not later than December 13, 1949. On that date, $ 182,116.44 ²⁰ was paid or transferred to Brookside Gardens, and the remaining $ 10,000 received from Hill, plus an additional $ 90, was likewise paid or retransferred on that date.

1961 U.S. Tax Ct. LEXIS 178">*253 As in the case of Springfield, the paid-in capital of Hill at no time during the period here pertinent exceeded $ 130, of which $ 100 was supplied by FHA and $ 30 by petitioners. Its first receipts shown of record were in the amount $ 66,316.40, received from its mortgagee on May 10, 1948, and consisted of $ 40,262.40, which had been deposited 36 T.C. 22">*53 with the mortgagee and represented the excess of the estimated cash required for construction costs, fees, carrying charges, and financing over the amount of the mortgage loan, and $ 26,054, being the first advance by the mortgagee of mortgage loan proceeds. A total deposit of $ 69,164.40 from sources not shown had previously been made with the mortgagee to cover the above $ 40,262.40 and $ 28,902 as the "cash working capital" required by the FHA to be so deposited. In addition to the receipts from its mortgagee, the Manhattan Company, and the retransfers of funds from Springfield, enumerated above, Hill on May 10, 1949, received $ 20,000 from Brookside Gardens and $ 17,500 from Madison Gardens.

Aside from the transfers and retransfers between Hill and Springfield, the transfers from Brookside Gardens and Madison Gardens, and $ 3501961 U.S. Tax Ct. LEXIS 178">*254 shown as fire loss insurance, the only receipts by Hill shown of record up to and including July 1950, consisted of the mortgage loan proceeds of $ 1,926,800 and the cash item of $ 40,262.40, both received from the mortgagee, plus receipts from the apartment operations, such as rent, security deposits, and small miscellaneous items.

In December of 1949, $ 23,266.17 ²¹ was paid or transferred from Hill to Brookside Gardens, Inc., and $ 17,500 to Madison Gardens, Inc.

During the course of its existence and operations the only funds shown to have been received and made available to N. B. Construction Co., Inc., consisted of $ 10,000 transferred from Brookside Gardens, Inc., on March 23, 1948, $ 75,000 ²² paid by Springfield on April 1, 1948, and $ 25,000 22 on April 14, 1948, on construction1961 U.S. Tax Ct. LEXIS 178">*255 costs of the Springfield projects, and $ 15,000 transferred from Brookside Gardens, Inc., on May 6, 1948, for a total of $ 125,000. 22

Up to April 30, 1948, N. B. Construction Co., Inc., had expended $ 93,346.70 under its contract for the construction of the Springfield project. In closing out its operations it transferred $ 30,000 in cash to the N. B. partnership on May 3, 1948. ²³ $ 1,199.46 was thereafter applied to cover checks which had been drawn by the N. B. partnership 36 T.C. 22">*54 but were cleared through the N. B. Construction Co., Inc., bank account, and the balance of $ 453.84 was transferred to N. B. partnership on August 23, 1948.

1961 U.S. Tax Ct. LEXIS 178">*256 On March 31, 1950, the N. B. partnership ceased to exist, and its cash and other assets were transferred to B. H. B. Associates, a joint account of petitioners Benjamin Neisloss, Harry Neisloss, and Benjamin Braunstein, and the closing balances in its assets and liabilities accounts became the April 1, 1950, opening entries on the books of B. H. B. Associates. At various times during the period of the N. B. partnership's existence and operations, funds of various of the petitioners' wholly owned projects and of the petitioners themselves had been made available to it. Except with respect to the excess payments it had received from Springfield and Hill, and as hereafter shown as to Brookside Gardens, there had been repayment in full.

Between March 23, 1948, and September 30, 1949, the N. B. partnership had either received or had paid out in its behalf funds from Brookside Gardens amounting in the aggregate to $ 233,803.95. In addition, it had been charged, under date of February 28, 1949, with the further sum of $ 150,925, representing an assumption by it of an obligation in that amount by petitioners personally to Brookside Gardens. For that amount petitioners were charged equally1961 U.S. Tax Ct. LEXIS 178">*257 against their cash advances to the N. B. partnership. Three payments or retransfers, all in 1948, were made by the N. B. partnership to Brookside Gardens, amounting in the aggregate of $ 157,500. At September 30, 1949, the balance in favor of Brookside Gardens on the books of the N. B. partnership stood at $ 227,228.95, which amount included the $ 150,925 with which the N. B. partnership had been charged for the account of the petitioners individually. Under date of December 13, 1949, this balance of $ 227,228.95 was satisfied by a payment in cash to Brookside Gardens. On the next day, $ 100,000 was transferred back to N. B. partnership from Brookside Gardens and on February 23, 1950, a further transfer of $ 195,000 was made to the N. B. partnership from Brookside Gardens, bringing to $ 295,000 the amount shown as owing to Brookside Gardens at March 31, 1950.

At January 10, 1950, the balance on the N. B. partnership books in favor of Benjamin Neisloss was $ 183,930.74; in favor of Harry Neisloss, $ 169,542.90; and in favor of Benjamin Braunstein, $ 180,748.26. Under date of January 10, 1950, checks on the N. B. partnership account with the Bank of Manhattan and signed by Benjamin1961 U.S. Tax Ct. LEXIS 178">*258 Neisloss and Harry Neisloss, were drawn for the respective amounts and in favor of each of the three petitioners, thereby clearing from the books of the N. B. partnership all amounts shown as owing to the said individuals. In each instance, $ 100,000 of the amount so paid a partner had been received from the partner on December 14, 36 T.C. 22">*55 only 27 days prior to repayment. In addition $ 15,720.53 was received from Harry Neisloss and $ 15,720.54 each from Benjamin Neisloss and Benjamin Braunstein in January 1950, the month of repayment.

At various dates prior to December 19, 1949, the N. B. partnership had the use of funds in lesser amounts from Brookside Builders, Inc., Oakland Gardens, Inc., ²⁴ Somerville Gardens, Inc., and Somerset Homes, Inc., all of which amounts had been paid or retransferred not later than December 14, 1949.

1961 U.S. Tax Ct. LEXIS 178">*259 Inclusive of the $ 300,000 which had been received by the N. B. partnership as loans from the Bank of Manhattan on the short-term notes of Springfield, the N. B. partnership, in August of 1948, had total loans from Manhattan of $ 400,000, the last of which loans it paid on August 26, 1948.

At the closing of the N. B. partnership on March 31, 1950, its books reflected assets of $ 576,666.84, and liabilities in the same amount. The principal asset shown was the Oakland Gardens mortgage receivable in the amount of $ 300,000, which had been received as covering that portion of the cost to the N. B. partnership in constructing the shopping center. It had cash in the amount of $ 154,547.77, which amount in full was transferred to B.H.B. Associates. $ 25,000 was a charge in that amount against Adelphi Academy. $ 12,000 shown as "F.H.A. -- Adelphi" and $ 15,000 shown as "F.H.A. -- Mitchell" represented amounts which had been paid by the N. B. partnership as fees on two FHA projects in respect of which the petitioners were planning to form corporations. $ 33,121.13 was listed as "Land (plus expenses)," and $ 26,889.50 as real estate. The petitioners were each listed with a charge of 1961 U.S. Tax Ct. LEXIS 178">*260 $ 669.38. Other items of the assets in comparatively smaller amounts were shown as office furniture and fixtures, machinery and equipment, and automobile.

The principal items of liabilities were shown as $ 295,000, owing to Brookside Gardens, $ 232,014.14, owing to Springfield, and $ 23,992.89, owing to Hill. $ 4,666.89 was listed as a liability to Oakland Gardens, ²⁵ $ 9,850 was reflected as "Mortgage payable -- Barkette" and $ 7,000 was reflected as "Mortgage payable -- Real Estate." There were accounts payable of $ 2,010.79, and comparatively smaller amounts shown as reserves for depreciation on office furniture and fixtures, machinery and equipment, and automobile.

1961 U.S. Tax Ct. LEXIS 178">*261 On October 20, 1949, the district director of the FHA approved a schedule of rents for the Springfield project, based on "480 living 36 T.C. 22">*56 units, 2240 rooms at an average rental of $ 20.79 per room per month plus $ 10.00 monthly for 303 garage spaces," or a "total approved gross potential rent" of "$ 49,598.00 per month."

On October 24, 1949, the district director approved a schedule of rents for the Hill project, based on "224 living units, 1,040 rooms at an average rental of $ 20.84 per room per month plus a rental of $ 10.00 monthly for 117 garage spaces," or a total "approved gross potential rent" of "$ 22,846.00 per month."

Until termination of all obligations of the FHA commissioner under the mortgage insurance contract, or any succeeding contract or agreement covering the mortgage obligation, Springfield and Hill were not permitted to make any rental charges in excess of the maximum rentals specified in schedules of rents approved by the district director. ²⁶

1961 U.S. Tax Ct. LEXIS 178">*262 Springfield and Hill leased their apartments for terms of 3 years. They had planned to lease the garages with the apartments as units, but were not successful in doing so. ²⁷ They next offered the garages for lease for a 1-year term, and again were unsuccessful. In the end the garages were rented on a month-to-month basis.

With respect to apartments, the vacancies experienced by Springfield through August of 1950 were substantially less than the 7 percent which had been used by the FHA in estimating gross rentals as shown in its project analysis and by petitioners in their mortgage insurance application. With respect to garages, its vacancy experiences ran comparatively quite high. In the case of the apartments, the percentages of vacancies for January, February, March, April, and May were1961 U.S. Tax Ct. LEXIS 178">*263 3.9, 3.8, 4, 3.8, and 3.3, respectively, whereas in the case of the garages for the same months, the percentages of vacancies were 47.2, 48, 49.3, 54.8, and 58.4.

In the case of Hill, the vacancies experienced with respect to both apartments and garages exceeded the 7 percent percentage which had been used by the FHA in estimating gross rentals as shown in its project analysis and by petitioners in their mortgage insurance application. In the case of the apartments for January through May of 1950, the vacancy percentages were 14.1, 12.4, 11, 11.5, and 10.9. In the case of the garages for the same months, the percentages were 47.9, 54.7, 47.4, 54.7, and 60.7.

