Suburban Realty Co. v. U.S.

Decision Date07 April 1980
Docket NumberNo. 77-3094,77-3094
Citation615 F.2d 171
Parties80-1 USTC P 9351 SUBURBAN REALTY COMPANY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Gerald W. Haddock, Charles W. Hall, Houston, Tex., for plaintiff-appellant.

M. Carr Ferguson, Asst. Atty. Gen., Tax Div., Gilbert E. Andrews, Act. Chief, Appellate Section, Richard Farber, Atty., Marilyn E. Brookens, Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Appeal from the United States District Court for the Southern District of Texas.

Before GOLDBERG, FAY and ANDERSON, Circuit Judges.

GOLDBERG, Circuit Judge:

We must today answer the riddle at once adumbrated and apparently foreclosed by the false dichotomy created by the United States Supreme Court in Malat v. Riddell, 383 U.S. 569, 572, 86 S.Ct. 1030, 1032, 16 L.Ed.2d 102 (1966) (per curiam): when profits have "aris(en) from the (ordinary) operation of a business" on the one hand and are also "the realization of appreciation in value over a substantial period of time" on the other, are these profits treated as ordinary income or capital gain? Lacking any clear guidance but the language of the capital asset statute 1 itself, we turn to that language for the answer. Before we can arrive at this interesting and important question, however, we must once again tramp along (but not trample on) that time- and precedent-worn path which separates capital gains from ordinary income. By the time we emerge into the light at the far edge of the forest, we will find that the Riddell riddle has seemingly answered itself, and all that will remain will be a brief reassessment of our answer. In our peregrinations, we of necessity wander into virgin territory. We hope that we shed new light onto this murky terrain; at the least, we think we have neither riddled the cases nor muddled the issues.

I.

Suburban Realty Company was formed in November, 1937 to acquire an undivided one-fourth interest in 1,742.6 acres of land located in Harris County, Texas ("the property"). Suburban received its interest 2 in the property in exchange for all of its stock from four individuals 3 who had themselves acquired the property in a foreclosure proceeding brought against the property as a result of a default in the payment of certain bonds, the payment of which was secured by the property. Suburban's corporate charter states that it was formed to erect or repair any building or improvement, and to accumulate and lend money for such purposes, and to purchase, sell, and subdivide real property, and to accumulate and lend money for that purpose.

The five transactions whose characterization is in dispute here concern six tracts of unimproved real estate sold from the property by Suburban between 1968 and 1971. 4 On its tax returns, Suburban originally reported profits from these sales, as well as all of its other real estate sales, as ordinary income. Later, Suburban filed a claim for refund asserting that these six tracts, as well as three similar tracts sold later, were capital assets, and that profits from these sales were entitled to capital gain treatment. The Internal Revenue Service denied Suburban's claim as to the sales here in issue. 5 Suburban then instituted this action for a refund of $102,754.50. The district court, in a non-jury trial, rendered a decision against Suburban and entered a judgment dismissing Suburban's complaint. Suburban appealed.

The parties' legal contentions are closely bound to the facts. It is undisputed that, at the time of sale, the tracts at issue here were subject to a grass lease which apparently covered much of the property. Except for this grass lease, the six tracts, as well as much of the rest of the property, were never put to any substantial use. However, certain other portions of the property were the subject of greater activity. The parties disagree to some degree concerning the extent of, and appropriate characterization of, the activities conducted relating to these other portions of the property, and they fundamentally dispute the weight such activities carry in properly characterizing the sales at issue here. We will first discuss Suburban's overall activities with respect to the entire property, and then turn to those portions of the property singled out by the parties as being the subject of greater activity.

A. Overall activities.
1. Total Sales Activity From the Property.

Between 1939 and 1971, Suburban made at least 244 individual sales of real estate out of the property. Of these, approximately 95 sales were unplatted and unimproved property legally suitable for commercial development for any other purpose, 6 and at least 149 sales were from platted property restricted to residential development. 7 In each of these 33 years, Suburban concluded at least one sale; in most years, there were four or more sales. Suburban's total proceeds from real estate sales over this period were $2,353,935. Proceeds from all other sources of income amounted to $474,845. 8 Thus, eighty-three percent of Suburban's proceeds emanated from real estate sales; only seventeen percent flowed from all other sources.

