Opinion
Docket No. 85174.
1961-09-21
DONALD J. LAWRIE AND BARBARA M. LAWRIE, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Frederick C. Kracke, Esq., for the petitioners. Joseph D. Holmes, Jr., Esq., for the respondent.
Frederick C. Kracke, Esq., for the petitioners. Joseph D. Holmes, Jr., Esq., for the respondent.
T, a contractor, owned subdivided property and in 1953 and 1954 sold some of the lots and houses built by him thereon. He sold the remaining lots in a single transaction. Held, all of the lots in the subdivided property were ‘held’ by him ‘primarily for sale to customers in the ordinary course of his trade or business,‘ sec. 1221(1), I.R.C. 1954; and the fact that in 1955 he chose to dispose of the remaining unsold lots in a single transaction without buildings houses upon them did not convert those lots into capital assets.
Respondent determined a deficiency in the income tax of petitioners in the amount of $4,640.49 for the year 1955.
The sole issue is whether certain real estate sold by petitioners in 1955 was held primarily for sale to customers in the ordinary course of business.
FINDINGS OF FACT.
Some of the facts have been stipulated, and, as stipulated, they are incorporated herein by reference.
Petitioners, husband and wife, are residents of Berkeley, California. They filed a joint income tax return for the year 1955 with the district director of internal revenue, San Francisco, California. Donald J. Lawrie will hereinafter be referred to as petitioner.
Petitioner has been a licensed building contractor in the State of California since 1950. During 1950, 1951, and 1952 he built approximately 75 houses. These houses were built for sale (‘speculative’ houses) upon improved lots acquired by petitioner from licensed real estate brokers or for persons who owned their own lots. Petitioner has never had a license to sell real estate.
In September 1951 petitioner was asked whether he was interested in purchasing approximately 8.75 acres of land in Danville, California, which the proposed seller was negotiating to obtain from the owner in exchange for commercial property. Petitioner agreed to make the purchase and made a $100 deposit on the 8.75-acre parcel. At that time this property was zoned for agricultural purposes by the County of Contra Costa. The proposed seller was unable to complete arrangements for the exchange of properties, and the contemplated purchase by petitioner from him was not consummated.
Petitioner then entered into direct negotiations with Robert Kerley, the owner of the 8.75 acres. On or about December 31, 1951, petitioners purchased 13.719 acres, including the 8.75 acres, from Robert Kerley for $41,157. Petitioners made a cash downpayment of $11,935.53 and gave the vendors a purchase money note for $29,221.47 secured by a deed of trust. Petitioner's intention in acquiring the tract was to subdivide it and sell lots with houses thereon which he intended to build, either speculatively or in accordance with specifications of the purchasers.
Some pear and walnut trees were located on the property purchased. During the years 1952 and 1953 petitioner had ‘an outside man’ rototill the property and some of his employees pruned the trees. During the year 1952 he realized a net profit of $1,029.42 from the 1952 walnut crop and during 1954 he realized a net profit of $254.03 from the 1953 walnut crop.
In January 1953 petitioner had the property rezoned from agricultural zoning to transitional agricultural residential zoning. Transitional agricultural residential property could be subdivided and residential homes built on it. A portion of the 13.719 acres was not suitable for residential construction at the time of purchase since drainage channels emptied upon the land and water from heavy winter rains settled on it and inundated the lower left-hand portion of the property.
Prior to 1953 petitioner had never subdivided any property. On or about May 14, 1953, petitioner filed a subdivision map with the Oakland office of the California Real Estate Commission covering approximately 4.05 acres of the land purchased from Kerly. This subdivision was designated Rancho del Amigo, United No. 2. On May 14, 1953, petitioner's subdivision plan for Rancho del Amigo, Unit No. 2, was approved by the County of Contra Costa and petitioner subsequently improved the subdivided property. The cost of development and improvements, consisting of water, grading, paving, engineering, etc., was $14,500. During 1953 and 1954 petitioner constructed a house on one of these lots on a speculative basis and the house and lot were sold as a ‘package deal.’ During 1953 and 1954 he sold eight additional houses and improved lots in Rancho del Amigo, Unit No. 2. These houses were constructed to the purchasers' specifications and house and lot were sold as ‘package deals.’ The sales of the houses and lots were made through a licensed real estate broker. In his income tax return petitioner reported the gain realized on these sales as ordinary income.
On or about May 2, 1954, petitioner filed an additional subdivision map with the Oakland office of the California Real Estate Commission for the subdivision of the remaining 9.669 acres of the 13.719 acres into 22 lots and an unsubdivided portion of approximately 1.26 acres. This subdivision was designated Rancho del Amigo, Unit No. 3.
On May 2, 1954, petitioner's subdivision plan for Rancho del Amigo, Unit No. 3, was approved by the County of Contra Costa.
Following the approval of the subdivision plan petitioner proceeded to improve and subdivide the 9.669 acres of Rancho del Amigo, Unit No. 3, into 22 lots and an unsubdivided portion of approximately 1.26 acres. The 22 lots were identified by lot numbers which ran from 46 to 67, inclusive.
In order to subdivide the property petitioner had to comply with the ordinances and regulations of the County of Contra Costa pertaining to subdivisions. In addition to street improvements petitioner was required to install a drainage ditch to drain the inundated land and construct some concrete culverts. The cost of developing Unit No. 3 was $22,500.