Combining the experiences of each project with respect to both apartments and garages, the percentages for Springfield for January 36 T.C. 22">*57 through May of 1950 were still below the 7 percent figure, namely, 6.5, 6.5, 6.7, 6.9, and 6.6. ²⁸ For Hill for the same months, the percentages were 15.8, 14.1, 12.9, 13.7, and 13.4. 28

1961 U.S. Tax Ct. LEXIS 178">*264 36 T.C. 22">*58 In early 1950, a number of tenants, regardless of their leases, moved from Springfield and Hill, and a number of suits were brought by these projects against tenants who had broken their leases. ²⁹

Between February 1, 1950, and June 8, 1950, the New York Times and the Long Island Daily Press published a number of articles on the budget of New York City and its probable effect on property taxes. 1961 U.S. Tax Ct. LEXIS 178">*265 On February 1, 1950, the Daily Press indicated that assessed values in Queens would be increased considerably. At the end of February the petitioners learned that the assessed values for Springfield were $ 3,435,000 and for Hill, $ 1,570,000, or $ 636,800 more than the aggregate amount which had been shown as the FHA estimate of assessed valuations in its project analysis of February 1948, but, which was still $ 505,000 less than the petitioners had estimated therefor in their mortgage insurance applications. At various times in March the newspapers published reports as to the record budget submitted by the mayor and predicted a rise in the basic and borough tax rates. On March 31, 1950, the Times stated that the budget was expected to produce a "basic" rate of at least $ 3.04, and perhaps as much as $ 3.09. On April 25, 1950, the Times reported that the board of estimate had voted to increase the budget submitted by the mayor and that according to city officials, such action indicated a rise of 15 to 20 points in the then "basic" rate of $ 2.89. Three days later, the Daily Press reported that the board had approved the increased budget and that the rate in Queens was therefore1961 U.S. Tax Ct. LEXIS 178">*266 expected to rise beyond $ 3.18. On May 25, 1950, the Daily Press recited that the new rate in Queens would be at least $ 3.18.

Benjamin Neisloss regularly read these papers, and the petitioners, in May, were of the view that the rate in Queens would be raised at least 20 points to as much as $ 3.22 per $ 100 of assessed valuation. On June 20, 1950, the tax rate for Queens was fixed at $ 3.27, or 25 points above the then-existing rate. For 1950-1951, the increased rate resulted in property taxes of $ 112,324.50 for Springfield and $ 51,339 for Hill. As a result, Springfield's property taxes at the new level exceeded the FHA estimates therefor as shown by its February 1948 project analysis by $ 21,194.50, and in the case of Hill by $ 8,801. In the case of Springfield they were still less by $ 4,292.50 and in the case of Hill $ 661 less than had been estimated by petitioners in their mortgage loan insurance applications.

36 T.C. 22">*59 The FHA in its estimates of the cost of operation shown in its project analysis did not include any amount as cost for the removal of garbage and rubbish. The City which at that time was providing such service discontinued the service in April of 1949 1961 U.S. Tax Ct. LEXIS 178">*267 and thereafter the removal of garbage and rubbish for tenants in the Springfield and Hill apartments was performed by a contractor at the expense of the two corporations.

When Springfield and Hill were constructed it was not contemplated that either project would furnish gas and electricity for the tenants. Competing projects did furnish gas and electricity and by May of 1950 the petitioners had decided that Springfield and Hill would have to do the same. Toward the end of the fiscal year ended August 31, 1950, the prospective purchasers of the projects, hereafter described, asked petitioners to arrange for contracts which would supply the tenants with gas and electricity.

On its income tax return for the year ended August 31, 1949, Springfield reported as gross income $ 347,846.21, of which $ 344,546.71 was shown as rents. Deductions were shown as $ 371,131.82 and a net loss of $ 23,285.61 was reported. Among the deductions claimed were $ 122,074.31 for mortgage interest and $ 111,244.17 as depreciation. It was stated that the depreciation was on a declining balance method. Real estate taxes were shown as $ 4,709.74 and $ 2,255.04 was deducted for rubbish removal. Fuel was 1961 U.S. Tax Ct. LEXIS 178">*268 listed at $ 21,283.49, electricity at $ 1,915.51, and gas at $ 705.80. On the return for the year ended August 31, 1950, gross income was shown as $ 565,485.68, of which $ 561,592.02 was reported as rent. Total deductions were $ 568,605.90 and a net loss of $ 3,120.22 was reported. Among the deductions was $ 171,350.78 as depreciation on buildings by a declining balance method. Real estate taxes were shown at $ 22,724.76, oil at $ 23,551.42, electricity at $ 5,256.34, gas at $ 818.90, rubbish removal at $ 5,896.85, and painting and decorating at $ 7,325.58. Interest on the mortgage was shown at $ 163,760.31. On the return for the year ending August 31, 1951, $ 572,723.89 was reported as gross income, of which $ 568,753.98 was listed as rents. Deductions were shown at $ 625,263.81 and a net loss of $ 52,539.92 was reported. Included in the deductions were $ 25,544.46 for oil, $ 12,323.57 for electricity, $ 3,519.27 for gas, $ 5,316 for rubbish removal, $ 17,458.01 for painting and decorating, $ 112,324.50 for real estate taxes, $ 163,237.18 for interest on the mortgage, and $ 163,640 for depreciation on buildings computed on a declining balance method. The deductions for ground1961 U.S. Tax Ct. LEXIS 178">*269 rent were $ 16,188 for the year ended August 31, 1949, $ 6,745 for the year ended August 31, 1950, and $ 16,188 for the year ended August 31, 1951. For each of the years ended August 31, 1949, and August 31, 1950, Springfield 36 T.C. 22">*60 deducted $ 15,000 for officers' salaries, which for the latter year was in addition to $ 4,918.08 for "Superintendents" and $ 8,088.34 for office salaries. For the year ended August 31, 1950, Springfield on its return deducted a total of $ 62,807.26 as administrative expenses, which in addition to the $ 15,000 for officers' salaries, the other salaries mentioned and various lesser items, included $ 11,355.70 as management fees and $ 20,425.55 as professional fees. On its return for the fiscal year ended August 31, 1951, the total of the administrative expenses deducted amounted to $ 21,660.51. No amount was shown as officers' salaries, while management fees were shown at $ 4,167 and professional fees at $ 2,779.85. Such items as office salaries, salaries for superintendents of apartments and garages, telephone, and other incidentals were somewhat comparable for the 2 years.

For Springfield the FHA in its project analysis had included as estimated1961 U.S. Tax Ct. LEXIS 178">*270 annual expenses $ 22,213 for decorating costs, $ 23,789 for heating and ventilating, and $ 5,264 for lighting and miscellaneous power. For all renting and administrative expenses its estimate was 5 percent of estimated gross income expectancy or $ 27,887. The petitioners in their Springfield application for mortgage loan insurance had estimated annual expenses of $ 25,300 for decorating, $ 21,872 for fuel for heating and hot water, and $ 5,954 for lighting and miscellaneous power. For administrative expenses the petitioners had estimated $ 30,654.

On its income tax return for the year ended January 31, 1950, Hill reported as gross income $ 187,847.87, of which $ 186,404.27 was shown as rents. Deductions were shown as $ 199,537.41 and a net loss of $ 11,689.54 was reported. Included in the deductions were $ 67,936.89 for interest, $ 2,645.53 for real estate taxes, $ 2,651.91 for electricity, $ 322.69 for gas, $ 10,272.44 for oil, and $ 2,005.71 for rubbish removal. Depreciation was claimed on a declining balance method and in the amount of $ 69,734.06. On the return for January 31, 1951, gross income was shown as $ 246,983.89, of which $ 245,572.50 was reported as rents. Total1961 U.S. Tax Ct. LEXIS 178">*271 deductions were $ 273,414.93 and a net loss of $ 26,431.04 was reported. Included in the deductions were $ 13,059.95 for fuel oil, $ 3,627.52 for electricity, $ 662.66 for gas, $ 2,618.26 for rubbish removal, $ 6,423.29 for painting and decorating, $ 31,100.63 for real estate taxes, and $ 76,144.86 for mortgage interest. Depreciation was claimed on a declining balance method and in the amount of $ 78,884.70. For the year ended January 31, 1950, the ground rent deduction was $ 5,727 and for the year ended January 31, 1951, $ 7,636.06. For the year ended January 31, 1950, $ 6,000 was deducted as compensation of officers. In addition, $ 12,264.02 was deducted for salaries and wages but other management costs, if any, were not separately shown. For the 36 T.C. 22">*61 year ended January 31, 1951, no amount was deducted as compensation for officers, but there was a deduction of $ 5,124.29 for management fees.

For Hill, the FHA in its project analysis had included an estimated annual expense of $ 10,393 for decorating costs, $ 11,130 for heating and ventilating, and $ 2,465 for lighting and miscellaneous power. For all renting and administrative expenses its estimate had been 5 percent 1961 U.S. Tax Ct. LEXIS 178">*272 of estimated gross income expectancy or $ 12,933. The petitioners in their Hill application for mortgage loan insurance, had estimated an annual expense of $ 12,625 for decorating, $ 10,369 for fuel for heating and hot water, and $ 2,600 for lighting and miscellaneous power. For administrative expenses petitioners had estimated $ 14,266.

In the case of Springfield and beginning with October of 1949, the mortgage loan payments were to be $ 19,134.50, or $ 229,614 annually. In the case of Hill and beginning with the month of November the payments under the mortgage loan were to be $ 8,831.17 monthly, or $ 105,974.04 annually. In each instance the installment payments were to be applied first to interest at the rate of 4 percent on the unpaid balance of the mortgage loan and the amount remaining was then to be applied to principal. With each monthly payment the portion thereof which was applicable to interest gradually decreased and the portion which was to be applied to principal gradually increased.

Of the first installment of $ 19,134.50 paid under the Springfield mortgage, $ 13,916 was applied to interest and $ 5,218.50 in reduction of the mortgage loan. Of the eleventh installment, 1961 U.S. Tax Ct. LEXIS 178">*273 which was for August 1950, the amount required for interest was $ 13,739.42 and the amount applied on principal was $ 5,395.08. At the end of the 11 months $ 58,369.88 of the mortgage loan had been paid.

Of the first installment of $ 8,831.17 paid for November 1949 under the Hill mortgage, $ 6,422.67 was required for interest leaving $ 2,408.50 to be applied on principal. Of the 10th installment, which was for August 1950, the amount required for interest was $ 6,349.43, and the amount to be applied on the principal was $ 2,481.74. At the end of the 10-month period the mortgage loan had been paid to the extent of $ 24,449.60.

