55 T.C. 1067">*1068 The Commissioner has determined deficiencies in petitioners' income taxes in the amounts and for the taxable years shown below:

The transferee petitioners in docket No. 3893-68 through 3898-68 concede their liability for any income tax deficiency 1971 U.S. Tax Ct. LEXIS 168">*170 of National Building Corp. Due to certain concessions made by both parties, the primary issues to be decided are: (1) Whether the transfer in May 1963 of ownership of the Pantlind Hotel property from National Building Corp. to Pantlind Hotel Co. was in part a dividend distribution to Jason and Edith Honigman to the extent of the excess, if any, of the fair market value of the hotel over the amount received by National Building Corp. from the Honigmans; (2) whether, if there was a dividend distribution, the dividend is a liquidating distribution taxable at capital gains rates or as ordinary income; (3) whether the loss of $ 806,888.30 which National allegedly realized on the sale of the hotel, or any part thereof, was deductible by National in that year; (4) whether expenditures by National of $ 87,294.27 in the fiscal year ended May 31, 1962, for the replacement of portions of the floor of the garage area of the First National Building were currently deductible as ordinary and necessary business expenses or nondeductible capital expenditures; and (5) whether expenditures of National of $ 10,976.44 in the fiscal year ended May 31, 1963, for services rendered in the course of a physical 1971 U.S. Tax Ct. LEXIS 168">*171 survey and recommendation of a program for further need for replacement of portions of the 55 T.C. 1067">*1069 floor throughout the garage area of the First National Building were currently deductible as ordinary and necessary business expenses or nondeductible capital expenditures.

FINDINGS OF FACT

Each of the petitioners in the cases designated as docket Nos. 3893-68 through 3898-68 was a stockholder and distributee of the assets of National Building Corp., hereinafter referred to as National, all of the assets of which were distributed to its stockholders, including petitioners, in the complete liquidation of National. The Federal income tax returns of National for the years in issue were filed with the district director of internal revenue at Detroit, Mich. At the time of filing the petitions herein, Jason L. and Edith Honigman and Gertrude Levin resided at Detroit, Mich., Harry and Sarah Galperin resided at Miami Beach, Fla., and Ben L. Silberstein resided at Beverly Hills, Calif.

National was formed in 1946 as a Michigan corporation with its principal office at Detroit, Mich. Its principal business was the ownership and operation of commercial real estate. From its incorporation and continuing 1971 U.S. Tax Ct. LEXIS 168">*172 through all relevant dates herein, the common shares of National, its sole outstanding capital stock, were owned substantially in the following proportions: Jason L. Honigman, his wife Edith, and their children and grandchildren (Honigman family), about 35 percent; Ben L. Silberstein, his former wife Gertrude Levin, and their children (Silberstein family), about 35 percent; Harry Galperin and his wife Sarah (Galperin family), about 20 percent; and the remaining 10 percent of the common stock was owned by a number of other individuals in relatively small proportions. There was no family relationship between the Honigman family and any member of either the Silberstein or Galperin families, nor were there any business relationships between the Honigman family and any members of either the Silberstein or Galperin families other than their relationship as stockholders, directors, and officers of National.

At all dates relevant herein, the following three persons were the directors of National and held the offices shown:

Real estate known as the First National Building was purchased 1971 U.S. Tax Ct. LEXIS 168">*173 by National in 1946 shortly after its incorporation.

55 T.C. 1067">*1070 During the year 1951, National acquired the stock of the Pantlind Hotel Co. (Delaware Pantlind), a Delaware corporation. At that time, Delaware Pantlind owned the Pantlind Hotel located in Grand Rapids, Mich. The hotel is a 10-story building with approximately 550 guestrooms and occupies an entire block located in the central business district in Grand Rapids. During the years in issue, in addition to guestrooms, the hotel had various specialty stores, four restaurants on the main floor, and a cafeteria and restaurant in the basement. A corner section of the hotel building, approximately 20 percent of the total square footage of the building, was owned by the Old Kent Bank which occupied the first floor, mezzanine, and basement areas and leased all of the upper floors to the owners of the hotel under a 99-year lease under the terms of which the tenant paid $ 16,500 annual rent. The lease provided the rental price was to be adjusted at the end of each 10-year period of the lease, based on changes in the fair market value of the property. The 10-year period existing during the years in issue was to expire in 1963. In 1952, 1971 U.S. Tax Ct. LEXIS 168">*174 the Pantlind Hotel was transferred as a dividend distribution to National by Delaware Pantlind and at the same time an agreement was entered into between National and Delaware Pantlind under the terms of which Delaware Pantlind was employed by National to operate the hotel and submit monthly financial reports and transfer to National the net income derived from the operations of the hotel. In return for these duties, Delaware Pantlind received a management fee equal to 3 percent of the entire gross income from the hotel operations. The management agreement remained in effect until National transferred the hotel on May 27, 1963.

