Ehlers v. Vinal
| Decision Date | 29 March 1966 |
| Docket Number | Civ. No. 01484. |
| Citation | 253 F. Supp. 58 |
| Parties | William A. EHLERS and William A. Ehlers, Executor of the Estate of Margaret C. Ehlers, Deceased, Plaintiff, v. Richard P. VINAL, District Director of Internal Revenue for the District of Nebraska, Defendant. |
| Court | U.S. District Court — District of Nebraska |
Rogers, Field & Gentry and Jack B. Robertson, Kansas City, Mo., and Burbridge & Burbridge, Omaha, Neb., for plaintiff.
John M. Bray, Dept. of Justice, Washington, D. C., and Theodore L. Richling, U. S. Atty., Omaha, Neb., for defendant.
This is an action instituted by William A. Ehlers, on his own behalf and as Executor of the estate of Margaret Ehlers, against Richard P. Vinal, the District Director of Internal Revenue for the District of Nebraska, to recover an alleged overpayment of income taxes, penalties, and interest for the years 1948 through 1958 in the total amount of $122,344.91 plus interest. Hereinafter we shall refer to William A. Ehlers as "Ehlers" or "taxpayer" and shall by those terms refer to William A. Ehlers both in his own right and in his capacity as executor of the estate of his wife.
The Court has jurisdiction pursuant to the provisions of 28 U.S.C.A. § 1340.
The taxpayer is an attorney who has practiced law in Omaha, Nebraska. During the years 1948 to 1958, he became engaged in purchasing property that was subject to a land contract and having the land contract assigned to him. During this period, joint federal income tax returns were filed by Ehlers and his wife. In 1954, the Internal Revenue Service began an investigation of these returns. It was determined that certain items of income had not been reported by taxpayer, and a net worth statement was prepared which indicated a substantial discrepancy between actual income and reported income. As a result of this investigation, additional income taxes were assessed, fraud penalties were added and additional interest was charged. Taxpayer paid these additional amounts for all of the years in question in August of 1961. The present case was filed to recover those payments after timely claim for refunds had been made.
The case was tried to the Court and to a jury, the jury returning a special verdict of wilful failure to report income with intent to defraud the Government against the taxpayer for each of the years in question.
We now have before us for determination the plaintiff's motion for a directed verdict and judgment at the close of all the evidence; plaintiff's motion to set aside the verdict and enter judgment notwithstanding the verdict or in the alternative for a new trial; and the issues which remained for determination by the Court after the trial herein. The latter includes the question of capital gain or ordinary income reporting of discounts from the land contract transactions and that of treating a proportionate part of each payment on the land contracts as income. We shall separately state and discuss each of those items that are before us.
The system used by Ehlers with respect to the land contracts was quite efficient. Generally, the transaction was brought to him by another party rather than his going out in search of a prospective purchase. After being contacted, Ehlers would personally appraise the property involved and run a check on the credit of the people who had signed the land contract. This method resulted in his refusal to accept approximately 75% of the prospective purchases offered to him.
The first issue to be determined is whether taxpayer should account for the profit he earned from discounts on land contracts as capital gains or as ordinary income. Many of the transactions involved the purchase by Ehlers of the property at an amount somewhat lower than the balance remaining on the land contract which would also be assigned to the taxpayer. The taxpayer urges that he was engaged in the purchase of real estate only and that it was incidental to the actual purchase of real estate that the land contract pertaining to that real estate was assigned to him. Since he was engaged in the purchase and sale of real estate, any gain made thereon should naturally be treated as a capital gain.
The Government takes the position that the form of these transactions indicates that Ehlers was actually financing these land contract transactions—loaning money and receiving the legal equivalent of interest in return. We agree with the Government.
Under Nebraska law, the land contract agreements here are considered to be coequal with mortgages. Section 76-251 of the Nebraska Revised Statutes, 1943, provides:
Every one of the pieces of real estate purchased by Ehlers was accompanied by a defeasance instrument which meant that the only interest in land that could be sold was that of a mortgagee. A cursory glance might leave the impression that the transactions here involved were the purchase and sale of real estate, but a closer examination and analysis lead directly to the conclusion that Ehlers was purchasing the rights under the land contract. He was in reality financing the sale between the original buyer and seller.
Having determined that Ehlers was not merely purchasing real estate but was purchasing the entire related bundle which basically amounted to the land contract, we must determine the legal effect thereof. The United States Supreme Court gave us the answer to the problem in the case of United States v. Midland-Ross Corp. 1965, 381 U.S. 54, 85 S.Ct. 1308, 14 L.Ed.2d 214, which was decided in the spring of 1965, at about the same time this case was tried. We concede that this case is different on its facts from Midland-Ross, but the theory expounded therein applies equally to the case at bar as it did under the differing factual circumstances. That which serves the same function as stated interest —in other words, compensation for the use or forbearance of money—is ordinary income and not entitled to capital gain treatment. The difference between the price paid by Ehlers and the remaining balance of the land contract is essentially equivalent to a discount. The money to be paid on the land contract, barring the risks which attend any investment, was a sum certain to be paid on a monthly basis. Congress intended capital gains treatment only in those situations normally involving the realization of appreciation in value accrued over a substantial period of time, thus softening the hardship of accepting the entire gain in one year. Commissioner of Internal Revenue v. Gillette Motor Transport Co., 364 U.S. 130, 80 S.Ct. 1497, 4 L.Ed.2d 1617. The effective discount which was received here did nothing more than raise the rate of interest which was received by the taxpayer on his investment. This is certainly reportable as ordinary income and we cannot find that taxpayer should have received capital-gains treatment in this respect.
We find that the earned discount received by taxpayer on the land contract transactions here in question should have been reported as ordinary income rather than as capital gains.
The next question to be considered is whether Ehlers should have treated a proportionate part of each payment on the land contracts as income rather than making a total recovery of his costs before reporting income. As we shall point out, the decision of this issue depends on the resolving of a factual question by this Court.
The taxpayer has been following the practice of recovering his entire cost, including miscellaneous additions to purchase price such as taxes, etc., before reporting any income on these transactions. His theory is that the possibility of a complete recovery on any of these contracts is highly speculative and he therefore has the right to make a complete recovery of his costs before he need report any income. The Government feels that there is no such speculative risk involved with these contracts and that a portion of each monthly payment should be allocated to income with the remainder being assigned to recovery of principal or costs.
Courts seem to agree that the test of whether discount income should be reported proportionately with each payment is the certainty of recovery on the contract or that the contract will be carried out. Whatever confusion may have existed in the Ninth Circuit Court of Appeals as a result of Phillips v. Frank 9th Cir., 1961, 295 F.2d 629, was dissolved by the clear statement of the court in Willhoit v. Commissioner of Internal Revenue 9th Cir., 1962, 308 F.2d 259, wherein the above rule was adopted in the following language at page 263 of 308 F.2d:
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...v. United States, 168 F.Supp. 720 (Neb.1958); Mitchell v. Commissioner of Internal Revenue, 118 F.2d 308 (Fifth Cir. 1941); Ehlers v. Vinal, 253 F.Supp. 58 (Neb.1966); First Trust & Savings Bank of Davenport, Iowa v. United States, 206 F.2d 97 (Eighth Cir. 1953). This last case is criticize......
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