49 T.C. 365">*365 The respondent determined deficiencies and overassessments in the income tax of the 1968 U.S. Tax Ct. LEXIS 191">*193 petitioners as follows:

Some issues raised by the deficiency notice have been disposed of by the parties. The remaining questions to be decided are: (1) Whether a seller of property who uses the accrual method of accounting for tax purposes and who receives as part payment for the sale a restricted savings account must include in gross income the full amount of such an account when received; (2) whether such a seller using the accrual method of accounting may deduct an addition for a reserve for bad debts in connection with such a restricted savings account; and (3) whether a seller of property who uses the cash method of accounting1968 U.S. Tax Ct. LEXIS 191">*194 for tax purposes and who receives such a restricted savings account must include in his gross income the full amount of such account when received.

FINDINGS OF FACT

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

The petitioner, Western Oaks Building Corp. (Western Oaks), is an Oklahoma corporation having its principal place of business in Oklahoma, at the time the petition was filed in this case. For its taxable years 1959 through 1962, Western Oaks filed its Federal income tax returns, using the accrual method of accounting, with the district director of internal revenue, Oklahoma City, Okla.

The petitioner, Don Brown Home Builders, Inc. (Home Builders), is an Oklahoma corporation having its principal place of business in Oklahoma, at the time the petition was filed in this case. For its taxable years ending October 31, 1958, through October 31, 1963, Home Builders filed its Federal income tax returns, using the accrual method of accounting, with the district director of internal revenue, Oklahoma City, Okla.

49 T.C. 365">*367 The petitioners, Donald I. Brown and Donetta Brown (the Browns), are husband and wife whose legal residence was in Oklahoma City, Okla., at the 1968 U.S. Tax Ct. LEXIS 191">*195 time the petition was filed in this case. For the calendar years 1958 through 1962, the Browns filed their joint Federal income tax returns, using the cash receipts and disbursements method of accounting, with the district director of internal revenue, Oklahoma City, Okla.

The facts in the three consolidated cases are substantially the same. During the taxable years in controversy, each of the petitioners was engaged in the business of constructing and selling houses. The purchasers were frequently unwilling or unable to pay in cash the difference between the selling price of the property and the amount of cash the mortgagee would lend. In most instances, the mortgagee was Local Federal Savings & Loan Association, Oklahoma City, Okla. Local was limited by State law in the amount it could lend in cash on a mortgage to 80 percent of the lower of the selling price or the appraised value.

To permit a sale in such a situation, the savings and loan association took a note and a mortgage on the property sold equal to the difference between the selling price of the house and the amount of the downpayment which the purchaser was able and willing to pay. The association thereupon paid 1968 U.S. Tax Ct. LEXIS 191">*196 in cash to the mortgagor and to the petitioner the amount of money it was willing to lend and delivered to the petitioner in the form of a savings account, or savings and loan shares representing such an account, the amount of the difference between the face of the mortgage and the amount of such cash paid to the petitioner. ² The petitioner received an unrestricted account which it then, as part of the same transaction, assigned back to the savings and loan association as additional security for the purchaser's mortgage note. The terms of the assignment were that funds were to be released to the petitioner at the rate of $ 100 for every $ 200 paid by the purchaser on the principal of his note. The assignment further provided that if the purchaser made principal payments over and above the monthly payments provided for by the terms of the note, an equivalent dollar amount of the account would be released to the petitioner. The savings and loan association on occasion released an account to the petitioner because of an increase in the value of the mortgaged property, although this method of release was not specified in the assignment agreement. In effect, the petitioner received1968 U.S. Tax Ct. LEXIS 191">*197 only a restricted 49 T.C. 365">*368 account or shares, evidenced by a copy of the "Assignment of Collateral," and did not receive an unrestricted account at the time of sale.