A schedule of National's financial operations for the fiscal years ended May 31, 1959 through 1962, and for the period June 1, 1962, to May 26, 1963, is shown below:

1971 U.S. Tax Ct. LEXIS 168">*177 55 T.C. 1067">*1071 A schedule of the Pantlind Hotel's room, food, and beverage statistics for the same years is shown below:

55 T.C. 1067">*1072 As of May 27, 1963, a downtown urban renewal development was in progress covering an area of approximately 26 acres just north and east of the Pantlind Hotel. Properties were acquired 1971 U.S. Tax Ct. LEXIS 168">*179 under the urban renewal program beginning on August 15, 1961.

Beginning in early 1963, National entered into a series of agreements which ultimately resulted in its complete liquidation. On February 11, 1963, National entered into a preliminary agreement to sell the First National Building. On May 6, 1963, National and Pantlind Hotel Co. (hereinafter Michigan Pantlind), a newly organized Michigan corporation, all of the capital stock of which was then owned by Edith Honigman, entered into a sale agreement pursuant to which, on May 27, 1963, National delivered title to and possession of the Pantlind Hotel to Michigan Pantlind which in return paid National $ 661,280.21, consisting of Michigan Pantlind's assumption of the mortgage indebtedness in the hotel property of $ 589,754.35, assumption of $ 21,525.86 of unpaid current real estate and personal property taxes, plus $ 50,000 in cash. For the calendar year 1963, Michigan Pantlind was a subchapter S corporation, the profit or loss of which was required to be reflected in the 1963 joint income tax return of petitioners Jason and Edith Honigman. At the date of sale, National's adjusted cost basis for determining gain or loss of the 1971 U.S. Tax Ct. LEXIS 168">*180 hotel was $ 1,468,168.51. On May 29, 1963, Pantlind Hotel Co. paid National an additional $ 37,911.05, representing a net adjustment to the above purchase price to account for the following items: 55 T.C. 1067">*1073

On August 12, 1963, National adopted a plan of liquidation which qualified as a liquidation under section 337. Pursuant to the plan of liquidation, certain assets of National, including the First National Building, were sold and the proceeds thereof, together with all of the remaining assets of National, were distributed to its stockholders on or before April 24, 1964. The liquidating distribution was $ 147.65 per share.

At the time National entered into the preliminary agreement to sell the First National Building on February 11, 1963, the directors were aware that the Pantlind Hotel which they were desirous of selling would be sold at a loss, while the other assets would be sold at a substantial gain. They therefore decided 1971 U.S. Tax Ct. LEXIS 168">*181 to sell the Pantlind Hotel and then adopt and pursue a plan of complete liquidation in accordance with section 337 which would shield the corporation from the recognition of the substantial gains to be realized in the sale of the remaining assets.

Following 4 months of unsuccessful efforts to procure a purchaser, in April 1963, the directors of National held a meeting during which they further discussed the desirability of selling the hotel and at a more suitable purchase price. The previous selling efforts included contact with several hotel chain representatives and hotel owners, real estate, and hotel brokers. Most of these people were contacted by Honigman in the form of telephone or brief letter inquiries. No appraisal of the hotel was made nor was a sales brochure prepared. During the negotiations with these people, the indicated selling price of the hotel ranged from $ 200,000 to $ 250,000 above the existing mortgage on the hotel property. During the meeting, Honigman suggested selling the hotel for a "nominal" sum of $ 50,000 above the existing mortgage. This price had not previously been offered to outside prospective purchasers, nor was such price ever offered to them. 1971 U.S. Tax Ct. LEXIS 168">*182 Silberstein 55 T.C. 1067">*1074 initially indicated an interest in purchasing the hotel for the aforementioned "nominal" sum, but declined to do so because of personal reasons. Honigman later decided to buy the hotel at the same price offered to Silberstein. The transaction was completed on May 27, 1963, at which time Michigan Pantlind purchased the hotel as outlined above.