On some date in May 1950, the petitioners were approached by a broker or brokers on behalf of Roy Penzell, as a prospective purchaser of the Springfield and Hill projects. On June 8, 1950, the petitioners entered into an agreement to sell Penzell their 30 shares of class A common stock in each corporation. Penzell then assigned the contract to M & P Holding Corporation. In executing the 36 T.C. 22">*62 contract, Penzell acted on behalf of himself and a then-undisclosed associate, Manoochehr Manoochehrian, and their respective interests were 60 and 40 percent. 1961 U.S. Tax Ct. LEXIS 178">*274 Penzell signed the contract without waiting for his accountant to examine the books of Springfield and Hill. He was anxious to obtain the contract as quickly as possible, because he thought he could promptly dispose of the stock at a profit. After the contract was signed he advertised the stock for sale.

The agreement of June 8, 1950, provided for a purchase price of $ 400,000, subject to some plus and minus adjustments as of August 31, 1950. Of the $ 400,000, $ 273,500 was allocated to the Springfield shares and the balance of $ 126,500 to the Hill shares. The buyer paid $ 25,000 on the execution of the contract, with the remaining $ 375,000, subject to the adjustments, to be due on the closing date, which was fixed as September 8, 1950. It was provided that if the buyer was unable to close on that date, he would be entitled to an adjournment until September 18, 1950, without penalty or forfeiture. The agreement provided for a further adjournment until September 30, 1950, if the buyer deposited an additional $ 50,000 against the purchase price. The brokerage commissions were to be paid by the sellers.

One of the plus adjustments in the contract was "Cash on hand in banks not1961 U.S. Tax Ct. LEXIS 178">*275 to exceed $ 5,000.00, or as mutually agreed." This provision was inserted at the insistence of the attorney for Penzell. Originally the attorney had proposed a provision limiting the cash on hand to $ 1,000. He wanted practically all cash removed from the corporations, because it was difficult to raise the money needed to pay for the cash on hand, and, in addition, he feared that if Penzel paid for the cash on hand and then withdrew it from the corporations, the distributions would be taxed to him as dividend income. The attorney who had represented buyers in other comparable transactions made it a practice to insist that the sellers leave the barest minimum of cash in their corporations. The attorney for petitioners opposed the provision requiring distribution of the cash to the petitioners before the sale, and wanted the sales price to cover all cash in the corporations at the time of closing. After considerable difficulty, the attorneys agreed on $ 5,000 as a compromise figure.

On June 1, 1950, while negotiations were going on, Benjamin Neisloss withdrew $ 55,000 from Springfield, which sum was charged to B.H.B. Associates and used as part payment of a deposit on land purchased1961 U.S. Tax Ct. LEXIS 178">*276 by Benjamin Neisloss, Harry Neisloss, and Benjamin Braunstein.

On June 30, 1950, the board of directors of Springfield voted to increase the book value of its buildings and equipment by $ 750,000, in accordance with the estimated value which had been shown by FHA in its project analysis of February 1948. At the same time, 36 T.C. 22">*63 the board declared a dividend of 5 cents on each share of the 100 shares of preferred stock owned by FHA, and a dividend of $ 13,666 2/3 on the outstanding shares of class A common stock, namely the 30 shares of such stock belonging to petitioners. The total dividend so declared was $ 410,000, payable on August 25, 1950, to stockholders of record on that date.

Similarly, on June 30, 1950, the board of directors of Hill voted to increase the book value of its buildings and equipment by $ 300,000 in accordance with the estimated value which had been shown by the February 1948 project analysis of FHA. At the same time, the board declared a dividend of 5 cents on each share of the 100 shares of preferred stock owned by FHA, and a dividend of $ 4,833 1/3 on each outstanding share of class A common stock, being the 30 shares owned by the petitioners. The total1961 U.S. Tax Ct. LEXIS 178">*277 of the dividend so declared on the common shares of stock was $ 145,000, payable on August 25, 1950, to stockholders of record on that date.

From June 30, 1950, the date of declaration, up to August 25, 1950, the date payable, Springfield at no time had sufficient funds with which to pay the $ 410,000 declared as a dividend on its common stock. After the withdrawal of the $ 55,000 on June 1, 1950, by the petitioners, the balance in its Bank of Manhattan account was $ 48,314.08, which balance remained unchanged until sometime in September. The balance in its Bayside bank account at June 30, 1950, was $ 121,466.43. During July it had receipts from its apartment operations of $ 46,842.99 and disbursements of $ 37,419.80, leaving a balance in the account at July 31, 1950, of $ 130,889.62. The receipts from operations during August amounted to $ 46,774.11, which, without taking into account any disbursements in respect of operations, would have increased the amount on deposit in the account during August to $ 177,663.73.

In the case of the B.H.B. Associates, its bank balance at August 18, 1950, was $ 132,282.26, and this balance continued without change until August 28, 1950.

Springfield, 1961 U.S. Tax Ct. LEXIS 178">*278 both prior to and after June 30, 1950, carried on its books the sum of $ 285,851.72 as receivables from B.H.B. Associates, which consisted of $ 232,014.41, representing the excess of payments by Springfield to the N. B. partnership over and above construction costs of the Springfield project, plus charges for payments made by N. B. partnership for the account of Springfield, and the $ 55,000 withdrawn by petitioners on June 1, 1950, less $ 1,162.69 described as an account payable to B.H.B. Associates to cover charges for Springfield's use and maintenance of a jeep owned by the N. B. partnership. At the same time, B.H.B. Associates carried entries on its books in the same amounts as accounts payable to Springfield, 36 T.C. 22">*64 the $ 232,014.41 having been transferred to the books of B.H.B. Associates from the books of the N. B. partnership under date of March 31, 1950.

According to its books, Springfield on August 25, 1950, made a disbursement of $ 285,851.72 to B.H.B. Associates and received a payment in the exact amount from B.H.B. Associates on August 31, 1950. According to the statement of its Bayside bank account, however, the deposit of the $ 285,851.72 and the charge of the check1961 U.S. Tax Ct. LEXIS 178">*279 to B.H.B. Associates in the same amount were both made on August 25, 1950. According to the books of B.H.B. Associates, it made the disbursement of $ 285,851.72 to Springfield on August 25, 1950, but received the offsetting payment from Springfield on August 28. According to its bank account, the charge for the $ 285,851.72 check to Springfield was made on August 29, 1950, whereas the check from Springfield for that amount was covered in a $ 600,000 deposit to the B.H.B. Associates bank account on August 28, 1950. In addition to the $ 285,851.72 exchange between it and B.H.B. Associates, Springfield, according to its books, made a further disbursement to B.H.B. Associates on August 25, 1950, in the amount of $ 164,148.28, and on August 31, 1950, received an additional payment of $ 40,000 from B.H.B. Associates. According to its Bayside bank statement, the August 25 check for $ 164,148.28 was cleared and charged on August 29, and $ 40,000 was deposited on August 31, 1950. According to the books of B.H.B. Associates, the disbursement of $ 40,000 to Springfield was made on August 25, 1950. According to the stipulation of the parties, the receipt and disbursement of the $ 40,0001961 U.S. Tax Ct. LEXIS 178">*280 between Springfield and B.H.B. Associates represented "exchange," described in "an offsetting receipt and disbursement which has no income tax consequences between the recipient and the payor, as the case may be." The total of $ 285,851.72 and $ 164,148.28 representing the Springfield checks dated August 25, 1950, to B.H.B. Associates, less the $ 40,000 of "exchange," was $ 410,000, the amount declared by Springfield as the dividend on its common stock payable on August 25, 1950. As in the case of the $ 40,000, the Springfield and B.H.B. Associates checks for $ 285,851.72 represented offsetting receipts and disbursements in the same amounts as between the parties. In neither instance could the $ 285,851.72 check have cleared the Springfield or the B.H.B. Associates' bank account without the deposit of the check from the other. The funds in Springfield's Bayside bank account would still have been insufficient to cover its $ 285,851.72 check in favor of B.H.B. Associates, even if the $ 48,314.08 balance in its Bank of Manhattan account had been transferred to its Bayside bank account.

36 T.C. 22">*65 As heretofore shown, Hill carried on its books the sum of $ 23,992.89 as a receivable from1961 U.S. Tax Ct. LEXIS 178">*281 B.H.B. Associates, which represented the excess of the payments by Hill to the N. B. partnership over and above the construction costs of the Hill project, plus charges for payments by the N. B. partnership for the account of Hill. At the same time, B.H.B. Associates carried entries on its books in the same amount as an account payable to Hill, which account payable had been transferred from the books of the N. B. partnership to the books of B.H.B. Associates on March 31, 1950.

According to its books, Hill on August 25, 1950, made a disbursement of $ 97,773.83 to B.H.B. Associates, and on the same date received payment of $ 23,992.89 from B.H.B. Associates, which disbursement and receipt were cleared from and credited to its Bank of Manhattan account. Also, according to its books, Hill made a disbursement from its Bayside bank account of $ 52,226.17 to B.H.B. Associates, likewise on August 25, 1950, and on August 30, 1950, deposited $ 5,000 in its Bayside bank account. According to the books of B.H.B. Associates, it made disbursements of $ 23,992.89 and $ 5,000 to Hill on August 25, 1950. The item of $ 5,000, according to the stipulation of the parties, represented "exchange," 1961 U.S. Tax Ct. LEXIS 178">*282 as described above with reference to certain offsetting receipts and disbursements between Springfield and B.H.B. Associates. The repayment of the $ 5,000 by Hill to B.H.B. Associates was covered in the $ 52,226.17 check of Hill on its Bayside bank account under date of August 25, 1950. The total of the $ 52,226.17 check on Hill's Bayside bank account and the $ 97,773.83 check on its Manhattan account, less the $ 5,000 of "exchange," was $ 145,000, the amount declared by Hill as the dividend on its common stock payable on August 25, 1950.

In the absence of the $ 23,992.89 check received by Hill from B.H.B. Associates on August 25, 1950, and deposited on that date in its Manhattan bank account, the funds in that account would not have been sufficient to clear the August 25, 1950, check for $ 97,773.83 drawn by Hill on its Manhattan account in favor of B.H.B. Associates. Hill would have had a sufficient balance in its Bayside bank account, however, to have covered the overdraft.

After the above payments and repayments, Springfield and Hill each had about $ 7,000 in cash "apart from funds representing rent and key securities" ³⁰ and amounts held for payment to the mortgagee on September1961 U.S. Tax Ct. LEXIS 178">*283 1, 1950. As of August 31, 1950, the mortgage balance was $ 4,116,430.12 for Springfield, and $ 1,902,350.40 for Hill. Neither Springfield nor Hill had any accumulated earnings or profits at the 36 T.C. 22">*66 time of the distribution or any earnings or profits for its taxable year in which the distributions were made.