While the mortgage so taken was not in default, interest or dividends were paid by the savings and loan association to the petitioner at the rate paid to owners or holders of unrestricted savings accounts or shares. The amount of such interest was unrelated to the amount paid by the purchaser on his loan. If the purchaser defaulted on his loan, it was the practice of the association to offer the petitioner1968 U.S. Tax Ct. LEXIS 191">*198 the option of obtaining a deed from the purchaser and maintaining the loan or paying off the loan and taking an assignment of the association's note and mortgage. Failure by the petitioner to adopt one of these courses resulted in a forfeit of its rights in the restricted account, which would be applied against the loan principal. The petitioner and the savings and loan association entered into a collateral pledge agreement with respect to each loan. The disposition of the savings account or savings and loan shares was controlled by the facts concerning only one loan so that a savings account set up in connection with one loan could not be applied against a balance owing on another loan. The petitioner did not guarantee the payment of any loan except to the extent that the account in its name stood as security for the loan, and the petitioner's liability on any loan was thus limited to the balance in the account connected with that loan.

The transaction here involved may be illustrated by an example: Suppose that the selling price and appraised value of a house is $ 20,000 and that the purchaser is willing and able to put up only $ 1,000 as downpayment. Since the savings and 1968 U.S. Tax Ct. LEXIS 191">*199 loan association is limited to lending 80 percent of the purchase price or $ 16,000 on a mortgage loan, a balance of $ 3,000 must be made up. To accomplish this, the savings and loan association takes the purchaser's note for $ 19,000, the whole difference between the selling price of the property and the cash downpayment, and a mortgage on the property in that amount. The savings and loan association then pays $ 16,000 in cash to the purchaser who pays that amount over to the petitioner. A savings account for the balance, $ 3,000, is set up in the petitioner's name but is assigned by the petitioner to the savings and loan association as additional security for the $ 19,000 loan to the purchaser. As the purchaser makes payment on the principal of the loan, for every $ 200 so paid, $ 100 in the account is released to the petitioner.

Although the period of time necessary to effectuate release of the entire account depends upon the percentage of the selling price represented by the account, ordinarily, a savings account pays out in 6 to 12 years. The petitioner preferred this method of financing to the more usual method whereby the seller takes the purchaser's note and 49 T.C. 365">*369 1968 U.S. Tax Ct. LEXIS 191">*200 a second mortgage on the property for several reasons. First, it was believed that a second mortgage in Oklahoma would take as long to pay out as the first mortgage, usually 25 years, instead of 6 to 12 years. Moreover, since the total amount the purchaser borrowed was included in one note, the savings and loan association serviced the entire loan. Finally, it was felt that a purchaser would be less inclined to default on a loan from a mortgage company or lending institution than one from an individual or small corporation. This method had been used by individuals in the past, and during the years herein involved, other builders in Oklahoma City had done business with the Local Federal Savings & Loan Association on these terms, although there was no evidence as to how many builders used this method or what amounts were involved.

The petitioners, Western Oaks and Home Builders, both accrual method taxpayers, and the Browns, cash method taxpayers, showed the restricted accounts on their tax returns as deferred income, not includable in gross income in the year of sale but includable as amounts were released by payments on principal by the purchaser. The face amounts of restricted1968 U.S. Tax Ct. LEXIS 191">*201 accounts received and the amounts reported as income from the accounts in the taxable years in controversy are shown in the following table:

49 T.C. 365">*370 In addition, the tax returns of Western Oaks and Home Builders for years subsequent to the years in controversy show the following amounts as "deferred income received":

The amounts reported as deferred income1968 U.S. Tax Ct. LEXIS 191">*202 received in the years following the taxable years in controversy included some amounts not attributable to the savings accounts.

Petitioners maintained no bad debt reserve accounts, and it appears that when a savings account was forfeited by reason of a purchaser's default on his loan, the petitioner took no bad debt deduction but simply reported no further income from the forfeited account.

The savings accounts and shares received by the petitioners were not easily negotiable and were not freely bought and sold in commerce.

OPINION

These facts present us with several issues for decision: (1) Are the petitioners who used the accrual method of accounting required to include in their gross income the face amount of the savings accounts when received? (2) If so, are they entitled to deduct as an addition to a reserve for bad debts the face amount of the savings accounts or some portion thereof? (3) Are the petitioners who used the cash method of accounting required to include in their gross income the fair market value of the savings accounts when received?

