Before DUFFY, Chief Judge, and FINNEGAN and SCHNACKENBERG, Circuit Judges.
On his federal income tax return for 1947 taxpayer claimed as deductions "lawyer's fees and expenses, $2231.10" and "safe deposit boxes, $9.60." The Commissioner disallowed these claims. The Tax Court held 23 T.C. 682 that taxpayer was entitled to deduct only $600 which sum it calculated was the reasonable proportion of the total fees and expenses which taxpayer incurred in the recovery of interest and rental income. The Court also held the expenditure of $9.60 for safety deposit rental was proper. The balance of the claimed deductions was disallowed.
Taxpayer is a resident of Milwaukee, Wisconsin. His father, Robert L. Kelly, owned certain rental property in South Dakota, and in 1929 and 1930 the father caused deeds to be drawn conveying these properties to his daughter Ilma Kelly Gram. The father retained possession of the deeds until his death in 1934. During the period after the date of the deeds and up to the time of his death, the father had undisputed possession and control of the properties.He collected rentals, paid the taxes and insurance, entered into a party wall agreement and paid part of the cost of the wall.
After the death of the father, taxpayer and his sister caused the deeds to be recorded. They treated the properties as being owned jointly, and opened a joint bank account in which rental income from the properties was deposited.Before and after the death of the father, taxpayer supplied a total of $5000 which was used to pay off mortgages against the properties. No evidence of debt or security was received by taxpayer when he made such payments.
In 1944, the daughter Ilma transferred the properties through a third party to her husband and herself as joint tenants. Taxpayer learned of this transfer in 1945 and shortly thereafter filed suit against his sister in a State Court in South Dakota.Taxpayer asked the Court to decree that he was the owner of a one-half interest in the property. He also asked for judgment for money loaned to his father and because he had paid a mortgage which was a lien on said premises. The trial court found that Ilma and her husband were the owners of all of the property in dispute but awarded judgment to taxpayer for the amount of money demanded in his complaint. Taxpayer appealed, but Ilma did not appeal as to the money judgment awarded against her. The Supreme Court of South Dakota reversed Kelly v. Gram, S.D., 38 N.W.2d 460, 461, holding that Ilma was estopped to deny that she held title to one-half the property in trust for taxpayer.
The question for determination here is whether attorney fees, travel, and out-of-pocket expenses incurred in the South Dakota trial court by reason of the lawsuit hereinbefore described, are deductible as ordinary and necessary expenses paid during the taxable year "for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income," within the meaning of Sec. 23(a) (2) of the Internal Revenue Code of 1939.*fn1
The Commissioner argues the entire sum of $2231.10 was incurred in perfecting the title to real estate; that such expenditure was a part of the cost of the property and being a capital expenditure was not deductible. The Commissioner also contends that the recovery of funds which taxpayer advanced to pay the mortgage indebtedness is not properly deductible under Sec. 23(a) (2) of the Code.
Taxpayer contends that the total expenditures for legal fees and expenses were incurred for the recovery of his own funds which he had advanced as loans, together with interest. He argues that the part attributable to the recovery of interest is an ordinary and necessary expense paid for the collection of income, and that the balance is ordinary and necessary expense for the management, conservation, or maintenance of property held for the production of income.
Taxpayer insists that court decisions cited by the Commissioner which support the legal principle that expenditures to acquire or perfect title to property are capital expenditures, are not applicable. Taxpayer points out that the expenditure of $2231.10 for lawyer's fees and expenses was incurred in the South Dakota trial court, which gave him judgment for the amount he had advanced to pay the mortgage plus interest, while it rejected his contention that he owned a half interest in the property. Taxpayer argues that such expenditures were directly and proximately related to the preservation and maintenance of his interest in income-producing property and, therefore, deductible under Sec. 23(a) (2) of the 1939 Code.
We do not think it controlling that the trial court granted only part of the relief demanded by the taxpayer in his suit. His claim to title to a half interest in the property was an issue in the trial court. In its opinion in Kelly v. Gram, supra, the Supreme Court of South Dakota stated: "Plaintiff in his complaint asked to be decreed the owner of a half-interest in the property which belonged to his father." Therefore, it is clear that taxpayer's suit was, at least in part, an action to perfect his title to a one-half interest in the property.
The question which is here for us to decide has given the courts considerable difficulty. In Rassenfoss v. Commissioner of Internal Revenue, 7 Cir., 158 F.2d 764 at page 766, this court said: "Both petitioner and respondent cite a number of cases in support of their respective contentions, a study of which reveals that the line of demarcation between an 'ordinary and necessary expense' as a deductible item and an expenditure incurred in defense of title to property and therefore not deductible is extremely narrow." More recently, the Fifth Circuit in Brown v. Commissioner of Internal Revenue, 215 F.2d 697, at page 699 observed: "* * * Whatever else may be gleaned from a study of the cases, it is certain that there is no hard and fast rule by which it can easily be determined whether such expenditures are or are not deductible."
Section 23(a) (2) was added to the Internal Revenue Code by the Revenue Act of 1942. Regulations were issued thereunder which provide that nonbusiness expenses incurred in defending or perfecting title are not deductible. Treas.Reg. 111, Sec. 29.23(a)-15. Also to be considered is the familiar rule that an income tax deduction is a matter of legislative grace and the burden is on the taxpayer to clearly show a right to the claimed deduction. Interstate Transit Lines v. Commissioner of Internal Revenue, 319 U.S. 590, 593, 63 S. Ct. 1279, 87 L. Ed. 1607; New Colonial Ice Co., Inc. v. Helvering, etc., 292 U.S. 435, 440, 54 S. Ct. 788, 78 L. Ed. 1348.
As to taxpayer's contention that he comes clearly within Sec. 23(a) (2) because his expenditures directly and proximately related to the preservation of his interest in income producing property, it must be admitted that, in a sense, every lawsuit to establish or perfect title to property is designed to preserve the plaintiff's interest in that property. However, we agree with the statement of the court in Brown v. Commissioner of Internal Revenue, 5 Cir., 215 F.2d 697, 699 where it was stated: "Of course, when property is held for the production of income, any expenditure which relates to the perfection or defense of the taxpayer's title to the property can, in one sense, be said to have been an expenditure for the conservation of the property. On the other hand, it seems equally as sound to say ...