Penzell and Manoochehrian undertook to sell the contract of June 8, 1950, for the purchase of the Springfield and Hill stock, but were unable to find a purchaser, and at September 8, 1950, the first date specified for closing, they exercised their privilege of postponing the closing until September 18, 1950. On the latter date, they secured another extension to September 30, 1950, by paying an additional $ 50,000. They were engaged at that time in negotiations with a prospective purchaser, but the sale1961 U.S. Tax Ct. LEXIS 178">*284 was not consummated, whereupon Manoochehrian refused to go ahead with the closing. Due to the inability of Penzell to complete the purchase by himself, he was granted a period of several more days within which to act, and on October 5, 1950, the petitioners agreed to a further extension of 30 days.

In the meanwhile, on September 1, 1950, Springfield and Hill each declared a dividend of all of their unissued shares of class A common stock, distributing 156 2/3 shares of such stock to each of the petitioners. On September 10, 1950, Springfield and Hill each issued all of their authorized class B common stock, distributing 33 1/3 shares of such stock to each of the petitioners. The distribution of the class A and class B common shares was in order to prevent the purchaser from issuing any unissued authorized stock not included in the escrow. The petitioners paid no cash or any other consideration for the newly issued shares.

On November 13, 1950, Penzell, joined by two other individuals, purchased all of the stock of Springfield and Hill. The sales price, after adjustments, was $ 399,701.58, and petitioners' offsetting items incident to the sale totaled $ 13,079.10. The purchasers1961 U.S. Tax Ct. LEXIS 178">*285 paid $ 100,000 at the closing, received a credit for $ 75,000 and gave notes for the balance, with the stock as security. They also paid the broker's commissions. At the request of the purchasers' attorney, petitioners' counsel agreed to have the sales contract state that the total price was $ 375,000, subject to a credit for $ 50,000, instead of $ 400,000, subject to a credit for $ 75,000. The litigation between Penzell and Manoochehrian was imminent and Penzell's attorney wanted the credit shown as $ 50,000, to support a claim that Penzell had lost $ 25,000 through Manoochehrian's default.

After the sale of the stock of Springfield and Hill to Penzell and his associates, the two corporations provided utilities free to their tenants. Springfield and Hill continued as owners of the two projects.

During the year ended August 31, 1949, and again on October 31, 1949, petitioners drew $ 5,000 each from Springfield as officers' salaries. Similarly, they drew $ 2,000 each from Hill during the year ended January 31, 1950.

36 T.C. 22">*67 The petitioners each owned more than 10 percent in value of the outstanding stock of Springfield and Hill at the time they acquired such stock and until the1961 U.S. Tax Ct. LEXIS 178">*286 sale thereof on November 13, 1950. On the date of sale, such stock had been held by the petitioners for more than 6 months. The shares were not held as stock in trade or as property of a kind properly includible in inventory, nor were they property held primarily for sale to customers in the ordinary course of any trade or business.

After the sale of the Springfield and Hill stock, the petitioners continued to be active in real estate and the construction of projects, including apartment houses, stores, and a building for the Post Office Department.

As capital gains attributable to the distributions to them by Springfield and Hill on August 25, 1950, each petitioner included in his 1950 return, one-third of the proceeds derived from the sale of Springfield and Hill stock on November 13, 1950. As reported, the capital gains were computed on the returns as follows:

The amount of $ 4,379.70 offset against the reported sales proceeds consisted of $ 20, the cost basis for the stock, and 1961 U.S. Tax Ct. LEXIS 178">*287 $ 4,359.70, one-third of the expenses incident to the sale.

On June 25, 1952, the internal revenue agent in charge in Brooklyn mailed to Benjamin and Julia Neisloss a letter, with a revenue agent's report attached. He mailed similar letters and reports on March 24, 1953, to Harry and Lillian Neisloss and to Benjamin and Diana Braunstein, the reports in those instances being dated February 9, 1953. Each report included a statement of deficiency in income tax for the calendar year 1950 and accompanying schedules. In each case the distributions received from Springfield and Hill and the gain on the sale of the stock in those corporations as reported by the petitioners were adjusted, and treated as ordinary income, rather than capital gains, and section 117(m) of the Internal Revenue Code of 1939 was cited as the ground for the adjustment. The petitioners, in each instance, filed a protest, taking exceptions to the findings set forth in the report and requesting an oral conference. The protests were dated September 22, 1952, in the case of Benjamin and Julia Neisloss, and April 3, 1953, in the other two cases. Each protest contained the following statement:

1961 U.S. Tax Ct. LEXIS 178">*288 The Capital Gains in the amount of $ 313,854.17 ¹ from the Hill Development Co., Inc. and the Springfield Development Co., Inc. are not "Gains on Other Assets" or "Ordinary Income" per Section 117(m) because of the fact that the two above mentioned corporations are not within the scope of corporations described by Section 117(m).

On December 8, 1954, the respondent mailed notices of deficiency to the petitioners, copies of which are attached to the petitions filed herein. In statements attached to the notices of deficiency, it was stated that careful consideration had been given to the report of examination, to the protests filed and the statements made at the conferences, and that it was held that the cash distributions from Springfield and Hill and the amounts realized by each petitioner on the disposition of their stock in the two corporations were fully taxable at ordinary income tax rates under the provisions of the Internal Revenue Code of 1939. The statements disclosed appropriate adjustments to give effect to that holding.

In paragraph 4 of each petition herein, it is alleged that the respondent1961 U.S. Tax Ct. LEXIS 178">*289 erroneously determined that the distributions received from Springfield and Hill and the proceeds received on the sale of the stock in those corporations "were taxable as ordinary income." In paragraph 4 of the original and amended answers, the respondent denied the allegations of error. In paragraph 5 of each amended answer, the respondent alleged certain factual matters with reference to section 117(m) of the 1939 Code, which allegations were denied by the petitioners in their replies filed herein.

The distributions made by Springfield and Hill to petitioners, their shareholders, and the sale by the petitioners of their Springfield and Hill stock were attributable to circumstances which had been advisedly created by the petitioners and which were present prior to the completion of the two projects and to circumstances which reasonably could be anticipated at the time of construction, and were not attributable solely to circumstances which arose after the time of construction.

OPINION.

It is the position of the petitioners that the applicability of section 117(m) of the Internal Revenue Code of 1939 was new matter pleaded by the respondent in his amended answers, and under Rule 1961 U.S. Tax Ct. LEXIS 178">*290 32 of the Court's Rules of Practice, he has the burden of proof with respect thereto. It is our opinion that this position is not well taken. The facts of record definitely show that the applicability of section 117(m) was at all times recognized and understood by the parties on both sides of these cases to be a basis of the differences between 36 T.C. 22">*69 them. That such was the case appears from the revenue agent's report and the protest of the petitioners. In that situation, the references in the notices of deficiency to the revenue agent's report and the protest make it clear that the applicability of section 117(m) to the stock sales proceeds and the distributions by Springfield and Hill was inherent in the respondent's determination. The burden of proof with respect thereto is accordingly that of the petitioners. Rose Sidney, 30 T.C. 1155">30 T.C. 1155, affd. 273 F.2d 928. See also C. D. Spangler, 32 T.C. 782">32 T.C. 782; Leland D. Payne, 30 T.C. 1034">30 T.C. 1034, affd. 269 F.2d 615; and Arthur Sorin, 29 T.C. 959">29 T.C. 959, affirmed per curiam1961 U.S. Tax Ct. LEXIS 178">*291 271 F.2d 741.

The primary issue for decision is whether, under section 117(m), ³¹ the gains realized by the petitioners upon the distributions received by them from Springfield and Hill and upon the sale of their stock in those corporations are to be considered as gain from the sale or exchange of property which is not a capital asset.

1961 U.S. Tax Ct. LEXIS 178">*292 According to section 117(m)(1), gain from the sale or exchange of stock of a collapsible corporation, whether in liquidation or otherwise, which gain, but for section 117(m), would be considered as gain from the sale or exchange of a capital asset, is to be considered as gain from the sale or exchange of property which is not a capital asset. According to section 117(m)(2)(A), a corporation is a collapsible corporation, if it is formed or availed of principally for the construction of property "with a view to * * * the sale or exchange of stock by its shareholders (whether in liquidation or otherwise), or a distribution to its shareholders, prior to the realization by the corporation * * * of a substantial part of the net income to be derived 36 T.C. 22">*70 from such property" and "with a view to * * * the realization by such shareholders of gain attributable to such property."

It is the contention of the petitioners that under section 117(m) and the regulations, section 29.117-11(b) of Regulations 111, ³² a corporation is not a collapsible corporation, unless the "view to" sell the stock of the corporation or have it make a distribution arose and existed prior to completion of construction1961 U.S. Tax Ct. LEXIS 178">*293 of the project; that with respect to Springfield and Hill, the view to sell the stock or to have them make distributions and the occurrences which gave rise to the view to sell and distribute did not arise until near the end of May 1950, which, undisputedly, was after construction had been completed, and such being the law and the facts, Springfield and Hill were not collapsible corporations within the meaning of the statute.

1961 U.S. Tax Ct. LEXIS 178">*294 Much of the petitioners' argument is directed against matter contained in briefs represented as having been filed by the Department of Justice in cases before various of the United States Courts of Appeals. It is charged that in those briefs the Department of Justice through reiterated misstatements of the respondent's regulations has assiduously urged the Courts of Appeals to disregard the regulations as invalid, with the result that in at least one case, Glickman v. Commissioner, 256 F.2d 108, the court was sufficiently impressed to indicate the view that it was sufficient under the statute if the requisite view to sell or distribute was present at the time the corporation was availed of for the proscribed purpose, even though the view to sell or distribute did not in fact arise until after completion of construction, and that in that respect the regulation was narrower than the statute. For the purposes of the instant cases, however, suffice it to say that the Department of Justice briefs not being of record are not before us, and further that the respondent not only does not urge 36 T.C. 22">*71 disregard of the regulations but to the contrary takes1961 U.S. Tax Ct. LEXIS 178">*295 the position that on the facts Springfield and Hill were collapsible corporations within the meaning thereof. Thus in this instance the parties are in accord that the regulation is controlling and if we find that it covers the situation here, there will be no occasion to consider whether the scope of the statute is or is not broader than the regulation.

