Petitioner borrowed from a bank $ 159,000 and purchased stocks and debentures, the dividends and interest on which were subject to income tax. Later she borrowed from another bank $ 159,000 with which she repaid the original loan. Subsequent to repaying the original loan, petitioner sold the securities which she had purchased with the money received from the original loan, did not repay the loan, and shortly after the sale purchased obligations the interest on which is wholly exempt from income tax in approximately the amount of the sales price received. Later in the same year she sold these tax-exempt securities and purchased other tax-exempt securities with the proceeds of these sales, which tax-exempt securities she held throughout the years here involved.
41 T.C. 154">*155 Respondent 1963 U.S. Tax Ct. LEXIS 27">*28 determined deficiencies in petitioner's income tax for the years 1958 and 1959 in the amounts of $ 5,457.98 and $ 5,600.85, respectively. The issue for decision is whether interest paid by petitioner in 1958 and 1959 in the respective amounts of $ 6,446.12 and $ 7,057.83 was on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from income tax, within the meaning of
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly.
Petitioner, who resides at Chagrin Falls, Ohio, was at all times here material a widow, over 65 years old. She filed her individual Federal income tax returns for the taxable years 1958 and 1959 with the district director of internal revenue at Cleveland, Ohio.
Petitioner's income is derived from investments and at all times here material her total investments, exclusive of real property, had a fair market value in excess of $ 3,500,000. During 1958 and 1959 petitioner owned real property with a cost basis in excess of $ 1 million and other assets 1963 U.S. Tax Ct. LEXIS 27">*29 in addition to her investments having a value in excess of $ 200,000. Approximately 75 percent in market value of petitioner's investments, exclusive of real property, was in steel industry stocks which had a zero basis in petitioner's hands.
As a result of petitioner's heavy investment in steel stocks, petitioner and her advisers wanted to diversify petitioner's portfolio for reasons of safety. In order to diversify, cash was needed to make the investments, but petitioner did not want to sell the securities she already owned in order to obtain the desired cash, because of the large amount of capital gains tax that would result. Consequently, it was decided to resort to borrowing for the necessary cash. The loans described below were incurred and continued for this purpose.
41 T.C. 154">*156 In 1954, petitioner borrowed $ 159,000 from the Society For Savings, Cleveland, Ohio, using as collateral securities which were not tax-exempt obligations under
On June 6, 1955, petitioner established 1963 U.S. Tax Ct. LEXIS 27">*30 an agency account at the Cleveland Trust Co., Cleveland, Ohio, to which were transferred substantially all her investments, exclusive of real property. The activity of this agency account was thenceforth recorded by the Cleveland Trust Co. on two ledgers: (1) A "principal" ledger which accounted for all capital transactions, and (2) an "income cash" ledger which accounted for all receipts and disbursements of cash from dividends, interest, etc.
At all material times petitioner also maintained a commercial account at the Cleveland Trust Co. This account along with the agency account mentioned above was considered by petitioner and her investment advisers as being available for general investment purposes. Throughout this period, transfers have been made to the agency account from the commercial account and from the agency account to the commercial account. This commercial account was also used for the payment of Federal income taxes and personal expenditures.
On June 6, 1955, the date petitioner's agency account was established at the Cleveland Trust Co., petitioner borrowed $ 159,000 from the Cleveland Trust Co. on a demand basis with interest at 3 percent per annum, using as collateral 1963 U.S. Tax Ct. LEXIS 27">*31 securities which were not tax-exempt obligations under
On March 14, 1956, petitioner sold all her stock and debentures in Producing Properties, Inc. (which had been purchased on November 24, 1954), for $ 223,424.18, realizing a gain on the sale in the amount of $ 64,424.18. The sales proceeds were deposited in the agency account. On March 27, 1956, petitioner transferred $ 26,900 in cash to the agency account from her commercial account. On April 2, 1956, petitioner redeemed U.S. savings bonds and deposited the proceeds -- $ 15,187.50 in cash -- in the agency account. As a result of the above 41 T.C. 154">*157 transactions, the principal ledger showed total 1963 U.S. Tax Ct. LEXIS 27">*32 assets and liabilities, as of April 2, 1956, as follows:
Investments | Cash | Liabilities |
1 $ 571,844.33 | $ 265,511.68 | $ 159,000 |
Also on April 2, 1956, the income ledger of the agency account showed a cash balance of $ 1,677.16 and the commercial account a cash balance of $ 64,242.58. This made a total cash "pool" as of that date of $ 331,431.42.
The next transaction recorded on the principal ledger was as follows: On April 5 and 10, 1956, petitioner purchased municipal bonds in the total amount of $ 216,875, such bonds being tax-exempt obligations under
Investments | Cash | Liabilities |
$ 788,719.33 | $ 48,636.68 | $ 159,000 |
On September 12 and 14, 1956, the municipal bonds purchased on April 5 and 10, 1956, were sold for $ 204,125, and the sales proceeds deposited in the agency account. On September 14, 1956, the principal ledger showed total assets and liabilities as follows:
Investments | Cash | Liabilities |
$ 655,662.02 | $ 204,125 | $ 159,000 |
Also on September 14, 1956, the income cash ledger account showed an overdraft of 1963 U.S. Tax Ct. LEXIS 27">*33 $ 2,941.17 and the commercial account a balance of $ 29,662.99.
