Dressen v. Commissioner

Martin Dressen, Petitioner, v. Commissioner of Internal Revenue, Respondent Dressen v. Commissioner Docket No. 32348 United States Tax Court 17 T.C. 1443; 1952 U.S. Tax Ct. LEXIS 258; March 6, 1952, Promulgated *258 Decision will be entered for the petitioner. Gain from Sales of Lots -- Capital Gain. -- The petitioner purchased country lots in 1931 as an investment. He held the lots for 15 years. Some of the lots were sold in 1946 and 1947. Held, under the facts, that the lots were not held primarily for sale to customers in the ordinary course of petitioner's business within section 117 (a) (1), I. R. C., and that gain realized from sales in 1947 is taxable as long term capital gain. Alric Anderson, Esq., for the petitioner. Thomas A. Steele, Jr., Esq., for the respondent. Harron, Judge. HARRON *1443 The respondent has determined a deficiency in income tax for the year 1947 in the amount of $ 334. The only question is whether the petitioner held lots primarily for sale to customers*259 in the ordinary course of a business so that the property is properly to be excluded *1444 from capital assets under section 117 (a) of the Code. The petitioner contends that the property was held as an investment and that the profit realized upon the sale of 14 lots in 1947 constitutes long term capital gain. The petitioner filed his return with the collector for the district of Minnesota. FINDINGS OF FACT. The petitioner lived in Shakopee, Minnesota, from 1931 to September 1948, when he moved to Cumberland, Wisconsin. In 1931 and thereafter he carried on a business of selling soft drinks, candy, cigarettes, and tobacco. During 1946, 1947, 1948, and 1949 he was engaged in a tavern business, and his income from that business amounted to $ 2,100 in 1946, $ 1,100 in 1947, $ 1,000 in 1948, and $ 3,600 in 1949. The petitioner has never had a real estate dealer's license, and he has never engaged in a real estate business. In 1931, C. T. Weiland, a friend who worked in a bank in Shakopee, told the petitioner he could buy 67 lots cheaply in a subdivision known as Northwood at Prior Lake, from a widow who wanted to sell her lots. Weiland was not engaged in the real estate business. *260 The Northwood subdivision was surveyed, platted, and subdivided in 1911, and the plat was recorded then. The lots were unimproved except one lot at one end of the tract where a summer cottage was located. There was no electric power line to the property. One side of the property had a lakeshore frontage. The 67 lots were contiguous, except for one lot. The petitioner bought the 67 lots at the end of 1931 for $ 3,000. In 1945 he bought the one lot remaining in the group for $ 20 at a tax lien sale. He then owned 68 lots which covered 34 acres. He purchased the lots to hold as an investment for himself and his family. The petitioner held the lots for 15 years during which time he made no effort to sell them. The only other real estate the petitioner has purchased are five lots in Shakopee which he bought in 1941 for $ 400. One of these lots was sold in 1947, at a profit of $ 313.57. During the time the petitioner held the Prior Lake lots, nothing was done by the petitioner to improve them except in minor ways. For example, he took out about 48 willow trees and replaced them with hardwood trees, he planted a lawn extending for an acre around his cottage, he planted a few*261 fruit trees, and he improved a bathing beach on the shore of the lake. During three years he let a farmer raise hay on 8 acres for one-third of the crops, i. e., for about $ 18 per year. The petitioner and his family occupied the cottage at one end of the tract in the summer until they moved to Wisconsin. However, there were some advancements in the vicinity of the property which were of benefit. In 1936, electric power was made *1445 available by R. E. A., and the petitioner had an electric power line brought in over the property to the cottage. Also, in 1938, the county built a dam at the outlet of Prior Lake which raised the water level. Before the dam was built at Prior Lake, there was a road along the shore which the petitioner used to get to his cottage. The road could not always be used after the lake was closed by the dam because it was flooded at times. And so the petitioner used a cart road in the rear of the property. This road ran over on the property of others to the extent of about 20 feet. In 1945 or the early part of 1946, the petitioner had his property surveyed and marked so as to regrade the road and fix it on his property. In his income tax return*262 for 1946, the petitioner reported expenditures of $ 1,200 on the property (which were made during and before 1946) as follows: Surveying costs, $ 160; road grading, $ 706; road gravel, $ 174; clearing away overgrowth, $ 160. In 1947, he spent $ 98 for the removal of some willow trees and the filling in and leveling of a small area. The petitioner maintained the road in the rear of the property for two years, and thereafter it was maintained by the town of Shakopee. The petitioner also fixed a "spur road" into the property. In 1946, the petitioner needed some money to pay debts and borrowed some money through Weiland. Weiland suggested that he sell some of his lots. He was not anxious to sell them, but he needed money. He wanted to sell all of the lots at one time for seven or eight thousand dollars. Weiland brought a Minneapolis real estate dealer, Wood Schol, to the petitioner to purchase the lots, but the petitioner and Schol could not agree on a price for all of the lots. Schol offered to sell the lots for a commission of $ 150 per lot. The petitioner considered the proposed charge to be too high. The petitioner knew nothing about the handling of real estate transactions*263 or about the preparation of the documents required to convey title. Furthermore, he