According to the regulations, a corporation formed principally for the construction of property is a collapsible corporation under section 117(m)(2)(A), if it was "formed or availed of with a view to * * * the sale or exchange of its stock by its shareholders, or a distribution to them, prior to the realization by the corporation * * * of a substantial part of the net income to be derived from such property." And this requirement is satisfied whether the described action "was contemplated unconditionally, conditionally, or as a recognized possibility." From the regulation, it would thus appear that the statute does not require that the view to sell or distribute be final or absolute, but that it is enough even though contemplation of the required action be qualified or conditional or a recognized possibility.

As to when the view to1961 U.S. Tax Ct. LEXIS 178">*296 the proscribed action must exist, the regulation covers three situations. If the requisite view existed at any time during construction, the regulation categorically states that the corporation is formed or availed of with a view to the described action in section 117(m)(2)(A). Where, however, the sale or distribution is "attributable solely to circumstances which arose after * * * construction," the rule is that "the corporation shall, in the absence of compelling facts to the contrary, be considered not to have been so formed or availed of," provided, however, that the circumstances there in contemplation do not include "circumstances which reasonably could be anticipated at the time of * * * construction." If, on the other hand, the circumstances to which the sale or distribution was attributable were present at the time of construction, the reverse is the rule, the regulation prescribing that "the corporation shall, in the absence of compelling facts to the contrary, be considered to have been so formed or availed of."

As observed by the court in Mintz v. Commissioner, 284 F.2d 554, affirming 32 T.C. 723">32 T.C. 723, "exactly1961 U.S. Tax Ct. LEXIS 178">*297 when the view arose is always difficult to determine." And that is particularly true where as here the only direct evidence which purports to fix the time when the view did arise or to specify the circumstances or occurrences to which the view was attributable was the testimony of Benjamin Neisloss, the only one of the three petitioners to testify. That his testimony was self-serving goes without saying but that does not mean that it is to be ignored for such testimony can be persuasive and convincing and particularly is that true when it is in harmony with and corroborated by evidence 36 T.C. 22">*72 otherwise derived. In substantial part, however, the testimony of Neisloss as to the basic facts advanced in support of his testimony as to the time the view arose is not corroborated by but is at variance with facts otherwise established of record.

The situation here is much the same in many respects as that in Elizabeth August, 30 T.C. 969">30 T.C. 969, affd. 267 F.2d 829. The petitioners here, as in that case, rely upon and stress the testimony of one of their number to the effect that when the construction of Springfield and Hill was begun1961 U.S. Tax Ct. LEXIS 178">*298 they did not expect there would be an excess of mortgage proceeds over cost because they did not expect the actual cost of construction to be less than the amount shown in the FHA estimates, although they did hope the cost would not be greater than the amounts shown in the estimates, and that the savings on carpentry, lumber, and plumbing and heating were unexpected. As we stated, in that case it is of no particular significance whether at the time construction of Springfield and Hill was being considered the petitioners did or did not contemplate that they would be able to build the apartments for amounts less than the mortgage loan funds for under the regulations it is sufficient if the distribution or the sale of the stock was contemplated even "conditionally, or as a recognized possibility" or if the circumstances which brought on the distributions or the stock sales when they actually occurred in 1950 could in reason be anticipated at the time of construction. Spangler v. Commissioner, 278 F.2d 665, affirming 32 T.C. 782">32 T.C. 782; Sydney v. Commissioner, 273 F.2d 928; August v. Commissioner, 267 F.2d 829,1961 U.S. Tax Ct. LEXIS 178">*299 affirming 30 T.C. 969">Elizabeth August, supra;Glickman v. Commissioner, supra; and Burge v. Commissioner, 253 F.2d 765, affirming 28 T.C. 246">28 T.C. 246. It is, of course, true that in FHA projects such as these mortgage loan funds may not exceed 90 percent of the amount estimated by the FHA as the cost of the completed property but as in the August case various items were included in the estimates as a matter of course and without regard as to whether or not such costs would in fact be incurred, or, if so, whether they would be incurred in the amounts shown in the estimates. Builder's and architect's fees were included in the estimates at $ 410,303 for Springfield and $ 189,438 in the case of Hill, although the record shows that it was the intent of the petitioners that the fees would never be paid as such. For Springfield title and recording expense was included in the FHA estimate at $ 89,400; the amount actually expended was $ 37,146.04. For Hill the title and recording expense was included in the FHA estimate at $ 41,268. It actually amounted to $ 16,989.23. Legal and1961 U.S. Tax Ct. LEXIS 178">*300 organizational expense for Springfield was shown by the FHA estimates at $ 13,000. The amount actually incurred was $ 4,921.04. With respect to Hill, the amount shown by the FHA estimate was $ 5,600 whereas only $ 1,514.77 was 36 T.C. 22">*73 incurred. It is true that the amount shown as paid by Springfield as interest during construction was $ 157,636.72 as compared with $ 104,370 in the FHA estimate, and the amount shown as paid by Hill was $ 63,328.88 as compared with $ 48,170 shown as estimated therefor by the FHA in its project anlysis. Be that as it may, the parties have stipulated that for income tax purposes only $ 10,281.73 of the $ 157,636.72 so expended by Springfield was capitalized whereas the remaining $ 147,354.99 was deducted and thus treated as a charge against income. As to Hill, the parties have stipulated that for income tax purposes only $ 14,825.80 of the $ 63,328.88 which was expended for interest during construction was capitalized, whereas the balance of $ 48,503.08 was deducted, and similarly treated as a charge against income.

With respect to carpentry and plumbing and heating, it was the testimony of Neisloss that in planning Springfield and Hill it had been1961 U.S. Tax Ct. LEXIS 178">*301 their purpose to have the work done by subcontractors, but because the prices quoted by the subcontractors were higher than had been contemplated they decided to do the work from the beginning for their own account and in so doing their cost was less than estimated by $ 80,000 on carpentry and $ 85,000 on plumbing and heating. With respect to lumber, it was his testimony that they had anticipated they would need about 5 million board feet and the cost would be $ 100 per 1,000 board feet, whereas they were able to make their first purchases at $ 98.50 per thousand feet, from which the prices paid ranged downward so that the final purchases were as low as $ 75 per thousand feet and the savings for lumber on the two projects were approximately $ 50,000.

Another item of significance was the cost for the construction of off-site improvements which had been estimated by the FHA at $ 101,443 and which according to the closing agreement were to be constructed without cost to Springfield and for which a deposit in escrow was supposed to have been made. Exclusive of the $ 101,443 estimated as the cost for off-site improvements the FHA's estimate of the cost of the physical construction of1961 U.S. Tax Ct. LEXIS 178">*302 the Springfield apartment and garages had been $ 4,002,959. Actually the cost to Springfield for the apartments, garages, and the off-site improvements combined was $ 3,807,908, or $ 159,051 less than the $ 4,002,959 which had been estimated for the apartments and garages alone, or $ 296,494 less than had been estimated for the three combined. There is no showing of the amount actually expended for off-site improvements or that any amount therefor was ever deposited in escrow by the petitioners, but from what is shown it would appear that such cost as was incurred was paid from mortgage money and thus became a liability of Springfield even though the FHA requirements were to the contrary.

36 T.C. 22">*74 In the case of Hill, a comparable factual picture is also shown with respect both to the construction cost of the apartments, garages and of the off-site improvements.

As shown by the facts, the total cost of the Springfield project, including the cost of the off-site improvements and including the entire $ 157,636.72 for interest paid during construction, was $ 4,069,007.82 which was less than the mortgage loan proceeds by $ 105,792.18. In the case of Hill, the total cost, including 1961 U.S. Tax Ct. LEXIS 178">*303 the cost of off-site improvements and including the entire $ 63,328.88 for interest paid during construction, was $ 1,872,834.53, which was less by $ 53,965.47 than the mortgage loan proceeds.

The petitioners were not novices in the construction business but were experienced builders. They had had substantial experience in comparable building operations, having constructed, among other housing projects, several apartments with FHA financing. And whatever their original plans may have been, we are satisfied that before and during actual construction they were fully aware of the savings factors and that they knew well before completion of the Springfield and Hill projects that there would be substantial balances of mortgage funds after all costs, including off-site improvements which were not supposed to be paid from mortgage loan funds, had been paid. Also, we are satisfied, as will hereafter appear, that plans had already been made for use of those funds which were wholly unrelated to the purposes and operations of Springfield and Hill.

As showing the basic facts to support the conclusion that there was no view to the distributions made or to the sale of the Springfield and Hill1961 U.S. Tax Ct. LEXIS 178">*304 stock within the meaning of the statute and the regulations or stated otherwise the facts which precipitated or brought on the view to the action taken the petitioners again rely on the testimony of Benjamin Neisloss, which was to the effect that having studied the literature of the FHA which stressed the stability and income-producing capacity of such projects and relying on the FHA estimates of the net income to be expected from Springfield and Hill, he, his brother, and Braunstein entered into the projects because they "saw the chances for a good return, management fees * * * profits" and "could accumulate over a period of time, some estate" for their families; that at no time before or during construction did they contemplate or have any intention to sell their stock or consider the possibility of selling or of having the corporations make distributions to themselves as the stockholders; they never listed the stock with brokers but refused to negotiate with several brokers who approached them after construction was completed and in March or April of 1950 refused an offer of $ 350,000 advising the broker that they were not interested in selling "at that 36 T.C. 22">*75 time"; and it was1961 U.S. Tax Ct. LEXIS 178">*305 not until the last 2 weeks in May of 1950 when because of reduced rental receipts due to increased vacancies and to increases in real estate taxes and certain added costs of operations, which had not been anticipated or estimated for by the FHA, they decided to sell their stock as quickly as possible before the projects began to operate at a loss.

