Applegate v. Comm'r of Internal Revenue, Docket No. 12721-88.
| Decision Date | 16 May 1990 |
| Docket Number | Docket No. 12721-88. |
| Citation | 94 T.C. No. 42,94 T.C. 696 |
| Parties | CALVIN P. APPLEGATE AND IRMA APPLEGATE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
During 1984, P, as a landlord farmer, sold grain crop share rentals for $83,280.79 and entered into contracts for future payments, the price of which was fixed at the market value one year after the execution of the contracts, subject to P's right to accelerate the time for establishing the price and for payment. HELD, the contracts did not constitute an evidence of indebtedness ‘payable on demand‘ within the meaning of sec. 453(f)(4)(A), I.R.C., and therefore did not constitute a ‘payment‘ under sec. 453(f)(3) with the result that the transactions qualify as an installment sale under sec. 453(a) and (b)(1). HELD, FURTHER, the cash payments received by Ps upon the execution of the contracts are taxable as ordinary income. Ronald K. Fellheimer, for the petitioners.*
Michael W. Bitner, for the respondent.
Respondent determined a deficiency in petitioners' Federal income tax for the taxable year 1984 in the amount of $240,955.00. After concessions, the issues for decision are whether the sales of grain received pursuant to crop share leases qualified for reporting on the installment method under section 453 1 and whether the payments received at the time of execution of the contracts for such sales of grain constitute ordinary income or capital gain.
All of the facts have been stipulated, and the stipulation of facts and attached exhibits are incorporated herein by reference.
Petitioners maintained their legal residence in Streator, Illinois, at the time of the filing of their petition herein. Petitioners timely filed their joint Federal income tax return for 1984 on the cash basis with the Internal Revenue Service Center, Kansas City, Missouri.
Petitioners owned farmland located in Livingston and LaSalle Counties, Illinois. During 1984, as well as during prior years, petitioner Calvin P. Applegate acted as a materially participating landlord with respect to the farmland. The actual physical farm labor was provided by six tenant farmers pursuant to material participation farm leases (leases) between petitioner Calvin P. Applegate as lessor and the respective tenant farmers as lessees. Under the terms of the leases, petitioners received one-half of all corn, soybeans, and small grains produced on petitioners' farmland, as well as paying the customary landlord's share of farm expenses.
During 1979 through 1983, petitioners sold a portion of the crop shares received by them pursuant to the leases, and the remainder was stored with local grain elevators. As of January 1, 1984, petitioners held documents from three local grain elevators evidencing their ownership from the 1979 through 1983 crop shares of 59,781.74 bushels of soybeans and 12,382.83 bushels of corn. During 1983, petitioners paid storage costs of $41,847.00 with respect to this grain.
During 1984, petitioner Calvin P. Applegate entered into ‘Price Later Contracts‘ (contracts) with the grain elevators for the sale of the stored grains. A contract with Blackstone-Sunbury-Nevada Grain Co., Inc., which is representative of all the price later contracts, provided:
Seller as identified below agrees that Buyer does hereby purchase from Seller and Seller does hereby sell to Buyer 5343.57 bushels of #2 Yel. Soybeans subject to market discounts applicable to Buyer at time of (cross out one): (delivery/pricing) under following terms and conditions:
1. The fixing of the price of the Grain is deferred, and may be established by Seller at any time, but not later than May 14, 1985, and upon demand by the Seller, the Buyer is obligated to pay his regular bid price upon the date of demand for the commodities being priced by the Seller. If no such notice is given by the Seller, by the date established in the preceding sentence, the Buyer's offered price on that date shall control, and Buyer shall promptly give Seller written notice of that price, unless a renewal has been written prior to the above expiration date covering the same Grain covered by this contract and agreed to by both Buyer and Seller. The following statements are made a part of this agreement pursuant to applicable regulations:
(a) Title to the Grain described in this contract passed to Buyer upon delivery of the Grain to him.
(b) The duration of this contract shall not exceed 12 months from the date delivery is completed.
(c) The buyer is required to maintain liquid assets equal to ninety per cent of price later obligations by Illinois law.
