Buono v. Comm'r of Internal Revenue
| Decision Date | 29 April 1980 |
| Docket Number | Docket No. 3504-78. |
| Citation | 74 T.C. 187 |
| Parties | GEORGE V. BUONO, JOHN R. FIORINO and MARGARET H. FIORINO, THOMAS F. KANE and JUDY K. KANE, FRANCIS A. MILLER and BARBARA A. MILLER, BEN ROBERTS and SYLVIA ROBERTS, and HENRY E. TRAPHAGEN and EDITH M. TRAPHAGEN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners formed a subch. S corporation in 1968 to acquire a tract of undeveloped land. They intended to sell the entire property intact as soon as the local municipality approved the corporation's application to subdivide the property. A dispute between the municipality and the corporation developed over the subdivision application. A major portion of the property was sold in 1973, after resolution of the controversy. The corporation acquired no other property and was engaged in no other activity. Held, the property sold in 1973 was not held for sale to customers in the ordinary course of a business and thus was a capital asset under sec. 1221, I.R.C. 1954. Held, further, the activities of the corporation's shareholders do not preclude capital gain treatment. Sec. 1.1375-1(d), Income Tax Regs. Phillip Lewis Paley, for the petitioners.
Marwin A. Batt, for the respondent.
Respondent determined deficiencies for 1973 for the following individuals:
+---------------------------------------+
¦George V. Buono ¦$9,621¦
+--------------------------------+------¦
¦John R. and Margaret H. Fiorino ¦17,550¦
+--------------------------------+------¦
¦Thomas F. and Judy K. Kane ¦35,420¦
+--------------------------------+------¦
¦Francis A. and Barbara A. Miller¦8,750 ¦
+--------------------------------+------¦
¦Ben and Sylvia Roberts ¦7,543 ¦
+--------------------------------+------¦
¦Henry E. and Edith M. Traphagen ¦10,214¦
+---------------------------------------+
Respondent also asserted an addition to tax for 1973 under section 6653(a) against Thomas F. and Judy K. Kane in the amount of $1,771. Although separate notices of deficiency were sent to the various petitioners, a single petition was filed by all petitioners, as permitted by Rule 34(a)(1), Tax Court Rules of Practice and Procedure, and the case was tried and briefed as a consolidated case.
Concessions having been made, the issues for decision are:
(1) Whether the sale of certain real property constitutes the sale of a capital asset within the meaning of section 1221,1 thus entitling the petitioners to report the income therefrom as capital gain; and
(2) Whether the activities of certain shareholders should, under sec. 1.1375-1(d), Income Tax Regs., be imputed to petitioners' subchapter S corporation for purposes of determining the character of the gain from such property's sale.
Some of the facts have been stipulated. The stipulation, together with the exhibits attached thereto, is incorporated herein by this reference.
The petitioners' legal residences on the date the petition was filed were as follows:
+----------------------------------------------------+
¦George V. Buono ¦New Brunswick, N.J.¦
+--------------------------------+-------------------¦
¦John R. and Margaret H. Fiorino ¦Matawan, N.J. ¦
+--------------------------------+-------------------¦
¦Thomas F. and Judy K. Kane ¦Summit, N.J. ¦
+--------------------------------+-------------------¦
¦Francis A. and Barbara A. Miller¦Matawan, N.J. ¦
+--------------------------------+-------------------¦
¦Ben and Sylvia Roberts ¦Matawan, N.J. ¦
+--------------------------------+-------------------¦
¦Henry E. and Edith M. Traphagen ¦Wickatuch, N.J. ¦
+----------------------------------------------------+
In 1973, a corporation known as the Marlboro Improvement Corp. (referred to hereinafter as Marlboro Improvement) sold some real property which gave rise to recognizable gain. During 1973, each of the male petitioners were shareholders of Marlboro Improvement,2 a corporation which had elected to be treated as a small business corporation under subchapter S of the Internal Revenue Code. Each shareholder reported his aliquot share of the net proceeds from the sale on his 1973 tax return as gain from the sale of a capital asset.
In 1967, petitioner Henry Traphagen learned that a neighbor, Kenneth V. Hayes, was interested in selling a large tract of farmland.3 With the exception of a 1-acre portion which was to be retained for a personal residence, Hayes wanted to dispose of the entire tract as he had recently retired from farming. The property was located in the township of Marlboro, Monmouth County, N.J. (referred to hereinafter as Marlboro or the town), about a half mile from Traphagen's residence, and consisted of approximately 130 acres.