Relying on the FHA estimates the petitioners, according to Neisloss, had anticipated that the annual net income of the two projects would be approximately $ 78,000; that in making these estimates the FHA had allowed for vacancies at 7 percent and each two percentage points beyond the 7 percent as projected by the FHA would result in a loss of about $ 16,000 in rental income; that early in 1950 many tenants moved out because they found more desirable apartments or bought homes of their own, and about 100 suits were pending against tenants who had broken their leases; that in the first 3 months of 1950 they figured the vacancies at 9 percent or over 9 percent and in May they became extremely concerned when the percentage of vacancies failed to go down. Other factors which, according to Neisloss, brought on the change in their attitude toward1961 U.S. Tax Ct. LEXIS 178">*306 continued ownership of the Springfield and Hill projects in late May of 1950, as contrasted with their refusal of the $ 350,000 offer in March or April were that in estimating the net income of the projects the FHA had estimated the prospective real estate taxes of Springfield and Hill at $ 91,130 and $ 42,538, whereas by the end of February the petitioners learned that the assessed values of Springfield would be $ 3,435,000 and for Hill would be $ 1,570,000 and by May 25 one New York newspaper declared the tax rate would be at least $ 3.18 which was 12 cents higher than the rate used in the FHA estimates, the final rate being $ 3.27 and the taxes for Springfield and Hill, $ 112,324.50 and $ 51,339, respectively, or an increase for the two of approximately $ 30,000 over the FHA estimates; that in addition they were incurring or were faced with increases in operating expenses amounting in the aggregate to approximately $ 51,000 per year which had not been estimated for by the FHA. This $ 51,000, according to Neisloss, consisted of $ 10,000 which was the anticipated cost per year for removing trash and garbage for tenants, the free removal of which was discontinued by the City of New1961 U.S. Tax Ct. LEXIS 178">*307 York, $ 10,000 for the redecoration of apartments resulting from the unexpected turnover of tenants, of which there had been about 70 in the first 5 months of 1950, and $ 31,000 which was an approximation of the cost of furnishing gas and electricity for tenants which it was thought would be required to meet the competition from the other projects. Thus, according to Neisloss, by taking into account the $ 30,000 for increased real estate taxes and the other 36 T.C. 22">*76 items making up the $ 51,000 above and allowing $ 16,000 as the reduction in rents due to vacancies they were faced with an increase of $ 97,000 in carrying charges which had not been estimated for and the net income of $ 78,000 which had been estimated by the FHA and upon which they depended would become a deficit of at least $ 20,000 or $ 21,000 a year.

At this point let us say that we are not impressed with the representation or suggestion that it was the FHA's estimate of net income that induced the petitioners to enter into the Springfield and Hill ventures. Petitioners were the applicants and based on their own experience they obviously had their own ideas as to operating results to be anticipated and had so indicated1961 U.S. Tax Ct. LEXIS 178">*308 on their applications. They were, of course, deeply interested in the FHA estimates of the costs of construction because it was on the basis of those estimates that the amount of obtainable mortgage money was determined. And in that connection note the prompt rejection of the FHA mortgage loan insurance commitments on the first applications. Note also that in their new applications the petitioners in their estimates of income, net after operating expenses and debt service requirements, were still of the opinion that the amounts would not be as great as had been estimated by the FHA on the original applications. Also the petitioners undoubtedly were interested in the rental rates appearing in the FHA estimates of gross income expectancy. But in that connection it is to be noted, as will be pointed out hereafter, that even at the higher rental rates which had been proposed by the petitioners in their applications and the correspondingly higher gross income expectancy, the petitioners' estimates of income, net after operating expenses and debt service requirements, were still substantially less than the net estimated by the FHA using the lower rental rates. It was on such estimates1961 U.S. Tax Ct. LEXIS 178">*309 of results of operations that petitioners sought approval of the Springfield and Hill projects.

For a great number of years the petitioners had been engaged in the construction of housing projects and previously had built five projects which similarly had been financed under section 608 of the National Housing Act, two of such projects having been completed as early as 1943, one in 1944, one in 1945, and the fifth in 1948 and apparently under construction when the Springfield and Hill projects were being planned. It was with this background of direct experience that they made application for mortgage loan insurance for the two additional projects and in making such application they sought approval on the basis of their own estimates not only of cost of construction but of gross income expectancy, operating expenses, fixed charges, which included debt service requirements, and the net results therefrom. And if the estimates of construction costs are to be regarded as indicative 36 T.C. 22">*77 it would appear that the tendency of both the petitioners and the FHA was definitely quite liberal. Actually the amounts here referred to as estimates of net income were not estimates of net income1961 U.S. Tax Ct. LEXIS 178">*310 but as already indicated were estimates of gross receipts, less operating costs including an addition to a "reserve for replacements" and less the amount necessary to cover debt service requirements. And whereas for Springfield the amount, net after operating costs and debt service requirements, as estimated by the FHA, was $ 53,925 and for Hill $ 24,916, or $ 78,841 for both, which latter amount in the round figure of $ 78,000 is referred to by petitioners as the FHA estimate of annual net income for the two projects, the estimates of the petitioners as shown by their applications, and which patently they regarded as sufficiently attractive to make them desirous of entering upon the ventures even with substantially greater mortgage loan burdens, were $ 28,361 for Springfield and $ 16,631 for Hill, or $ 44,922 for both. Further it is to be noted that such were the estimates of the petitioners even though due to the differences in the rental rates per family unit applied for by petitioners and the rates allowed by the FHA, the gross income expectancy for Springfield as estimated by the FHA was lower by $ 22,298 than estimated by petitioners and for Hill approximately $ 7,000. In1961 U.S. Tax Ct. LEXIS 178">*311 the case of Hill the FHA estimated for 117 garage spaces and petitioners for only 109.

The evidence does show that by May of 1950, Springfield and Hill were facing some operating costs which had not been estimated for and that some drop in 1950 income to a point below the estimated gross income expectancy was likely, and in that respect the testimony of Neisloss does find support in the facts of record. In amounts, however, his testimony is not supported by the evidence and in one instance the facts show that not only had allowance been made therefor in the estimates of both the FHA and the petitioners, but in each instance the amount which had been estimated was substantially greater than the expenditures actually made by Springfield and Hill therefor.

In estimating the gross income expectancy for Springfield and Hill, both the FHA and petitioners allowed for vacancies of 7 percent. Stipulated facts show that for the first 11 months of 1950 the vacancies in the case of Hill were 15.3 percent and in the case of Springfield 7.9 percent. It was the testimony of Neisloss that the increase in vacancies for Springfield and Hill as a unit was more than 2 percent, and with each 2 percent1961 U.S. Tax Ct. LEXIS 178">*312 increase in vacancies the gross income would drop $ 16,000 which was the amount they allowed for in making their decision to sell. According to the evidence, however, Springfield had rental income of $ 561,592.02 for the year ended August 31,1950, or $ 3,860.02 more than the $ 557,732 the FHA had estimated and in addition 36 T.C. 22">*78 had other income of $ 3,893.66 for which no estimates had been made by either the FHA or the petitioners, thereby bringing Springfield's total gross income for the year to $ 565,485.68. The evidence further shows that for the year ended August 31, 1951, Springfield's rental income was $ 568,735.98, or $ 11,003.98 more than the FHA had estimated, and in addition it had other income of $ 3,987.91 for which no allowance had been made in the estimates, thereby bringing total gross income to $ 572,723.89, or $ 14,991.89 more than had been estimated for by the FHA. As to Hill, the evidence is limited to only 1 year of operation with full capacity available, namely the year ended January 31, 1951. For that year its reported rental income was $ 245,572.50, or $ 13,093.50 less than the $ 258,666 as estimated by the FHA. As in the case of Springfield, Hill had1961 U.S. Tax Ct. LEXIS 178">*313 other income which had not been estimated for which in the case of Hill was $ 1,411.39, thereby bringing Hill's actual gross income for the year to an amount $ 11,682.11 under the FHA estimate. And if the actual experience of Springfield for the year ended August 31, 1950, and that of Hill for the year ended January 31, 1950, be taken as representative of what appeared to be in store for the two projects combined as of May 1950, the drop in their gross income below the FHA estimate was no more than $ 3,928.43. If on the other hand Springfield's year ended August 31, 1951, be regarded as more nearly indicative of prospects, there was no drop of gross income below the FHA estimates.

As for rubbish and garbage removal, the income tax returns indicate an expenditure of $ 5,896.85 by Springfield for the year ended August 31, 1950, and by Hill $ 2,618.26 for the year ended January 31, 1951, which together would indicate an annual expenditure of approximately $ 8,500. This was an expense which originally had not been estimated for by either the FHA or the petitioners. It was not an expense arising for the first time in early 1950, but one which had regularly been incurred beginning with1961 U.S. Tax Ct. LEXIS 178">*314 April 1949 when the City of New York had discontinued such service.

As for the cost of redecorating apartments, the facts show that in the case of Springfield the FHA in its estimate of operating expenses allowed for an annual expense of $ 22,213 for decorating, of which $ 16,448 was for tenant space, and that the petitioners in their application had allowed for an annual expenditure of $ 25,300. In the case of Hill, the FHA had allowed for an annual expense of $ 10,393 of which $ 7,695 was for tenant space, and the petitioners in their application had allowed for an annual expenditure of $ 12,625. In contrast, Springfield's income tax return for the year ended August 31, 1950, indicated an expenditure of only $ 7,325.58 for all painting and decorating during the year and its return for the year ended August 31, 1951, expenditures of $ 17,458.01, which was still substantially less 36 T.C. 22">*79 than the $ 22,213 allowed by the FHA and the $ 25,300 which had been anticipated by the petitioners. Hill in its income tax return for the year ended January 31, 1951, reported total expenditures for all painting and decorating at $ 6,423.29 compared with the $ 10,393 allowed by the FHA in its1961 U.S. Tax Ct. LEXIS 178">*315 estimates and the $ 12,625 which, according to their application for mortgage loan insurance, had been anticipated by the petitioners. On brief the petitioners call attention to the fact that the FHA in making its estimates anticipated the redecorating of each apartment once every 3 years. Possibly this was regarded as bolstering the testimony of Neisloss that the rate of turnover was such as to require substantial decorating expenses which had not been estimated for, in that the amounts shown in the FHA estimates were to be spread over a 3-year period, but whatever petitioners may have had in mind the above estimates of both the FHA and petitioners were estimates of annual expenditures and were not amounts which were to be spread over a 3-year period. As to the rate of turnover actually experienced, the question when directed to Neisloss was objected to on the grounds that the records of Springfield and Hill would be the best evidence and upon such objection the question was withdrawn and no further proof on the point was thereafter offered.