The Inclusion Issue. -- The petitioners, Western Oaks and Home Builders, who used the 1968 U.S. Tax Ct. LEXIS 191">*203 accrual method of accounting, contend that they are not required to include as gross income the face amounts of the savings certificates when received, but that they are required to include the amounts of such accounts only when they are released and available to them. This same contention was considered and rejected by this Court in Key Homes, Inc., 30 T.C. 109">30 T.C. 109 (1958), affirmed per curiam 271 F.2d 280 (C.A. 6, 1959). In that case, the petitioner was also engaged in the business of building and selling homes. Because of the 49 T.C. 365">*371 purchasers' inability to make downpayments sufficient to cover the difference between the selling price and the amount that the lending institution could loan on the property, the parties adopted financing arrangements essentially similar to those used in the case before us. The petitioner received a restricted savings account for the difference between the amount that could be loaned on the property and the amount of the downpayment which the purchaser could make. The petitioner could not withdraw the restricted savings account until payments by the purchaser had reduced the outstanding balance1968 U.S. Tax Ct. LEXIS 191">*204 of the loan to an amount specified in the assignment of collateral agreement. This Court held that the petitioner, who used the accrual method of accounting, was required to treat as a receipt of gross income the amount of the restricted savings account when received, notwithstanding that the petitioner could not withdraw such amounts until some time in the future. Our decision in Key Homes was affirmed per curiam by the Sixth Circuit (271 F.2d 280 (1959)) and has been followed in several decisions of this and other courts. Bolling v. Commissioner, 357 F.2d 3 (C.A. 8, 1966), affirming on this issue T.C. Memo. 1964-143; United States v. Wood, 352 F.2d 522 (C.A. 5, 1965); Lewis Building & Supplies, Inc., T.C. Memo. 1966-159; Warren G. Morris, T.C. Memo. 1963-139; Carl B. Holland, T.C. Memo. 1963-108. See also E. J. Gallagher Realty Co., 4 B.T.A. 219">4 B.T.A. 219 (1926).

Despite our earlier decision in Key Homes and the subsequent acceptance1968 U.S. Tax Ct. LEXIS 191">*205 of that decision, the petitioners ask us to reconsider the issue. The petitioners argue that the affirmance of Key Homes was based on an erroneous interpretation of Commissioner v. Hansen, 360 U.S. 446">360 U.S. 446 (1959), a decision involving dealer reserves, and that to impose a tax on the petitioners when they have no right to withdraw the funds imposes an inequitable tax burden upon them. We have reexamined the basis for the Key Homes decision, together with the pertinent principles of tax law, and we have concluded that this Court's decision and the Sixth Circuit's affirmance in reliance on Hansen were proper.

Section 451(a) of the Internal Revenue Code of 1954³ provides:

SEC. 451. GENERAL RULE FOR TAXABLE YEAR OF INCLUSION.

(a) General Rule. -- The amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period.

1968 U.S. Tax Ct. LEXIS 191">*206

Section 1.451-1(a), Income Tax Regs., provides in part: "Under an accrual method of accounting, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy." In Spring City Co. v. Commissioner, 292 U.S. 182">292 U.S. 182 (1934), 49 T.C. 365">*372 the Supreme Court said at page 184: "it is the right to receive and not the actual receipt that determines the inclusion of the amount in gross income. When the right to receive an amount becomes fixed, the right accrues."

Spring City Co. dealt with the accruability of an account receivable arising out of a sale of merchandise, when the purchase price was immediately due and payable but the actual payment was postponed. It is clear, however, that even when payment is not due until some time in the future, as in the case of an installment sale, an accrual method taxpayer, not using the installment method, must include the amount of the payment in income at the time of the sale, i.e., when the taxpayer acquires the right to receive that amount in the future. First Savings & Loan Association, 40 T.C. 474">40 T.C. 474 (1963);1968 U.S. Tax Ct. LEXIS 191">*207 George L. Castner Co., 30 T.C. 1061">30 T.C. 1061 (1958). Moreover, when property is sold, it is the face amount of the right, not its fair market value, which must be treated as received and includable in income. 40 T.C. 474">First Savings & Loan Association, supra.⁴ It is true that where there is "real doubt and uncertainty" that a claim for payment will ever be turned into cash or its equivalent "A taxpayer * * * is not required to accrue an item like this as income and pay income tax thereon, but is permitted to wait until the uncertainty is removed in some way." Cuba Railroad Co., 9 T.C. 211">9 T.C. 211, 9 T.C. 211">215 (1947). Cf. H. Liebes & Co. v. Commissioner, 90 F.2d 932 (C.A. 9, 1937); Georgia School-Book Depository, Inc., 1 T.C. 463">1 T.C. 463 (1943). However, "The fact that there is always the possibility that a purchaser or debtor may default in his obligation is not sufficient to defer the accruing of income that has been earned." 40 T.C. 474">First Savings & Loan Association, supra at 487.