was fully occupied with his tavern business, where he often worked all day and until midnight. He asked Weiland to sell his lots so that he could raise money to pay his debts. Weiland worked in the bank in Shakopee, but he was willing to handle sales of the lots. There was no contract made by the petitioner and Weiland. It was understood, however, that Weiland would receive the customary commission of 10 per cent of the purchase price for bringing purchasers to the petitioner. It was customary to pay a commission to anyone who brought in a purchaser of property. The petitioner did nothing. Weiland submitted each offer for a lot which he obtained, some of which the petitioner rejected. In September 1948 the petitioner moved to Wisconsin. *1446 No sales office was located on or near the Prior Lake property. Weiland's sales activities were limited to the following: He replaced worn out markers on the property to show the locations of lots; he put notices in the newspaper that the lots were for sale, and he put a for sale sign on the property and on a road nearby, the expenses of which he*264 paid. The lots which were sold were sold under installment contracts for a down payment, part of which Weiland retained as his commission. The petitioner used the money he received to pay debts, and he did not reinvest any of the proceeds in other property. The number of lots sold and the net profit realized during the years 1946-1951 were as follows: Year Lots sold Net profit [1946] 8 1/2 $ 2,416.40 [14] 3,571.53 [1948] 12 1/2 2,067.29 [8] 5,155.24 [9] 1,574.28 [5] (not shown) [57] The petitioner realized profit during 1947 in the total sum of $ 3,885 from sales of lots at Prior Lake and in Shakopee. He treated the gain as capital gain in his return for 1947 and included 50 per cent, or $ 1,942.55 in his taxable income. The Commissioner determined that the petitioner was a "real estate dealer" during 1947, and that, therefore, his gains were taxable in full as ordinary gain. The petitioner was not a real estate dealer during 1947. He did not hold the Prior Lake lots or the lots in Shakopee primarily for sale to customers in the ordinary course of his business. He held the lots as an investment from the time he purchased them, and the sales thereof*265 were in liquidation of capital assets from which he realized capital and not ordinary gain in 1947. OPINION. The question is whether the profit which the petitioner realized from the sale of the Prior Lake lots and one lot in Shakopee is taxable as capital or ordinary gain. The respondent has determined that the properties involved must be excluded from the class of capital assets, under section 117 (a) (1) of the Internal Revenue Code, because they were "held by the petitioner primarily for sale to customers in the ordinary course of his trade or business." He relies upon Richards v. Commissioner, 81 F. 2d 369; Welch v. Solomon, 99 F. 2d 41; Ehrman v. Commissioner, 120 F. 2d 607; Brown v. Commissioner, 143 F. 2d 468; McFaddin v. Commissioner, 148 F. 2d 570; White v. Commissioner, 172 F. 2d 629; and C. E. Mauldin, 16 T. C. 698 (on appeal C. A. 10). *1447 The petitioner contends that the properties were not so held and that he was not engaged*266 in a business of selling real estate. The petitioner relies upon Foran v. Commissioner, 165 F. 2d 705; Thompson Lumber Co., 43 B. T. A. 726; Frieda E. J. Farley, 7 T. C. 198; and Harriss v. Commissioner, 143 F. 2d 279, affirming 44 B. T. A. 999. There are several tests which are applied to determine whether a taxpayer is engaged in a real estate business in which he holds property primarily for sale to customers within the meaning of section 117 (a) (1) of the Code. In general, the courts have analyzed the records of proceedings before them for evidence which shows the extent of the taxpayer's activities in selling his property; and the frequency, continuity, and substantiality of sales is usually a factor which indicates that the taxpayer held property primarily for sale to customers and engaged in a business of selling the property. Boomhower v. United States, 74 F. Supp. 997. However, the question is a question of fact in each case, to be determined in the light of all of the evidence; *267 and no test can be regarded as determinative of the question. W. T. Thrift, Sr., 15 T. C. 366, 369. In this proceeding the facts differ distinctly from the facts in the cases of Richards, Solomon, Ehrman, Brown, White, McFaddin, and Mauldin on which the respondent relies. It is clear that the petitioner put his savings into the purchase of the lots in 1931 as an investment and as a way of securing his savings at a time when banks were having difficulties. See Foran v. Commissioner, supra.The petitioner had no intention of going into the real estate business, cf. Spanish Trail Land Co., 10 T. C. 430; and he had no intention of developing the property. The property had been subdivided in 1911, so that we do not have here the situation of a taxpayer who acquires acreage and later subdivides it into lots, and engages in developmental activities and extensive selling activities as was true in the Ehrman, Brown, White, McFaddin, and Mauldin cases. Cf., also, Oliver v. Commissioner, 138 F. 2d 910. And when, in 1946, the petitioner first *268 considered selling his lots, he was not motivated by a desire to go into a real estate business. He was not anxious to sell his property, and he gave consideration to disposing of it only because he was borrowing money to pay debts and needed funds. Of course, "Where liquidation of an asset is accompanied by extensive development and sales activities, the mere fact of liquidation will not be considered as precluding the existence of a trade or business," Frieda E. J. Farley, supra, page 204. The narrow question here is whether petitioner's activities in 1947 in connection