The $ 204,125 realized from the sale of municipal bonds on September 12 and 14, 1956, was reinvested as follows:
(a) On September 18, 1956, $ 3,800 was reinvested in taxable securities.
(b) On September 18, 21, 24, and 27, 1956, $ 200,512.50 was reinvested in obligations tax-exempt under
On October 5, 1956, a purchase of tax-exempt obligations in the amount of $ 18,050 made on September 27, 1956, was canceled, and another purchase of tax-exempt obligations in the same amount was substituted.
On December 4, 1956, tax-exempt obligations purchased on September 21 and October 5, 1956, in the total amount of $ 63,175 were sold for $ 57,400 and the sales proceeds deposited in the agency account. On December 5, 1956, the cash balance in the agency account was $ 86,607.39, including the $ 57,400 proceeds on the sale of December 4, 1956. The next transactions charged to the cash account were the purchase of $ 41,039 of taxable securities on December 6 and 10, 1956, 41 T.C. 154">*158 and the purchase of $ 57,925 in tax-exempt securities on December 11, 1956.
At all times after December 3, 1956, petitioner owned municipal bonds, constituting 1963 U.S. Tax Ct. LEXIS 27">*34 tax-exempt obligations under
At December 31 of each of the following years, petitioner had cash balances and investments in taxable securities and obligations tax-exempt under
Year | Cash | Obligations | Securities |
tax-exempt 1 | taxable 2 | ||
1955 | $ 202,541.00 | $ 4,918,445.00 | |
1956 | $ 70,839.02 | 466,328.56 | 4,746,156.12 |
1957 | 77,011.07 | 487,122.64 | 3,024,542.31 |
1958 | 40,118.75 | 528,314.79 | 4,647,630.37 |
1959 | 72,501.65 | 525,896.51 | 5,092,132.62 |
On March 17, 1959, petitioner's agency account at the Cleveland Trust Co. was closed, and the assets and liabilities therein were transferred to a revocable trust, with the Cleveland Trust Co. as trustee, and petitioner as settlor and sole beneficiary.
As of March 17, 1959, there were held in the agency account $ 137,337 of tax-exempt securities which had been purchased in September 1956, and $ 57,925 of tax-exempt securities purchased on December 11, 1956.
Petitioner on her Federal income tax returns for 1958 and 1959 deducted interest paid to the Cleveland Trust Co. in the respective amounts of $ 9,050.65 and $ 10,431.39. Respondent in his notice of deficiency disallowed 1963 U.S. Tax Ct. LEXIS 27">*35 $ 6,446.12 of the claimed interest deduction for 1958 and $ 7,057.83 for 1959 with the explanation that the disallowance was under the provisions of
OPINION
Against this factual background, the question is the narrow one of whether the $ 159,000 loan was continued to purchase or carry tax-exempt securities. Since petitioner continued to hold the tax-exempt securities purchased later in 1956 with the proceeds of the sale of the tax-exempt securities purchased in April 1956, it is clear that if the loan was continued to purchase the securities, it was continued to carry the obligations. See
Petitioner argues that since the loan was not secured by tax-exempt securities and all purchases were made from commingled funds in her agency account, the provisions of
The difference in the pertinent facts here and in
Our attention has been directed to no case, nor have we found one, dealing precisely with the question of when a loan not originally incurred to purchase tax-exempt securities is continued for that purpose. We have held that a loan not incurred to purchase tax-exempt securities but for the purpose of operating a taxpayer's business, was not "incurred or continued to purchase or carry" tax-exempt securities even though such securities were hypothecated as security for the loan.
Applying this reasoning in the instant case, the loans were continued after March 14, 1956, to enable petitioner to purchase and carry tax-exempt securities. Certainly in any ordinary sense of the word "continued," petitioner "continued" her loan at the Cleveland Trust Co. after March 14, 1956, and thereafter throughout 1959. She did not repay the loan but left it outstanding. This is the generally understood meaning of the word "continued" when used in connection with a loan. She continued the loan instead of repaying it with 41 T.C. 154">*161 the proceeds of the sale of the non-tax-exempt securities, so that she would have the funds to purchase and hold tax-exempt securities. This, we consider to be continuing the loan to purchase and carry the tax-exempt securities.
The purpose of
As a last argument petitioner contends that
We sustain respondent in his disallowance of petitioner's claimed interest deductions in the amounts of $ 6,446.12 and $ 7,057.83 for the years 1958 and 1959, respectively.
1. All references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩
1. Investments are carried at cost, not fair market value.↩
1. At cost.↩
2. At market.↩
2.
No deduction shall be allowed for --
* * * *
(2) Interest. -- Interest on indebtedness incurred or continued to purchase or carry obligations (other than obligations of the United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest on which is wholly exempt from the taxes imposed by this subtitle.↩
3. For convenience, obligations the interest on which is wholly exempt from Federal income tax will be referred to herein as tax-exempt securities and other securities will be referred to as non-tax-exempt securities.↩