1968 U.S. Tax Ct. LEXIS 191">*208 Under these general rules, if the petitioners in the present case had taken and held a note of the purchaser, instead of a restricted account, these notes would clearly have been includable in income in the year of the sale at face amount. 292 U.S. 182">Spring City Co. v. Commissioner, supra;40 T.C. 474">First Savings & Loan Association, supra. Similarly, if the petitioners had taken such notes and immediately assigned them or sold them to the savings and loan association, subject to the same right of release as in the present case, to induce the savings and loan association to take on the transaction, the face amount would again be includable in the year 49 T.C. 365">*373 of sale. 360 U.S. 446">Commissioner v. Hansen, supra;General Gas Corporation, 33 T.C. 303">33 T.C. 303 (1959), affd. 293 F.2d 35 (C.A. 5, 1961), certiorari denied 369 U.S. 816">369 U.S. 816 (1962).

The petitioners agree that in the case supposed, the seller, having received obligations of his purchaser subject to no restrictions on disposition, is taxed at the time of receipt, whether or not he subsequently1968 U.S. Tax Ct. LEXIS 191">*209 takes steps to postpone or otherwise restrict immediate realization on their value. Here, however, they argue, the seller never received an unrestricted passbook or savings and loan share but only a contingent right to receive funds on their release by the savings and loan association in the future. Instead of arising from a separate voluntary transaction to obtain working capital, the petitioners argue that the restrictions in this case were a part of the original transaction, necessary to the consummation of the sale. This difference, the petitioners argue, is sufficient to take this case outside the rules governing accrual of a fixed right to receive income. We disagree. In the first place, it is immaterial how, or from whom, the petitioners in this case acquired the unconditional right to receive future payments. In any event, they acquired such a right at the time of the sale of the property, and under the accrual method of accounting which they used for tax purposes, the face amount of the obligation must be treated as income at that time. The facts that the funds could not be withdrawn until some future time and that they would not become available if the purchaser failed1968 U.S. Tax Ct. LEXIS 191">*210 to perform his obligation would not alter the accruability of the right if it had been received directly from the purchaser, and do not change the tax consequences merely because the right is acquired from the lending company.

A proper reading of 360 U.S. 446">Commissioner v. Hansen, supra, resolving the tax treatment of dealer reserves, also supports our conclusion. The typical dealer reserve transaction involved the credit sale of an automobile, trailer, or other equipment for an agreed price. The purchaser made a cash downpayment and delivered an installment note to the seller for the balance of the purchase price plus a time or finance charge. The dealer then sold or discounted this note to a finance company, the dealer guaranteeing payment. The finance company remitted a percentage, usually 90 or 95 percent, of the price of the note to the dealer in cash, and credited the balance to a dealer reserve account. Under the terms of this arrangement, the dealer reserve account served as collateral for the dealer's liability to the finance company as guarantor of the notes or otherwise. This account was to be maintained at a specified percentage of the total1968 U.S. Tax Ct. LEXIS 191">*211 unpaid balance of notes which the dealer discounted with the finance company. Periodically, the finance company released to the dealer any excess in his account. The question involved was the proper year of accrual of amounts in the dealer reserve 49 T.C. 365">*374 account -- the year in which the amounts were credited to the reserve or the year in which they were released.