with the sales which were made in liquidating his asset were sufficient to constitute the carrying on of a real estate business and to convert the lots which he bought and held as an investment into property held primarily for sale to customers in the course of his business. *1448 The record convinces us that the petitioner's activities in 1946 and 1947 were not sufficiently frequent, substantial, or engrossing to constitute the operation of a real estate venture or business. See Phipps v. Commissioner, 54 F. 2d 469. In the first place, the petitioner*269 demonstrated by his testimony that he was thoroughly ignorant in matters pertaining to real estate transactions. His friend of forty years, Weiland, who worked in a bank which made real estate loans, interested the petitioner in the lots in the beginning. Although he had no intention of handling sales for the petitioner when, in 1946, the petitioner needed money, and brought a real estate dealer from Minneapolis to the petitioner, he was the only person who could give the petitioner the assistance he needed. Shakopee was a small town of about 1,800 people in 1946. The petitioner impressed the Court as a man of limited education and experience, whose business activities were restricted to the comparatively simple business of selling drinks -- soft and hard, who worked long hours in the operation of a tavern, and who did not have the faintest idea of what would be involved in a "land-office" business. His earnings were not large, and his means were modest. He had been a passive investor in the lots, and he was passive in 1946 and 1947 when some of his lots were sold. Compared to many cases where the familiar tests have been applied and discussed, the petitioner's investment was*270 small, and the sales in 1946 and 1947 were not the substantial sales which are found where it has been concluded that selling activities constituted the operation of a real estate business. This is quite apparent in making comparison with the facts in the White case, for example, on which respondent relies, where the taxpayers sold 267 lots in the two years preceding the taxable year, and in one year sold 250 lots for over $ 200,000. In this proceeding the respondent, by cross examination of the petitioner and Weiland, endeavored to elicit testimony to the effect that the two of them undertook a real estate operation to "cash in" on a large demand for lots, a little boom, but the responses to respondent's counsel's questions did not substantiate such hypothesis or theory at all. There is a suggestion in the record that Weiland later went into the real estate business, but the petitioner has testified that he never discussed such undertaking with Weiland and that he did not know whether Weiland did or did not later go into a real estate business. What Weiland may have done later, the record does not show clearly, and, in any event, is immaterial. The petitioner moved away from*271 Shakopee in 1948, and he did not reinvest the proceeds of sales in other real estate, but, rather, paid his debts. The evidence does not support the respondent's theory, and he misjudged the situation when he made the determination that the petitioner was a dealer in real estate in 1947. *1449 We have observed, before, that it is often difficult to draw the line between what amounts only to liquidating an asset and primarily holding property for sale to customers in the conduct of a business. Thomas E. Wood, 16 T. C. 213, 227. We do not have such difficulty here. There were no extensive development and sales activities and the sales of 14 lots in 1947 were not, in our opinion, substantial sales. It is concluded that the number of sales and the sales activities in connection therewith were insufficient to constitute the carrying on of a business and to convert the lots which had been held for investment into property held primarily for sale to customers in the course of a business. This proceeding resembles in several respects the cases of Farley and Wood. One factor common to those cases and to this one is that commissions were retained*272 by those who brought in purchasers, out of the purchase price. Whether that factor is important and critical depends upon all of the facts in a particular case. It was not regarded as critical in the Farley and Wood cases, but it was treated as having importance in the Erhman and Brown cases, for the reason, however, that all the evidence showed that selling activities were so substantial as to constitute the carrying on of a business. In this proceeding, we are satisfied that the petitioner really was passive in the matter of sales efforts and that as in the Farley case, offers came to him. The agency concept is not overlooked, either, but we are convinced, also, that Weiland acted independently of the petitioner. See Guthrie v. Jones, 72 F. Supp. 784. And the fact that there was an element of continuity of sales is off-set by the length of time during which lots were sold. At the end of 6 years, all of the lots had not been sold, and in some years only 8 lots were sold. The average in 6 years was about 9 lots per year. If the petitioner had been able to sell all his lots at once, as he tried to do, for what he considered*273 a fair price, the element of continuity of sales would have been eliminated here. But we understand that test to mean that sales must be substantial as well as frequent and involve extensive sales activities. At any rate, we regard the sales of lots here as gradual and under the principles of Burnet v. Harmel, 287 U.S. 103, believe that this petitioner is entitled to the application of the capital gains provision of the statute. It is held that the gains realized by the petitioner in 1947 from the sales of lots are capital gains and are not taxable as ordinary income. Decision will be entered for the petitioner.