Haynsworth v. Comm'r of Internal Revenue
| Decision Date | 22 August 1977 |
| Docket Number | Docket No. 5501—75. |
| Parties | ROBERT F. AND HAZEL HAYNSWORTH, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
In 1959, a partnership of which petitioner-husband was a member acquired a piece of land for subdivision purposes, obtained an estimate of the costs of developing it, and began development and sales of lots from the subdivision. The partnership created a reserve account in the amount of the estimated costs and debited that account with development costs actually paid. As each lot was sold, the partnership deducted a proportionate part of the land costs as well as a proportionate part of the estimated development costs from the selling price in computing the gross profit from the sale. By Nov. 1, 1972, when all lots remaining in the subdivision were sold, and the partnership was liquidated, the total amount of estimated development costs deducted as part of the cost of lots sold exceeded the development costs actually expended by $45,219.77. Held, upon the sale of all lots remaining in the subdivision and liquidation and distribution of the partnership assets, the reserve created for the estimated cost of developing the subdivision was ready to be, and was, closed. As a result of the closing of that reserve and the release of the reserved funds, petitioner-husband, through the partnership, realized taxable income in the amount of his distributive share of the $45,219.77. Towner Leeper, for the petitioners.
Bernard B. Nelson, for the respondent.
Respondent determined a deficiency of $7,993.52 in petitioners' Federal income tax for 1972. The issue for decision is whether petitioners realized ordinary income in 1972 in the amount of the distributive share of the unused portion of a reserve for estimated subdivision development expenses which had been deducted by a partnership, of which petitioner Robert F. Haynsworth was a member, in computing its gain in prior years on the sale of lots from the subdivision.
Petitioners Robert F. Haynsworth (hereinafter Haynsworth) and Hazel Haynsworth, husband and wife, were legal residents of El Paso, Tex., when they filed their petition. They filed a joint Federal income tax return for 1972 with the Internal Revenue Service, Austin, Tex.
In 1959, Haynsworth & Guaranty Title Co. (hereinafter GTC) formed a partnership known as Magnetic Hills Joint Venture (hereinafter the partnership). In that year, the partnership bought lots in an area of El Paso, Tax., known as Canyon Hills. Under the terms of the partnership agreement, Haynsworth was to receive 90 percent of the profits and bear the same percentage of the partnership losses. This percentage of the profits and losses did not change from 1959 through 1972.
In 1961, Lance Engineering, Inc., submitted to the partnership an estimate of the cost of developing the partnership's lots in Canyon Hills. This cost estimate included expenses for paving, curbs and gutters, street grading, lot grading, utilities, engineering expenses, interest, taxes, supervision, and miscellaneous overhead expenses. The total estimate was $404,406.
This estimate of development costs was sent to the partnership's accountant, and he made entries on the books to reflect an increase in the development cost of the Canyon Hills property. He did this by debiting an account entitled ‘Canyon Hills Development Cost’ with the $404,406 and crediting an offsetting reserve entitled ‘Provision to develop Canyon Hills' with the same amount.
In 1962, 1963, and 1964, the partnership's accountants made adjustments to the original Lance Engineering, Inc., estimate. These adjustments included a decrease of anticipated development costs by $62,023.30 in 1962 to eliminate the estimated interest expenses as a result of the payment of a mortgage on the property. The estimated costs were also decreased by $32,400 in 1963 but were increased by $35,000 in 1964.
The partnership developed the Canyon Hills lots and incurred and paid expenses for this purpose. It also sold some of the lots each year, either outright or on an installment basis. As the partnership sold individual lots during those years, it reported the sales in its partnership returns. In computing its cost of goods sold, the partnership included in such cost the actual cost of the lots which were sold plus the estimated development cost per lot.
The partnership credited the account entitled ‘Canyon Hills Development Cost,’ originally debited for the total estimated cost of development ($404,406), each year with a proportionate share of the estimated cost of the lots which were sold during that year as well as with the adjustments referred to above. As of November 1, 1972, the account showed a debit balance of $74,656.73.
The account entitled ‘Provision to develop Canyon Hills,‘ which began with a credit in the amount of the estimated development cost ($404,406), was debited for the expenses which were actually incurred and paid as development costs as well as for the adjustments referred to above. As of November 1, 1972, this account showed a credit balance of $119,876.50, a sum of $45,219.77 greater than the corresponding account entitled ‘Canyon Hills Development Cost.’
The reason for the difference of $45,219.77 in the balances in the ‘Canyon Hills Development Cost’ and ‘Provision to develop Canyon Hills' accounts is that, during 1959 through 1972, the first of these accounts was credited with, and deductions were taken on, the partnership returns for more expenditures than were actually paid by the partnership.
On November 1, 1972, Roman & Russell Builders, Inc. (Roman & Russell), purchased the remaining 38 residential lots in the Canyon Hills subdivision not previously sold. The contract of sale recited that ‘R. F. Haynsworth, doing business as Canyon Hills' was the seller. The consideration for the sale was a vendor's lien promissory note in the original principal sum of $125,000. The purchaser made no payment to the partnership in 1972. After this sale, neither petitioner nor the partnership owned any residential lots in Canyon Hills.
As of November 1, 1972, the records of the partnership reflected a distribution of all assets and liabilities to the partners as follows:
As noted, the unabsorbed development costs of $45,219.77 were treated by the partnership as part of the sales price. The partnership attached this schedule to its 1972 tax return to show the gain, reported as long-term capital gain, on the sale of the remaining 38 Canyon Hills lots to Roman & Russell.
Petitioners reflected on their books and records the following for the taxable year ended December 31, 1972:
In a supporting schedule to part II, Schedule D, of their individual income tax return for 1972, petitioners reported long-term capital gain of $34,328.76 from the sale of the Canyon Hills land as follows:
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¦Schedule D, part II
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