Some of the Courts of Appeals viewed this transaction as a "three-cornered" one: The dealer agreed to sell the automobile to the purchaser for a cash downpayment; the purchaser agreed to borrow the balance of the purchase price from the finance company and to direct its payment to the dealer; however, it was agreed that the finance company could retain a portion of the loan as a reserve to secure payment of all the loans which it made for the dealer and that the reserve would be released to the dealer at a later date when it was no longer needed to secure performance of the loan. So viewing the transaction, those courts held that the dealer acquired merely a contingent right to receive the amounts withheld by the finance company and that such amounts were not taxable to the dealer until they were received. Hansen v. Commissioner, 258 F.2d 5851968 U.S. Tax Ct. LEXIS 191">*212 (C.A. 9, 1958), revd. 360 U.S. 446">360 U.S. 446 (1959); Texas Trailercoach v. Commissioner, 251 F.2d 395 (C.A. 5, 1958), reversing 27 T.C. 575">27 T.C. 575 (1956).

According to the petitioners' argument, the dealer-reserve transaction as so reconstructed or interpreted by these Courts of Appeals is very similar to the facts of the case before us. However, in 360 U.S. 446">Commissioner v. Hansen, supra, the Supreme Court held that those lower courts had "assumed facts which are contrary to the records and are wholly without substance" (360 U.S. 446">360 U.S. at 462), and that the transaction had to be viewed in two steps -- a sale of the commodity followed by a separate sale of the note. Thus, the petitioners argue that the Supreme Court's decision in Hansen was based upon facts not analogous to those in the Key Homes case or the case before us and that therefore it is not applicable in resolving the issue before us.

We disagree. After finding that the case before it involved two transactions, the Court could have held that the taxpayer by reason of its use of the accrual method1968 U.S. Tax Ct. LEXIS 191">*213 of accounting was required to include in income the face amount of the note which was paid for the automobile and which was received at the time of the sale regardless of its subsequent disposition of the note. However, the Court viewed the question as:

whether amounts of purchase price withheld by finance companies as security to cover possible losses on installment paper purchased from dealers, who employ the accrual method of accounting, constitute income to them at the time the withheld amounts are recorded on the books of the finance companies as liabilities to the dealers. [Emphasis added. 360 U.S. 446">360 U.S. at 463.]

The Court concluded that the dealer acquired a fixed right to receive amounts withheld and credited to the reserve at the time of the sale of the notes to the finance company, and that the dealer would eventually 49 T.C. 365">*375 receive the funds either in cash or as payment on debts owed by it to the finance company. Hence, although the facts in the dealer-reserve cases are significantly different, the Supreme Court reached its decision by principles of law that are relevant to the issue before us, and its decision supports the Key 1968 U.S. Tax Ct. LEXIS 191">*214 Homes decision.

We therefore hold that the face amount of the restricted savings accounts and savings and loan shares were includable in gross income when received by the petitioners using the accrual method of accounting.

The Deduction Issue. -- The next issue is whether the petitioners are entitled to a deduction for an addition to a reserve for bad debts. The petitioners argue that if the restricted savings accounts must be treated as income when received, the impact of that result should be mitigated by allowing them to establish a reserve for bad debts and to treat the amounts of the restricted savings accounts as additions to that reserve. In support of this contention, the petitioners point to Bolling v. Commissioner, 357 F.2d 3 (C.A. 8, 1966), reversing T.C. Memo. 1964-143; Foster Frosty Foods, Inc. v. Commissioner, 332 F.2d 230 (C.A. 10, 1964), reversing 39 T.C. 772">39 T.C. 772 (1963); and Wilkins Pontiac v. Commissioner, 298 F.2d 893 (C.A. 9, 1961), reversing 34 T.C. 1065">34 T.C. 1065 (1960). This argument1968 U.S. Tax Ct. LEXIS 191">*215 is apparently based on the assumption that the petitioners' relationships to the lender are those of guarantors. Cf. H. Rept. No. 2157, 89th Cong., 2d Sess. (1966), 1966-2 C.B. 905, 906 fn. 2. ⁵ As such, it is clear that they are not entitled to any deduction for an addition to a bad debt reserve for the years in controversy.