Traphagen believed that acquisition of this property would present a good opportunity for financial gain. Up until that time, there had been minimal residential development in Marlboro because many residents wanted to preserve the town's rural atmosphere. Traphagen feld that a significant market for the sale of residential property had resulted from the town's antidevelopment climate. For example, he was aware that Monmouth Heights, a successful residential development having over 300 homes, had been built approximately one-third of a mile from Hayes's tract.
Traphagen also realized that property which had been approved for subdivision was significantly higher in value than raw land. In this context, approval of a subdivision plan means that the local municipality has authorized the respective sizes for each building lot within a tract as well as the layout for streets, sewers, sidewalks, and any commercial areas. As a consequence, developers of residential housing are generally willing to pay a premium for land which has already obtained subdivision approval.
At the time, the zoning ordinance of Marlboro Township provided for 4 0/30 or three-quarter-acre zoning. Under this ordinance, 40 single-family residences could be built per 30 acres of land. In other words, each building lot was required to contain three-quarters of an acre of land. During the negotiations with Hayes, Traphagen informally approached the Marlboro Planning Board to ascertain whether an application for subdivision approval pursuant to the 4 0/30 zoning ordinance would encounter any difficulty. Members of the planning board informed Traphagen that he would not have any problems in processing an application under the current zoning ordinance.
Hayes and Traphagen agreed to a purchase price of $2,200 an acre. After this final price was negotiated, Traphagen contacted a longtime friend, petitioner John Fiorino, and asked him if he would be interested in jointly purchasing Hayes's property as Traphagen felt that the transaction was too large to handle alone. Fiorino agreed to join Traphagen in this venture.
A contract for purchase of the property was executed on December 11, 1967, with both Traphagen and Fiorino as parties thereto. The total net purchase price was $270,600.4 Hayes received $20,000 on the signing of the contract with an additional $30,000 due on April 30, 1968. The balance of the purchase price was to be financed by a purchase-money mortgage held by Hayes. No principal payments were due until 4 years after the closing date.5 Interest on the mortgage was set at 6 percent and due quarterly.
Soon after the purchase contract was executed, Fiorino and Traphagen sought other investors to join them. Both realized that the transaction, with all of its attendant financial burdens, was too large for them to manage by themselves. The additional people who entered into the transaction comprise the remaining petitioners in this case. All were personal friends of either Fiorino or Traphagen (or both).
The petitioners agreed that a corporation would be formed to hold the property with each petitioner being entitled to a percentage interest commensurate with his respective capital contribution. Accordingly, Marlboro Improvement was formed on June 19, 1968, under the laws of New Jersey with Traphagen, Fiorino, and petitioner Francis A. Miller listed as the incorporators.
Marlboro Improvement's shareholders and the respective shares each held were:
+----------------------------+
¦Name ¦Shares ¦Percent ¦
+---------+--------+---------¦
¦ ¦ ¦ ¦
+---------+--------+---------¦
¦Buono ¦40 ¦10 ¦
+---------+--------+---------¦
¦Roberts ¦60 ¦15 ¦
+---------+--------+---------¦
¦Miller ¦60 ¦15 ¦
+---------+--------+---------¦
¦Traphagen¦60 ¦15 ¦
+---------+--------+---------¦
¦Kane ¦80 ¦20 ¦
+---------+--------+---------¦
¦Fiorino ¦100 ¦25 ¦
+----------------------------+
In addition, Marlboro Improvement elected to be taxed as a small business corporation under the provisions of subchapter S, subtitle A, of the Internal Revenue Code.
On June 19, 1968, Hayes transferred the property to Marlboro Improvement by deed. The final purchase price was $286,374. As the corporation was credited with a $50,000 downpayment, the amount of the purchase-money mortgage was $236,374.
The petitioners, generally, were in agreement that the property would be held for about 11;2 years. They intended to sell the entire tract intact as there were no plans to develop the property and dispose of it in separate lots. However, as it was apparent that an approved subdivision plan would significantly enhance the property's marketability and value, soon after the property was acquired, Marlboro Improvement undertook the preliminary steps needed to process a subdivision application.
In connection with its subdivision application, Marlboro Improvement was required to submit a plan setting forth the boundaries of the respective lots as well as the street plans for the tract. Marlboro Improvement retained engineers to draft a map (or sketch plat) showing the division of land into...
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