During 1954 petitioner constructed houses for sale on two of the lots in Rancho del Amigo, Unit No. 3, lots 62 and 47, on a speculative basis. These houses and lots were sold for petitioner by the same real estate broker who had sold the property in Rancho del Amigo, Unit No. 2. The broker also sold two specification houses during 1954 which petitioner constructed upon lots 65 and 67 in Rancho del Amigo, Unit No. 3.
In the latter part of 1954 or early in 1955 petitioner told his banker that he was interested in selling the entire unsold portion of Rancho del Amigo, Unit No. 3, and asked him if he knew anybody who might be interested in purchasing it. The banker informed petitioner that he did and arranged for William K. Houston and Justin G. Knowlton to meet petitioner. They insisted that the three unsold lots in Rancho del Amigo, Unit No. 2, be made a part of the deal.
On January 14, 1955, Houston and Knowlton purchased the remaining 18 lots in Rancho del Amigo, Unit No. 3, together with the unimproved property in Unit No. 3, and the remaining three lots in Rancho del Amigo, Unit No. 2. This sale was made directly by petitioner and no real estate commission was paid upon the sale to any real estate agent or broker. This was the first sale of an improved subdivision ever made by petitioner. He did not advertise this property as being for sale.
Since 1955 petitioner has made purchases and sales of land and has subdivided property.
On their income tax return for the year 1955, petitioners reported a gain of $23,817.95 from the sale of the foregoing lots and the unsubdivided parcel as a long-term capital gain. Respondent determined that the gain realized by petitioners in the amount of $23,817.95 was ordinary income.
At the time of the 1955 sale the property was held by petitioner primarily for sale to customers in the ordinary course of his business.
OPINION.
RAUM, Judge:
Petitioner is a contractor. His business consists of acquiring land and building houses thereon for sale (i.e., ‘speculative’ houses), or selling lots and building houses pursuant to specifications of the purchasers of the lots. His sales are made through brokers.
We have no doubt on this record that he purchased the 13.7 acres of land here in controversy for the purpose of subdividing it, and building houses thereon in his usual manner, either speculatively or pursuant to specifications of the purchasers of individual lots. He in fact did so subdivide the property into two tracts, Rancho del Amigo, Unit No. 2, containing 12 improved lots, Rancho del Amigo, Unit No. 3, containing 22 improved lots, and an unimproved parcel of approximately 1.26 acres. In accordance with his usual method of operation he sold nine lots and houses in Unit No. 2 and four lots and houses in Unit No. 3. Clearly, the gains from such sales constituted ordinary income, since the lots thus sold were held by petitioner ‘primarily for sale to customers in the ordinary course of his trade or business.’ Sec. 1221(1), I.R.C. 1954. But those lots are not involved herein. Had petitioner sold the remaining lots in like manner, any resulting profit would similarly be ordinary income.
However, for reasons that are not entirely clear on this record, he did not build any houses on the remaining lots, and he liquidated his entire investment in the property in one transaction, disposing of the remaining 18 lots in Unit No. 3, the remaining three lots in Unit No. 2, and the unsubdivided parcel in a single sale. Does this mode of disposition change the character of the profit from ordinary income to capital gain? Precedent in this field calls for a negative answer. Grace Bros., Inc., 10 T.C. 158, affirmed 173 F.2d 170 (C.A. 9); August Engasser, 28 T.C. 1173; cf. Ernest A. Watson, 15 T.C. 800, affirmed 197 F.2d 56 (C.A. 9), affirmed 345 U.S. 544, rehearing denied 345 U.S. 1003.
We reject as unconvincing petitioner's contentions relating to the use of the property for agricultural purposes. Plainly, he bought the property for subdivision, and any agricultural use was merely temporary, prior to its principal and intended use for subdivision purposes.
The statutory test is whether the property sold was held primarily for sale to customers in the ordinary course of the taxpayer's trade or business. And, apart possibly from the unsubdivided parcel of 1.26 acres,
the record is clear that the property was so ‘held.’ The fact that petitioner disposed of the lots ‘in bulk’ does not change the manner in which they were ‘held’ by him, namely, for sale to customers in the ordinary course of his trade or business. What was said in Estate of Jacques Ferber, 22 T.C. 261, 263, is pertinent here:
As to the 1.26 acres there is nothing in the record to show that any portion of the gain on sale of the entire property was allocable to this unsubdivided parcel. Moreover, even as to this unsubdivided parcel the contract of sale, in evidence, shows that the parties treated this portion of the property as three lots, and it is a fair conclusion from the contract as a whole that this parcel was similarly held for sale to customers in the ordinary course of petitioner's business.
Section 117(a)(1) defines capital assets as property held by the taxpayer but not to ‘include stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * * .’ Obviously the furs were not capital assets in the hands of the decedent and there are cases holding that he could not have changed their character by deciding to terminate or liquidate his business and sell the assets whether in bulk or to his usual customers. Grace Bros., Inc., 10 T.C. 158, affd. 173 F.2d 170; Ernest A. Watson, 15 T.C. 800, affd. 197 F.2d 56, affd. 345 U.S. 544, rehearing denied 345 U.S. 1003; Williams v. McGowan, 152 F.2d 570. Cf. Renziehausen v. Lucas, 280 U.S. 387, affirming 8 B.T.A. 87 and 31 F.2d 675. * * *
We hold that the Commissioner did not err in his determination in this case. Cf. James E. Kesicki, 34 T.C. 675.
Decision will be entered for the respondent.