Section 166(g), which was enacted in 1966, ⁶ provides the exclusive right of a guarantor or endorser to deduct additions to a reserve for bad debts. ⁷1968 U.S. Tax Ct. LEXIS 191">*217 In the case of taxable years ending before October 22, 1965, a guarantor is entitled to such a deduction only if he made a claim 49 T.C. 365">*376 for such a deduction before such date. ⁸ The committee report explains that for purposes of this provision, "The taxpayer may have claimed the deduction in his original return for the taxable year, in an amended return, or in a claim for refund, if1968 U.S. Tax Ct. LEXIS 191">*216 such return, amended return, or claim for refund was filed before October 22, 1965." H. Rept. No. 2157, 89th Cong., 2d Sess. (1966), 1966-2 C.B. 905, 912.

1968 U.S. Tax Ct. LEXIS 191">*218 In the facts before us, we have no evidence of any claim for an addition to a bad debt reserve before the time when the petitioners filed their original brief on March 16, 1967. On their returns, they showed the amounts of the restricted savings accounts as deferred income, but nothing was said about a reserve for bad debts. Congress has now spoken and laid down the rules as to when a guarantor may establish a reserve for bad debts and deduct the additions thereto; and under these rules, it is altogether clear that the petitioners are not entitled to such a deduction.

As to the petitioners who used the cash method of accounting for tax purposes, the Browns, we reject the respondent's contention that they were required to include in gross income the face amounts of the restricted savings accounts when received. We hold that these accounts were taxable only as amounts could be withdrawn. In determining the income derived from the sale of property by a cash method taxpayer, a right to receive future income is not included in the computation of the "amount realized" under section 1001(b) unless that right is the equivalent of cash. Estate of Coid Hurlburt, 25 T.C. 1286">25 T.C. 1286 (1956);1968 U.S. Tax Ct. LEXIS 191">*219 Curtis R. Andrews, 23 T.C. 1026">23 T.C. 1026, 23 T.C. 1026">1034-1035 (1955); Estate of Clarence W. Ennis, 23 T.C. 799">23 T.C. 799 (1955); Nina J. Ennis, 17 T.C. 465">17 T.C. 465 (1951); Harold W. Johnston, 14 T.C. 560">14 T.C. 560 (1950). This is true even though for other purposes that right may be considered to have a fair market value. 25 T.C. 1286">Estate of Coid Hurlburt, supra.Where the right is the equivalent 49 T.C. 365">*377 of cash, it is included in the income of a cash method taxpayer in the year of receipt at its fair market value. Joseph Marcello, Jr., 43 T.C. 168">43 T.C. 168, 43 T.C. 168">180 (1964).

In determining whether the right to receive income in the future is equivalent to cash, the test is whether the debtor's promise to pay is embodied in "notes, mortgages, or other evidence of indebtedness such as commonly change hands in commerce." 14 T.C. 560">Harold W. Johnston, supra at 565. The obligations must, "like money, be freely and easily negotiable so that it readily passes from hand to hand in commerce." 17 T.C. 465">Nina J. Ennis, supra at 470.1968 U.S. Tax Ct. LEXIS 191">*220

The evidence shows that the petitioners did not receive a freely negotiable evidence of indebtedness at the time of the sale. Apparently, they received only the executed "Assignment of Collateral" forms, containing the terms of the restriction, and did not even receive a savings account passbook or share certificate. In any event, it is clear that they did not receive a negotiable instrument. See Uniform Commercial Code, sec. 3-104(1); Okla. Stat. Ann. tit. 12A, sec. 3-104(1) (1963). Moreover, J. B. Fiddler, executive vice president of Local Federal Savings & Loan Association, the lender in most of the transactions under consideration in this case, testified that "You might go for months and not hear anything about a savings account being sold, and then maybe in the next week * * * you will hear about two or three sales." This testimony shows that the pledged accounts did not "readily pass from hand to hand in commerce."

Because the accounts, or shares representing such accounts, were not easily negotiable and freely exchanged in commerce, we find that they were not the equivalent of cash and therefore not includable in the income of the cash method petitioners when received.

1968 U.S. Tax Ct. LEXIS 191">*221 Decision will be entered under Rule 50.