CHAPTER XXV INCOME FROM GAINS UPON SALE OR EXCHANGE OF PROPERTY-APPRAISALS, WITH PARTICULAR REFERENCE TO MARCH 1, 1913 VALUE As has been shown in Chapter XXIV, the basis from which gains and losses are measured is either cost or an appraisal, usually as of March 1, 1913. The cost basis presents relatively few difficulties, although troublesome questions sometimes arise regarding its allocation and apportionment.1 Appraisals, which present many difficulties, form the subject matter of this special chapter. This chapter, however, does not attempt a comprehensive treatment of valuations. The determination of net income involves appraisals at various stages in the process. The establishment of the basis for determining gain or loss requires in a vast number of cases valuations of property on March 1, 1913 and, in scattered cases, valuations as of other dates, as when property has been acquired by inheritance,2 sometimes when property has been acquired by gift, when property is received in exchanges of certain types,* See page 671. * See page 672. Even in cases of reorganizations and continuing transactions in which "boot" is received in the exchange. See page 641 et seq. and when property is received in certain types of corporate distributions.5 But valuations are also required in connection with inventories, and often in connection with the establishment of bases for depreciation and depletion. It is true that in the last case the bases are usually the same as those established for measuring gain or loss but it is with appraisals in connection with gains upon sale or exchange and, in particular, with appraisals as of March 1, 1913, that this chapter has to deal. General Procedure with Respect to Appraisals The 1924 law makes a change in the phrase regarding March 1, 1913 value in the substitution of "fair market value" for the former "fair market price or value" and, for the first time gives directions that regard shall be given to the market value of corporate assets in arriving at the value of the stock. "Fair market value" not "fair market price or value."In section 204 (b) of the 1924 law, the basis for determining gain or loss in certain cases is specified as "the fair market value of such property as of March 1, 1913." The phrase "fair market value" has been used throughout the law in place of the phrase "fair market price or value" which appeared in the earlier law. What significance if any is to be attached to this change in phraseology is a matter for speculation. The new phrase appeared in the Treasury draft of the bill when first submitted to the Committee on Ways and Means. The fact that Mr. Gregg makes no comment which would indicate that the change was to be considered a substantial one raises the presumption that it was thought of as a minor alteration of language not designed to be of any practica! effect. Indeed Mr. Gregg in speaking of section 204 (b-1) of the draft where the phrase also was changed, merely remarks that the new paragraph "is the same as the last sentence of sections 214 (a) (8) and 234 (a) (7)" of the 1921 law. It is not the same with respect to the wording of this phrase and, if the change had As for example sales to stockholders or employees at less than cost (page 620) and distributions of unrealized appreciation since March 1, 1913 (page 666.) See Chapter XXI. See Chapters XLI and XLIII. "Discovery value" in the case of mines, oil and gas wells is an exception. P See page 653. been considered of any significance, Mr. Gregg would certainly not have been free to make this statement. Regard to be given to fair market value of assets. Section 204. LAW. (b) .... In determining the fair market value of stock in a corporation as of March 1, 1913, due regard shall be given to the fair market value of the assets of the corporation as of that date. The above sentence in the 1924 law is the first statutory instructions given regarding the appraisal of values as of March 1, 1913. It was inserted to prevent the Treasury from using forced or isolated sales of comparatively small blocks of stock as grounds for valuations. A provision is inserted providing that in determining the fair market value of stock in a corporation, as of March 1, 1913, due regard shall be given to the fair market value of the assets of the corporation as of that date. It is alleged that the Treasury Department in valuing the stock of close corporations, as of March 1, 1913, has given insufficient weight to the value of the assets as of that date and too great weight to forced or isolated sales of comparatively small blocks of the stock. This provision is to prevent such practice by the department in the future by providing specifically that in determining the value of the stock due regard shall be given to the value of the corporate assets." In Quite aside from this, however, the law directs that the value shall be "fair," that is, representative and not narrow. The sale of a few shares of stock out of thousands is not a fair criterion.11 addition the price must meet the common definition of "market," which presumes a willing buyer and a willing seller. Often the Treasury fails to consider the second standard and insists on the first. Unfortunately in the past the Treasury has often failed to consider the fair market value of the assets and has leaned too heavily on sales which were not truly representative of values. The valuations arrived at by the Treasury have in some cases been so arbitrary as to be astonishing even to the courts. A taxpayer sold land in 1917 for $8,000. He fixed the March 1, 1913, value at $5,000. The Treasury reduced the value to $300. The court held: DECISION. The question with respect to the profit on the sale of meadow land is purely a fact question. .. I have no hesitancy in Report of Senate Finance Committee on 1924 law, pages 19, 20. "Walter v. Duffy, Collector, 287 Fed. 41. 