While owned by National, the Pantlind Hotel property was encumbered by a mortgage executed in 1952 and originally bearing interest at 4 3/4 percent. The mortgage matured in 1962 at which time it was extended an additional 2 years and the interest rate was increased to 6 percent. The mortgage was payable in monthly installments of $ 6,462 each, inclusive of principal and interest, and the entire unpaid balance of the mortgage matured and was payable on August 31, 1964.

In October 1964, Michigan Pantlind paid the entire balance due on the mortgage encumbering the hotel property. The payment was made with the proceeds of a new $ 550,000 mortgage loan secured by a real estate mortgage on the hotel property plus Jason Honigman's personal guaranty of the first $ 175,000 payable under the loan agreement.

On November 18, 1964, Michigan1971 U.S. Tax Ct. LEXIS 168">*183 Pantlind sold to three Roberts brothers 2,400 shares of its common stock out of its total capital stock of 7,500 shares then issued and outstanding. The sales price was $ 10 per share which was the same price per share paid therefor by Edith Honigman upon incorporation of the Michigan Pantlind in May 1963, prior to purchasing the Pantlind Hotel. All of the Roberts brothers were employees of Michigan Pantlind at the time of the sale and for many years prior thereto had been employed by Delaware Pantlind. On December 21, 1964, Michigan Pantlind purchased at a price of $ 137,500 from Old Kent Bank, the corner portion of the Pantlind Hotel building, the upper floors of which had for many years prior thereto been leased by the owners of the hotel from Old Kent Bank.

During its fiscal year ended May 31, 1962, National paid $ 87,294.27 for materials and labor for the replacement of portions of the floor of the parking garage area of the First National Building and during the year ended May 31, 1963, paid $ 10,976.44 for services rendered in the course of a physical survey and recommendation of a program for further need for replacement of portions of the floor throughout the parking garage 1971 U.S. Tax Ct. LEXIS 168">*184 area of the First National Building. National deducted these sums as current ordinary and necessary business expenses in its income tax returns for those periods.

55 T.C. 1067">*1075 The Pantlind Hotel's financial operations improved subsequent to its acquisition by Michigan Pantlind primarily due to better management, progress in the urban renewal program, and the addition of two profitable restaurants, the Backroom Saloon and the Upstairs Saloon.

A schedule of Pantlind Hotel Co.'s financial operations for the period May 27 to December 31, 1963, and for the years ended December 31, 1964 and 1965, is shown below:

1971 U.S. Tax Ct. LEXIS 168">*185 55 T.C. 1067">*1076 A schedule of room, food, and beverage statistics for the same periods is shown below:

In his notices of deficiency to petitioners Jason and Edith Honigman, respondent determined that the fair market value of the Pantlind Hotel on the date of the sale was $ 1,300,000, and consequently that the Honigmans received a taxable dividend equal to the difference between $ 1,300,000 and the amount they paid for the hotel. Respondent also asserted deficiencies against petitioners as transferees of the assets of National based upon his disallowance of both the loss deduction claimed by National on the sale of the hotel and the expense deductions claimed by National for the expenditures with respect to the garage floor areas of the First National Building.

OPINION

Section 316 of the Code defines a dividend as "any distribution of property made by a corporation to its stockholders -- (1) out of its earnings 55 T.C. 1067">*1077 and profits." Property is defined in section 317 as "money, securities, and any other property."

Section 1.301-1(j), Income Tax Regs., provides in pertinent part:

If property is transferred by a corporation to a shareholder which is not a corporation for an amount less than its fair market value in a sale or exchange, such 1971 U.S. Tax Ct. LEXIS 168">*187 shareholder shall be treated as having received a distribution to which section 301 applies. In such case, the amount of the distribution shall be the difference between the amount paid for the property and its fair market value. * * *

This regulation has repeatedly received Court approval. See, e.g., Lester E. Dellinger, 32 T.C. 1178">32 T.C. 1178 (1959).

Section 301 of the Code provides in pertinent part:

(a) In General. -- Except as otherwise provided in this chapter, a distribution of property * * * made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).

* * * *

(C) Amount Taxable. -- In the case of a distribution to which subsection (a) applies --

(1) Amount constituting dividend -- That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.