2. Buyer may deduct from the purchase price applicable charges on grain ticket or the specific following charges:
Deferment Charge: (specify) $7106.94 Premium Ck # 7510
Other Charges: (specify) [None]
3. THE GRAIN COVERED BY THIS CONTRACT IS SOLD, (NOT STORAGE) AND AS SUCH IS COVERED BY A GRAIN DEALER'S BOND FOR A PERIOD OF 160 DAYS FROM THE DATE OF DELIVERY OR PRICING, WHICHEVER IS LATER, MAXIMUM 270 DAYS.
The execution of these contracts eliminated the storage costs previously incurred by petitioners with respect to such grain. Upon execution of the contracts, petitioners received total payments of $83,280.97 from the following grain elevators:
+----------------------------------------------------+
¦Grain Elevator ¦Date ¦Amount ¦
+----------------------------------+-------+---------¦
¦Blackstone Grain ¦5/14/84¦$7,106.94¦
+----------------------------------+-------+---------¦
¦Blackstone Grain (Cahill Division)¦5/14/84¦40,627.54¦
+----------------------------------+-------+---------¦
¦Farmers Elevator ¦5/15/84¦22,240.00¦
+----------------------------------+-------+---------¦
¦Farmers Elevator ¦5/16/84¦7,115.00 ¦
+----------------------------------+-------+---------¦
¦Blackstone Grain (Cahill Division)¦7/19/84¦6,191.31 ¦
+----------------------------------------------------+
These payments represented the approximate difference, or ‘price spread,‘ between the market/‘bid price‘ per bushel then quoted by the respective grain elevators and the November 1, 1984, ‘futures price‘ quoted by the grain elevators for crops to be harvested in 1984, which ‘futures prices‘ were, in ] instances, lower than the current ‘bid prices.‘
During 1984, petitioner Calvin P. Applegate took no further action with respect to the contracts and received no further payments. Petitioners reported the receipt of the payments of $83,280.79 as a short-term capital gain on their 1984 Federal income tax return. 2 Petitioners reported no other tax consequence on their 1984 Federal income tax return with respect to the contracts.
By statutory notice of deficiency, respondent determined that the payments received by petitioners were to be treated as ordinary income from the sale of grain and increased petitioners' farm rental income accordingly. Respondent further determined that, as a result of the execution of the price later contracts, petitioners' farm rental income should be increased in the amount of $483,063.00. Respondent arrived at this figure by multiplying the ‘bid price‘ offered by the respective grain elevators on the dates the contracts were executed by the number of bushels of grain covered by such contracts and subtracting from this product ($549,250.00) the cash payments received by petitioners.
By entering into the contracts, petitioners did not accept the ‘bid price‘ being offered on the date the contracts were executed. Petitioners' receipt of $83,280.79 did not reduce the amount of funds which they were otherwise entitled to receive under the contracts.
There is no established secondary market by which price later contracts are bought and sold. Such contracts, standing alone, are not normally accepted as collateral on loans. Rather, they are one item listed as an account receivable or intangible asset with an uncertain monetary value on a financial statement or balance sheet and are only partially determinative of the creditworthiness of any grain producer applying for a loan. It is unusual for a farmer holding such a contract to assign the contract rights as repayment for a debt owed. Within the Illinois banking industry, some banks accept the assignment of such a contract as repayment of a loan and some do not based upon the perceived uncertainty as to its value.
We turn first to the issue whether petitioners, not having elected out of section 453, are therefore entitled to report the sales in question as installment sales in accordance with that section. Respondent asserts that petitioners' unfettered ability to demand payment of the amount in excess of the cash payments at any time under the terms of the contracts caused the recognition of income in the amount of the cash equivalent of the fair market value of the grain on the dates the contracts were executed, with the result that all payments were received in 1984 and that section 453 is inapplicable. Petitioners counter by asserting that the execution of the contracts did not result in the recognition of any amount as income in 1984 beyond the payments actually received and therefore the transactions qualify for reporting under the installment method of section 453. We agree with petitioners.
An ‘installment sale‘ is defined as ‘a disposition of property where at least one payment is to be received after the close of the taxable year in which the disposition occurs.‘ Sec. 453(b)(1). In defining what constitutes ‘payment,‘ section 453(f) provides in pertinent part:
(f) Definitions and Special Rules. -- For purposes of this section --
* * *
(3) Payment. -- Except as provided in paragraph (4), the term ‘payment‘ does not include the receipt of evidences of indebtedness of the person acquiring the property (whether or not payment of such indebtedness is guaranteed by another person).
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