10 finding that the value of the land in March, 1913, was $5,000, but I do not wish to pass this phase of the case without noting the action of the department in placing arbitrary assessment, as of March, 1913, of $300. Clearly no real estate situate in Newark could increase between 1913 and 1917 over 2,500 per cent, nor is reason assigned for the government's action in selecting a valuation 25 per cent of a city assessment.” Treasury instructions as to methods of determining value.— The general regulation on the subject of determining value as at March 1, 1913 is as follows: REGULATION. .. What the fair market value of property was on March 1, 1913, is a question of fact to be established by competent evidence. In determining the fair market value of stock in a corporation due regard shall be given to the fair market value of the corporate assets on the basic date. In the case of property traded in on public exchanges, actual sales at or about the basic date afford evidence of value, but in each case the nature and extent of the sale and the circumstances under which it was made must be considered. Thus, prices received at forced sales or prices received for small lots of property may be no real indication of the value of the property in question. (Art. 1591.) Possible methods of establishing “fair market value.”—The following extract from a charge to a jury in a case which was approved 13 on appeal to the United States Supreme Court throws light upon what the court considered "fair market value" to mean. DECISION. The market value of goods is the price at which the owner of the goods, or the producer, holds them for sale; the price which they are freely offered in the market to all the world; such prices as dealers in the goods are willing to receive, and purchasers are made to pay, when the goods are bought and sold in the ordinary course of trade. The defendant asserts . . . . that the only way to arrive at the market value is to take the cost of production, to compute how much the manufacturer has actually disbursed in producing the goods, and that thus you have the actual market value. The United States, however, maintain that . . . . they are freely offered to all the world, and held at known and established rates; ... and at which they are ready to furnish them to all the world. If this latter state of facts be true, then it is evident that the prices at which the producers so hold them are the market prices. The Treasury's definition of "fair market value" is set forth in a ruling quoted on page 615. In the case of Virginia v. West Virginia,14 decided June 14, 1915, by the United States Supreme Court, wherein the issue was to determine what proportion of Virginia's indebtedness the new state 12 13 14 Pitney v. Duffy, 291 Fed. 621. 238 U. S. 202, 59 L. Ed. 1272, 114, 70 U. S. 114, 18 L. Ed. 116. of West Virginia should pay, it became necessary to make adjustments of certain credits and debits as of January 1, 1861, arising out of the valuation of certain railway stocks and other securities as of that time. Justice Charles E. Hughes, in speaking of stock of Richmond, Fredericksburg and Potomac Railroad Company (one lot amongst the several involved), said: DECISION. The fact, however, that there was no sufficient proof of market value, was not an insuperable obstacle to the making of a fair valuation. It was clearly proper to introduce evidence tending to show the intrinsic value of the shares. Nelson v. First National Bank, 69 Fed. 798, 803; Critchfield v. Julia, 147 Fed. 65, 73; Henry v. N. A. Construction Co., 158 Fed. 79, 81; Murray v. Stanton, 99 Mass. 345; Industrial Trust Ltd. v. Tod, 180 N. Y. 215, 232; State v. Carpenter, 51 Oh. St. 83; Redding v. Godwin, 44 Minn. 355; Moffitt v. Hereford, 132 Mo. 513. The terms "value" and "market value" are also discussed in the following quotations: Property concerning which no proof of value in the market can be given, because it is not brought into the course of trade and is incapable of any estimate in the mode, is often the subject of legal valuation. In such cases the value is to be ascertained from such elements of value as the property represents, among which may be the cost of producing an article. The question of value is not to be determined by considering the separate elements of which the property is composed, but by taking it as a whole, where it is, regard being had for the purpose for which it was intended and for which it is to be used."5 Where property is destroyed and injured which has a market value, this must be shown as the measure of damages; where it has no market value and a real value is shown, this is the measure of plaintiff's recovery; where it has neither a market value' nor a real value, but it is shown what it would cost to replace or reproduce the article, then such cost is the measure of damages. But if the article has no market value nor real value, and it cannot be reproduced or replaced, then in that event it would be proper to show what it was worth to the plaintiff. 16 .. Yet, a thing not bought and sold in the market may have a value, as when it is an article fitted for a specific use of the owners, and worthless for every other purpose. To attempt to test it by the open market, where it is never offered for sale, and is never bought, would be absurd. In reason the cost of replacing it would ordinarily be the standard of its value." Ordinarily, when an article of sale is in the market, and has a market value, there is no difference between its value and the market price, and the law adopts the latter as the proper evidence of its value. This is not, however, because value and price are really convertible terms, but only 15 Sutherland_on_Damages, Fourth Edition, Volume 2, Article 448. 1 M. K. & T. Ry. Co. v. Crews, 120 S. W. 1110, 54 Tex. Civ. App. 548. Martinez v. State, 16 Tex. App. 122, quoting 2 Bish. Crim. Prac., sec. |