2. North Loop Freeway.

In 1957, the Texas Highway Department proposed that the limited access superhighway now known as the North Loop would be located from east to west across the property. In 1959 and 1960, Suburban sold at least two parcels out of the property to the Texas Highway Department for the purpose of constructing this highway. The location of the highway had a dramatic effect on the price of land in the area. Land which had been selling for between three and five thousand dollars per acre prior to announcement of the highway rose in value to between seven and twelve thousand dollars per acre.

3. Corporate Discussions and Investments.

Starting not later than 1959, Suburban's officers, directors and stockholders began discussing liquidation of the corporation. Many of these discussions occurred after 1961, when Rice University became a stockholder of Suburban and the Treasurer of Rice University became a member of the board of directors. Because Rice University desired investments in income-producing assets rather than raw land, discussions concerning liquidation 9 of Suburban's real estate holdings and the possibility of a partition of its holding among its stockholders 10 were common. Starting in 1966, Suburban made substantial investments in stocks and bonds and began receiving substantial income from these investments.

B. Specific portions.

1. Houston Gardens. In 1938, Suburban and the other owners of the property formed a separate corporation, Houston Gardens Annex, Inc. ("Houston Gardens"), to plat and sell a parcel in the northeast quadrant of the property. The stock ownership in Houston Gardens was in the same proportion as ownership interests in the property i. e., Suburban and Mrs. Talbot each owned one-quarter of the stock of Houston Gardens; Mr. Hamman owned one-half of the stock. Houston Gardens owned approximately 200 or 250 lots, which were generally sold in bulk to builders. These sales covered as many as 20, 30, or even 50 lots at a time. By 1961, Houston Gardens had sold all but two of its lots, and it was then liquidated. Houston Gardens never engaged in advertising, used brokers or real estate agents, or employed a sales organization at any time during its existence.

2. Homestead Addition. Certain portions of the property, located near its center, were designated as Homestead Addition Sections One, Two, Three, and Four. Little was done with Homestead Addition Section One except for platting it and running a few utility lines up to it.

Homestead Addition Section Two, however, was the primary subject of Suburban's activities. In July, 1948, Suburban acquired 100 percent ownership of Homestead Addition Section Two by exchanging cash and other land for the other owners' interests. Immediately thereafter, Suburban commenced development of Homestead Addition Section Two. The area was platted, streets and sewers were put in, and a sewage disposal plant was built nearby. 11 Suburban also built a lumberyard in Section Two. 12 At the instance of one of the individuals whom Suburban hired to collect water bills and notes on houses and to manage the lumberyard, Suburban also built eleven houses in Section Two in the early 1950's. The last was built by 1955, and none was sold later than 1958. 13 Between 1948 and 1966, Suburban sold 252 subdivided lots out of Section Two. About half of these lots were sold in bulk to builders 10, 15, or 20 lots at a time. 14

Homestead Addition Sections Three and Four were platted for residential use by Suburban in 1951. This area was never developed by Suburban, however. In 1961 the plats were withdrawn and cancelled. This had the effect of eliminating restrictions which prevented commercial use of the land. Subsequently, the real estate within Sections Three and Four was sold to commercial and industrial users.

3. Other Parcels. The remainder of the property appears to have been treated as one undifferentiated bulk by Suburban. It is from this undifferentiated, undeveloped remainder that the sales at issue here were made. There are no specific findings by the trial court, and there appears to be no evidence of record from which we could ourselves make findings, concerning the number and frequency of sales of real estate from other parts of the property. Rather, the evidence concerning annual sales groups all sales made by Suburban, including sales from the Homestead Addition Sections, together. 15 However, it is clear that throughout the period 1939-1971, sales were being made from the remainder of the property.

II.

Our analysis of this case must begin with Biedenharn Realty Co., Inc. v. United States, 526 F.2d 409 (5th Cir.) (en banc), cert. denied, 429 U.S. 819, 97 S.Ct. 64, 50 L.Ed.2d 79 (1976). Biedenharn is this Court's latest (and...

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