With respect to gas and electricity for tenants, the record does support Neisloss in his testimony that neither the FHA nor the petitioners1961 U.S. Tax Ct. LEXIS 178">*316 made any allowance therefor in their estimates of operating expenses. According to Neisloss they realized by May of 1950 that they were faced with that added expense which they estimated would amount to approximately $ 31,000 annually and at the request of the purchasers of the Springfield and Hill stock they made arrangements for such service. We are not advised when the furnishing of gas and electricity actually began. The contract with the sellers was signed in June. Settlement of certain matters preparatory to closing the sale was made as of August 31, 1950, and actual closing was on November 13, 1950. From the first income tax returns filed, it appears that each project had expenditures for both gas and electricity from the beginning of their operations. For the year ended August 31, 1950, Springfield, according to its return, expended $ 5,256.34 for electricity and $ 818.90 for gas. If any part of the amount so expended represented the cost of electricity and gas for tenants, the record does not show. That the expenditures could in part have been for tenants has some support from the fact both the FHA and the petitioners in their estimates indicated all costs for gas1961 U.S. Tax Ct. LEXIS 178">*317 were to be borne by the tenants. According to its return for the year ended August 31, 1951, Springfield in that year expended $ 12,323.57 for electricity and $ 3,519.27 for gas, or a total for the two of $ 15,842.84. These expenditures exceeded those of the prior year by $ 9,767.60 and presumably represented in some 36 T.C. 22">*80 amount expenditures for tenants, but as to how much and whether for a full year or only part of the year, the record is silent. With respect to Hill, the only information of record which would appear to cover a full year of operation after construction had been completed is to be found in its income tax return for the year ended January 31, 1951. According to that return the expenditures were $ 3,627.52 for electricity and $ 662.66 for gas. There again we are not advised as to the portion of those amounts which represented the cost of gas and electricity for tenants. But even if it be assumed that the amounts shown as so expended by both Springfield and Hill represented in substantial part, or in full, expenditures for tenants the results would still be substantially short of the $ 31,000 figure testified to by Neisloss. And not only because of the state1961 U.S. Tax Ct. LEXIS 178">*318 of the evidence as indicated but in the light of the undependability of the representations in his testimony as to other items, we are not convinced or persuaded that it should be regarded as accurate or substantially so in this instance.

With respect to real estate taxes the facts do show that at or about the end of February the assessed value of the Springfield and Hill properties were fixed at amounts considerably higher than the FHA had estimated and with the subsequent increase in the tax rate the real estate taxes for the two projects were increased to amounts which in the aggregate were approximately $ 30,000 more than the FHA had estimated. Actually there is no showing that there ever had been a prior assessment of the completed properties and that the February figures did in fact represent increases in assessments. The facts do show, however, that the petitioners in their applications for mortgage loan insurance had been of the opinion that the assessed values of the projects would be even higher than the amounts at which they were fixed at or about the end of February 1950, and that the resulting real estate taxes would likewise be greater than the taxes actually were 1961 U.S. Tax Ct. LEXIS 178">*319 after the rate increase in May or June of 1950. In short, the taxpayers in their estimates had made allowance for real estate taxes greater in amount than they were after the 1950 increase.

As demonstrating that there could have been no view to have Springfield and Hill make distributions or to sell the stock thereof until May of 1950, the petitioners on brief summarize as facts shown by the evidence, that they went into the projects as an attractive long-term investment, they expected a good return and planned to accumulate an estate for their families, they did not intend to sell their stock or even consider the possibility of selling it until late May of 1950 when their fears as to the future of the corporations were aroused and "reluctantly" they decided to sell. Aside from the testimony of Neisloss to that effect, we find no evidence of 36 T.C. 22">*81 record which in our opinion would justify or supply the basis for such conclusions of fact. Rather we think the evidence, including the acts of the petitioners themselves, tends to support and establish a contrary conclusion. We can readily agree that the making of distributions would not have been compatible with a purpose to build1961 U.S. Tax Ct. LEXIS 178">*320 up Springfield and Hill as an estate for the families of petitioners. And while we find no occasion to discount the existence of a purpose on the part of the petitioners to build estates for their families, we think the course of action followed by them points away from rather than to Springfield and Hill as repositories of such estates.

In evaluating the intentions of the petitioners and the testimony of Neisloss upon which they rely, it is significant, we think, that the petitioners in organizing Springfield and Hill and during the entire period of their ownership, never supplied either corporation with other than token amounts of cash risk capital, namely $ 30 to each corporation, which amounts would not even cover the expenses of organization. Being thus wholly dependent upon borrowed capital, Springfield was required to begin operations with its properties burdened with a mortgage loan of $ 4,174,800 which exceeded by $ 105,856.18 the total cost of the properties as well as legal and organization expenses, fees, interest, and taxes during construction and the like, and similarly Hill began its operations with its properties burdened with a mortgage loan of $ 1,926,800, which1961 U.S. Tax Ct. LEXIS 178">*321 exceeded by $ 53,965.47 the entire cost of its properties plus other costs as in the case of Springfield. These mortgages were amortizable in monthly installments and Springfield and Hill, having no capital of their own and there being no apparent intent of supplying them with such capital, could build up their equities, other than appreciation, in their operating properties only as each installment was paid. Of the initial installment in each instance approximately 70 percent was absorbed in paying the interest charges on the loans and approximately 30 percent was applicable in satisfaction of principal. With the payment of each installment, however, the portion applicable to principal would increase and the portion required for interest would correspondingly decrease. Such being the situation, it would not have been illogical, to say the least, to expect that the petitioners would not only take steps to see that the projects were operating to their best advantage, but that any and all funds belonging to the corporations would be carefully administered and applied for the full benefit of the corporations if in truth and in fact they did intend to own and hold their stock as a1961 U.S. Tax Ct. LEXIS 178">*322 long-term investment so as to accumulate "over a period of time some" estate for their families. The evidence, however, does not show that such was the case.

36 T.C. 22">*82 At the outset the petitioners had obtained options to purchase land for the Springfield and Hill projects, with the options containing a provision for refund of the payments made therefor if the applications to the FHA for mortgage loan insurance should not be approved. In December of 1947, the options were exercised and of the total price paid $ 81,600 was attributable to the land to be utilized in the Springfield project and $ 38,400 to the land to be utilized in the Hill project. The purchases, however, were not made for the account of Springfield and Hill, neither was there any subsequent transfer of the land to the corporations as contributions to capital or otherwise. Instead the land was conveyed to the wives of the petitioners and the only estates received by Springfield and Hill in the land they were to develop were 99-year leases for which they were to pay an annual ground rent of $ 16,188 in the case of Springfield and $ 7,636 in the case of Hill, to wives of the petitioners. By this course of action 1961 U.S. Tax Ct. LEXIS 178">*323 Springfield and Hill not only would not be the beneficiaries of the appreciation in the value of the land, which would result from their improvement thereof, but from the beginning and for a period of 99 years were obligated to make fixed annual payments of ground rent in amounts which in slightly more than 5 years would cover the total price just paid for the land. The wives of the petitioners thus acquired valuable estates which, without any of the normal burdens usually attendant upon the ownership of land, assured them of very attractive annual returns in the form of ground rent, the right to which was in no way dependent upon any continued ownership by the petitioners of the Springfield and Hill stock. From its commitments for insurance, it would appear that the FHA was of the opinion that as a result of the construction of Springfield the value of the land occupied by it would be increased from its cost of $ 81,600 to $ 404,700 and that of Hill from its cost of $ 38,400 to $ 190,900, and these amounts of $ 404,700 and $ 190,900 represented the amounts the FHA would be required to pay to the wives of the petitioners if later it became necessary to take over the projects and 1961 U.S. Tax Ct. LEXIS 178">*324 it was found expedient to acquire the land in fee.

In the case of Springfield the payments under the mortgage bond were to be $ 19,134.50 monthly and in the case of Hill, $ 8,831.17 monthly. It was provided that the installments should be applied first to interest at the rate of 4 percent on the principal sum, or so much thereof as should from time to time remain unpaid, with the balance to be applied to principal. By specific provision, there was reserved to Springfield and Hill the privilege "to pay the debt in whole or in an amount equal to one or more monthly payments on principal next due, on the first day of any month prior to maturity upon at least thirty (30) days prior written notice to the holder." By a rider attached it was provided that such prepayment could be made 36 T.C. 22">*83 up to 15 percent of the original face amount of the mortgage without any additional charge. If, however, the prepayment exceeded such 15 percent, additional charges were provided ranging from 4 percent downward as the number of remaining years under the mortgage decreased.

Having received excess mortgage funds of $ 105,856.18, Springfield by taking advantage of the privilege afforded of prepaying1961 U.S. Tax Ct. LEXIS 178">*325 one or more monthly payments on "principal next due," not only could have reduced the principal sum owing under its mortgage but could have relieved itself of the further running of interest on the amount of principal so paid and Hill could have utilized its excess mortgage funds of $ 53,965.47 to its similar advantage. Patently, Springfield did not require the use of the $ 105,856.18 in connection with its operations and Hill similarly did not require the use of at least $ 23,992.89 of its mortgage funds, since very shortly after their receipt from the mortgagee these amounts were paid over or advanced to the N.B. partnership for its use or for the personal use of the petitioners and were never thereafter held or used in any way by Springfield and Hill. The facts further show that by December 13, 1949, Springfield had similarly paid over to the N.B. partnership the further sum of $ 126,047.37 which apparently represented accumulated rents received and which petitioners must have concluded was not needed or required in the operation of Springfield's business, since those funds were never thereafter paid to Springfield for its use and benefit. Insofar as appears, this sum likewise1961 U.S. Tax Ct. LEXIS 178">*326 might well have been applied in prepayment of monthly payments on "principal next due" and thereby have strengthened and built up the equity of Springfield in its operating properties and, by reducing the unpaid principal balance on mortgage loan, relieved Springfield of further interest charges on the principal so prepaid.

In the course of their operations the petitioners freely transferred funds back and forth between their controlled or wholly owned projects, incorporated or otherwise, and there is no indication of formal authorizations for such transfers or written evidences of indebtedness. In short, there was nothing arm's length about any of the transactions, and petitioners, insofar as the shifting of funds was concerned, treated the wholly owned corporations no differently from the N. B. partnership or B. H. B. Associates, which was their joint account and successor to N. B. partnership. They would dip into the till of any one of their corporations for funds to launch a new venture. They would take money from their various ventures for their own personal use and charge it on the books of another, as for instance, the funds drawn from Brookside Gardens and charged as the1961 U.S. Tax Ct. LEXIS 178">*327 liability of N. B. partnership on the books of the partnership. They would, 36 T.C. 22">*84 it is true, have appropriate bookkeeping records made to reflect debits and credits but by a further shifting of funds they would clear those accounts in part or in whole if, as, and when they saw fit.

