The opinion of the court was delivered by: HOLTZOFF
This is an action against the United States for a refund of payment of income tax for 1963, which the plaintiff claims was erroneously assessed and should not have been paid.
The question involved is whether a deduction claimed by the taxpayer was properly or erroneously disallowed by the Internal Revenue Service. The salient facts are as follows. The plaintiff is a widow who has been a professional musician and a music teacher. She had accumulated certain securities in part as result of her savings and in part as an inheritance from her deceased husband. At the solicitation of a securities firm located in Washington, D.C., named Balough & Company, she turned over to Balough & Company, on April 12, 1962, securities having the market value of approximately $210,000. She delivered these securities to Balough & Company as a loan in order that Balough & Company might use them as part of their capital, in compliance with certain regulations of the Securities and Exchange Commission.
The principal features of the agreement are as follows. Paragraph 1 provided that Stahl, namely the plaintiff, "Hereby agrees to loan and to deliver to Balough certain securities", and then the securities are listed.
Paragraph 2 provided that Stahl agreed to subordinate to the claims of all present and future creditors of Balough her right to demand the return of the securities or receive payment for them.
Paragraph 7 of the agreement provided that:
"Balough agrees to return the securities to Stahl on May 12, 1963."
Paragraph 8 provided that:
"the securities loaned to Balough pursuant to this instrument may be used and dealt with by Balough as part of its capital and shall be subject to the risks of Balough's business."
The securities were never returned. Extension agreements were entered into from time to time. On October 31, 1963, Balough & Company sold the securities for $257,078.90. In 1964 Balough and Company filed a petition of bankruptcy and the bankruptcy proceeding is now pending in this district.
In her amended income tax return for the year 1963 the plaintiff claimed a loss of $87,146, which was based on the cost of the securities that had been sold. Counsel deducted from the claim the sum of $39,866, which was the expected recovery out of the bankruptcy proceeding and thus arrived at the amount of the claimed loss. The Internal Revenue Service disallowed the deduction on the theory that the loss was in the nature of a nonbusiness bad debt, and therefore came under the Capital Gains Provision.
The plaintiff, having paid the additional assessment, now sues for a refund. The position of the government is predicated on the proposition that the original transaction between the plaintiff and Balough & Company created a debtor-creditor relationship. If this major premise were accepted, the conclusion reached by the government would necessarily follow. The Court, however, disagrees with the major premise.
At this point it is appropriate to consider the statutes that are relevant to this case. Section 165 of the Internal Revenue Code, 26 U.S. Code § ...