The N. B. partnership took over the contracts for the construction of Springfield and Hill from N. B. Construction Co., Inc., shortly after construction of Springfield, and possibly that of Hill, had been started. And while those contracts provided for the payment of specified sums for construction of the two projects, it is the representation of the petitioners that they were constructed strictly on a reimbursement-of-costs basis. That such was the case receives support from the fact that the partnership returns were filed on that basis and they were accepted and approved by the respondent as filed. The facts also indicate that the building of the shopping center for Oakland Gardens, Inc., was likewise handled on a reimbursement-of-cost basis. There is no showing or claim that the N. B. partnership ever had any funds or capital of its own or that it was intended to have. And in addition to the1961 U.S. Tax Ct. LEXIS 178">*328 payments received from Springfield and Hill as construction of those projects progressed, N. B. partnership at various times received funds from the petitioners individually and from various of their other enterprises including Brookside Gardens, Inc., Brookside Builders, Inc., Somerville Gardens, Inc., and Somerset Homes, Inc., in respect of which funds, appropriate entries were made on the partnership books to show the amounts so received as owing by the partnership to the various enterprises, except of course those amounts received from Springfield and Hill which were applied in satisfaction of the charges in respect of the construction of their properties.

When Springfield was approximately 82 percent completed and Hill approximately 72 percent completed the petitioners entered on the construction of the shopping center adjacent to the two projects. For that type of project they did not have access to financing such as that provided through the FHA. The shopping center was in corporate form and was owned and controlled by the petitioners but insofar as appears it had been provided with no capital of its own with which to pay any of the costs of construction and there is no indication1961 U.S. Tax Ct. LEXIS 178">*329 that there was ever an intent to supply it with any such capital. It was constructed by the N. B. partnership from a pool of materials which originally had been set up for the construction of the Springfield and Hill projects and its completed cost of $ 313,213.58 was an allocated amount from a total of $ 5,878,703.20 which represented the total cost of the Springfield, Hill, and shopping center projects combined.

There was no earmarking of the dollars or any recording of the sources of the funds which were actually applied in satisfaction of the 36 T.C. 22">*85 costs of constructing the shopping center. According to the stipulation of the parties the books of the N. B. partnership show that on December 13, 1949, $ 227,228.95, being the full amount shown as owing to Brookside Gardens, which amount included approximately $ 150,000 which Brookside Gardens had advanced to petitioners individually and for which the N. B. partnership had been charged, was paid in full. When that payment was made all advances to the N. B. partnership, as shown by its books, had been fully repaid except for the moneys received from Springfield and Hill and the amounts shown as being the net advances from the1961 U.S. Tax Ct. LEXIS 178">*330 petitioners individually. On the next day, December 14, 1949, N. B. partnership, according to its books, received $ 100,000 back from Brookside Gardens. Also on December 14, 1949, the N. B. partnership received from Oakland Gardens the first payment on the cost it had incurred in constructing the shopping center. The amount of the payment was $ 8,543.46, leaving $ 304,670.12 as the balance owing by Oakland Gardens. On January 10, 1950, all amounts standing on the partnership books as owing to petitioners individually were shown as paid in full. The amount paid to Benjamin Neisloss was $ 183,930.74, the amount paid to Harry Neisloss $ 169,542.90, and the amount paid to Braunstein $ 180,748.26. After these payments the only funds shown by the partnership's books as having been received from the petitioners or their various enterprises and still remaining unpaid, consisted of $ 232,014.41 from Springfield, $ 23,992.89 from Hill, and $ 100,000 from Brookside Gardens. Thus, it was only from these funds that on that date the N. B. partnership could account for the $ 304,670.12 which had been expended in the construction of the shopping center and which was still owing to it from 1961 U.S. Tax Ct. LEXIS 178">*331 the shopping center. In lieu of payment of the said balance still owing by it to the N. B. partnership, Oakland Gardens at or prior to January 31, 1950, executed in favor of the N. B. partnership or the petitioners an interest-bearing mortgage for $ 300,000. The balance of $ 4,670.12 was finally paid to the B.H.B. Associates on March 31, 1951.

Not only do the facts thus show that the petitioners were freely using the surplus funds of Springfield and Hill for their individual purposes which were in no way related to Springfield and Hill or their operations, but since for all practical purposes the funds of Springfield and Hill necessarily accounted in substantial part for the $ 304,670.12 balance which had been expended in the construction of the shopping center, Springfield and Hill were thus supplying to the petitioners free of charge funds on which the petitioners under the Oakland Gardens mortgage were receiving interest at 6 percent annually, and not only that, but of the funds so provided by Springfield and Hill, Springfield on $ 105,856.18 and Hill on $ 23,992.89 were, at their own expense, paying interest at the rate of 4 percent. By way of 36 T.C. 22">*86 contrast, the evidence1961 U.S. Tax Ct. LEXIS 178">*332 shows that when repayments were made to Brookside Gardens by Springfield and Hill of moneys they had received shortly after their organization, the amounts when repaid were greater than the amounts shown to have been received, and insofar as appears could have represented the payments of interest by Springfield and Hill.

It requires no effort to understand the willingness of the petitioners to use 4 percent money to earn 6 percent, and particularly so where they are able to use the 4 percent money free of charge. But where, as here, such use of the money was at the expense of Springfield and Hill and had been initiated substantially prior to the completion of the construction of the Springfield and Hill projects, it requires considerably more effort than we have the power to muster to see wherein the fact thereof is a fact compelling the conclusion that ultimate distributions were not attributable to circumstances present at the time of construction but were attributable solely to circumstances which arose after construction. Furthermore, it is, in our opinion, not without significance that after the agreement to sell had been reached and the formal distributions were made, the 1961 U.S. Tax Ct. LEXIS 178">*333 said distributions by Springfield and Hill to the petitioners could not be made without the kiting of checks between those two corporations and the petitioners' joint account, B.H.B. Associates.

According to Neisloss, the petitioners in entering upon the Springfield and Hill projects were not thinking solely in terms of attractive long-term investments but had in mind benefiting currently to the extent of fees for management services to be rendered the two projects, and the income tax returns do indicate that both Springfield and Hill did pay fees for such services, which presumably were paid to the petitioners. In the case of Springfield, however, the management fees were in addition to office salaries, the salary of the superintendent, and that of the manager of the apartments and garages. The facts further show that in addition to such management fees and salaries, petitioners in each of the years ended August 31, 1949, and August 31, 1950, drew $ 5,000 each, or a total of $ 15,000, from Springfield as officers' salaries and similarly drew $ 2,000 each, or a total of $ 6,000, from Hill for the year ended January 31, 1950. We are unable to conclude that such salaries to officers1961 U.S. Tax Ct. LEXIS 178">*334 were contemplated by the FHA or estimated for by the petitioners. Both the FHA and the petitioners did make estimates for administrative expenses but there was no breakdown and taking into account the expenditures by the two projects for management other than the salaries to petitioners as officers and other normally to be expected items of administration expenses, we are satisfied that the FHA in making its estimates did not contemplate the payment of salaries to officers in addition to the other management costs incurred, whatever may have been in the minds of the petitioners. 36 T.C. 22">*87 In the case of Springfield, the estimate of the FHA for all administrative expenses was $ 27,887 and the estimate of the petitioners $ 30,654, whereas for the year ended August 31, 1950, Springfield is shown to have expended $ 11,355.70 for management fees and $ 13,006.42 as office salaries and other managerial services, or a total of $ 24,362.12 before showing any expenditures for other administrative purposes and without including the $ 15,000 which the petitioners drew as officers' salaries. For the year ended August 31, 1951, during most of which Springfield operated under new owners, the total1961 U.S. Tax Ct. LEXIS 178">*335 amount expended for all administrative expenses was $ 21,660.51, of which $ 15,744.42 covered all management and office salaries. No amounts were shown as officers' salaries.

After outlining the occurrences in the spring of 1950, which were said to have brought about a "reluctant" decision to sell, it was the testimony of Neisloss, in response to a question on cross-examination, that while every project had its own analysis and every project could not be treated the same, the occurrences in the spring of 1950 leading to the decision to sell "would certainly worry" them "about building another job or doing anything else." It is to be noted, however, that 8 days before the signing of the agreement to sell the Springfield and Hill stock the petitioners had drawn $ 55,000 from Springfield for the purpose of launching another FHA project, which amount likewise was carried as a loan.

When the pieces of the jigsaw are put in place and the resulting picture is viewed as a whole, we find no real support for the self-serving conclusions outlined by Neisloss in his testimony. To the contrary, the picture, we think, reflects a purpose on the part of petitioners not to look on Springfield and1961 U.S. Tax Ct. LEXIS 178">*336 Hill as long-term investments but rather that their purpose and intention was to use them for a quick profit for themselves individually and for their wives a continuing profit which was in no way dependent upon the continued ownership of Springfield and Hill.

On the evidence of record and the facts shown thereby, it is our opinion, and we conclude and hold, that the sale of the stock and the distributions made by Springfield and Hill to their stockholders were attributable to circumstances which were present and had been advisedly created by the petitioners prior to the completion of construction of the two projects and were not attributable solely to circumstances which arose after construction, "other than circumstances which reasonably could be anticipated at the time of * * * construction" and that Springfield and Hill accordingly were collapsible corporations within the meaning of section 117(m).

In the light of the conclusions reached, it becomes unnecessary to pass upon the respondent's alternative contention that the distributions made in August of 1950 constituted compensation under section 36 T.C. 22">*88 22(a). In that connection, however, we could have considerable difficulty1961 U.S. Tax Ct. LEXIS 178">*337 with the testimony of Neisloss that it was purely a matter of coincidence that the distribution by Springfield of $ 13,666 2/3 to petitioners for each share of class A common stock held by them was in total amount a distribution of $ 410,000 and thus within $ 303 of the builder's and architect's fees included by the FHA in its estimate of cost of construction in arriving at the amount of the insurable loan.

Decisions will be entered for the respondent.

Kern, J., dissenting. I am unable to agree with the conclusions reached by the majority from the evidentiary facts herein, few of which are themselves in dispute.

In my opinion the sale by petitioners of their stock was "attributable solely to circumstances which arose after * * * construction * * * (other than circumstances which reasonably could be anticipated at the time of * * * construction * * *)." I would therefore conclude on the authority of Charles J. Riley, 35 T.C. 848">35 T.C. 848, and Maxwell Temkin, 35 T.C. 906">35 T.C. 906, that the corporations here involved were not collapsible corporations within the meaning of section 117(m) of the Internal Revenue Code of 1939.