Ehlers v. Vinal

• Decision Date: 08 September 1967
• Docket Number: No. 18578.,18578.
• Parties: William A. EHLERS and William A. Ehlers, Executor of the Estate of Margaret C. Ehlers, Deceased, Appellant, v. Richard P. VINAL, District Director of Internal Revenue for the District of Nebraska, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

382 F.2d 58 (1967)

William A. EHLERS and William A. Ehlers, Executor of the Estate of Margaret C. Ehlers, Deceased, Appellant, v. Richard P. VINAL, District Director of Internal Revenue for the District of Nebraska, Appellee.

No. 18578.

United States Court of Appeals Eighth Circuit.

August 15, 1967.

Rehearing Denied September 8, 1967.

COPYRIGHT MATERIAL OMITTED

Walter H. Cropper, Omaha, Neb., for appellant, J. Patrick Thornton and William A. Ehlers, Omaha, Neb., with him on brief.

Donald A. Statland, Atty., Dept. of Justice, Washington, D. C., for petitioner, Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson and David O. Walter, Attys., Dept. of Justice, and Theodore L. Richling, U. S. Atty., Omaha, Neb., with him on brief.

Before VAN OOSTERHOUT, MATTHES and LAY, Circuit Judges.

LAY, Circuit Judge.

Taxpayer instituted this action against 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.¹

The taxpayer, appellant in this court, is an attorney. This litigation arises from his purchase of various properties in and about Omaha, Nebraska, which were subject to land contracts. At the time of the purchase, he would receive from the vendor a blank deed, an abstract of title, an insurance policy on the land, and an assignment of the land contract formerly executed between the vendor and the vendee. Over the period from 1948 to 1958, he was involved in 300 to 400 such transactions. At issue are the tax consequences of these purchases. A more complete statement of the pertinent facts is set forth in the lower court opinion by the Honorable Richard E. Robinson, Chief Judge. 253 F.Supp. 58 (D. Neb.1966).

The taxpayer reported the income received over the purchase price of the land contract as a capital gain rather than ordinary income. Except for a proration which he allowed for the interest received, the taxpayer did not report his income from payments on the land contracts at the time it was received, but waited until the year when he had totally recovered his cost before reporting any gain. The government assessed deficiencies on the premise that the gain should have been reported as ordinary income and should not have been deferred. Taxpayer paid the tax deficiencies, penalties and interest assessed for the eleven years in question. In August 1961 he brought this action in the District Court to recover his alleged overpayment.

The case was submitted to a jury for determination of the issue of fraud for the taxable years 1948 to 1958. The court reserved for its own decision the remaining questions of law and fact involved.²

The trial court found generally against the taxpayer as to the deficiencies involved; it held that the income received under the land contract transactions was ordinary income and could not be treated as a capital gain under §§ 1212 and 1221 of the Internal Revenue Code of 1954; that the recovery of the costs was not speculative and appellant should have reported his income proportionately at the time that it was received; and that the government was justified in employing the net worth system to determine taxpayer's income during the period in question. The jury determined that the taxpayer was guilty of fraud for each of the eleven years. The trial court, however, sustained taxpayer's motion for judgment notwithstanding the verdict on the issue of fraud for the years 1955 through 1958, because of an improper application of the net worth method to those years.³ Appellant was therefore granted refund only as to the fraud penalty from 1955 through 1958. Taxpayer appeals. We affirm.

The parties are in basic agreement as to the issues presented on this appeal. They are as follows:

1. Whether the amount received by taxpayer above costs on land contract transactions should have been reported as ordinary income rather than as capital gain.

2. Whether taxpayer should have allocated a proportionate part of each payment on the land contracts to income and a part to recovery of cost in the year received.

3. Whether the Internal Revenue Service should have been permitted to use the net worth method of reconstructing taxpayer's income.⁴

4. Whether the District Court erred in submitting the issue of fraud to the jury.

Appellant claims that the property he held by his land contract transactions meets the definition of a capital asset in Tit. 26 U.S.C.A. § 1221. Argument is made that he was purchasing an interest in real estate, holding it for six months or more as an investment and that therefore his income on the transaction should be entitled to "capital gains treatment." Overlooked is the doctrine of equitable conversion applicable in Nebraska. In Buford v. Dahlke, 158 Neb. 39, 62 N.W.2d 252, at 254-255, it was stated:

"It has been frequently and consistently decided by this court, as it is quite unanimously agreed by courts generally, that if the owner of real estate enters into a contract of sale whereby the purchaser agrees to buy and the owner agrees to sell it and the vendor retains the legal title until the purchase money or some part of it is paid, the ownership of the real estate as such passes to and vests in the purchaser, and that from the date of the contract the vendor holds the legal title as security for a debt as trustee for the purchaser. The interest or estate acquired by the vendee is land and the rights conferred by the contract upon and vested in the vendor are personal property."

Under Nebraska law it is clear that all the vendor of a land contract could transfer to a third person — the taxpayer in this instance — was personal property. The legal title retained by the vendor is merely a form of security. See also In re Wiley's Estate, 150 Neb. 898, 36 N.W. 2d 483, opinion supplemented on other grounds, 151 Neb. 633, 38 N.W.2d 434; United States v. Sode, 93 F.Supp. 398 (D. Neb.1950).

In Arthur E. Wood, 25 T.C. 468 (1955), the Tax Court was faced with the same type of transaction. The court acknowledged the doctrine of equitable conversion under the law of Michigan. As to the assignee of the land contract who claimed a long term capital gain, the court said:

"The profits derived by petitioner from such contracts were realized simply by holding the contracts until maturity, meanwhile collecting the periodic payments from the purchaser of the property. Petitioner merely collected the proceeds of assigned claims. * * * It is well settled that gain resulting from the collection of a claim or chose in action is taxable as ordinary income. * * * Petitioner appears to be in the same economic position as a bondholder who realizes gain from the recovery of discount on bonds purchased for less than their face amount." 25 T.C. at 476-477. (Emphasis ours)

See also Darby Investment Corp., 37 T.C. 839, 843 (1962), aff'd 315 F.2d 551 (6 Cir. 1963), wherein the parties conceded in a similar transaction that the "discount income" received was ordinary income, not capital gain. Compare United States v. Midland-Ross Corp., 381 U.S. 54, 85 S.Ct. 1308, 14 L.Ed.2d 214 (1965). We therefore conclude that taxpayer was not entitled to a refund based upon a capital gain computation.

Appellant's second contention is that the gain, whether treated as a capital gain or as ordinary income, is not realized until the taxpayer has completely recovered his cost, relying upon Burnet v. Logan, 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143 (1931). The identical argument was offered and rejected in Darby Investment Corp., supra. The court in Darby submits that:

"Determination of the issue turns on the question of whether the investment in the contracts is of such a speculative nature that the purchaser, the petitioner herein, cannot be reasonably certain of ever recovering his cost." 315 F.2d at 552.

This test was properly recognized by the trial court below. The court found under the evidence that these investments were not speculative and therefore a proportionate part of the payments should have been assigned to income.

The evidence demonstrates that while there was some degree of uncertainty whether any one vendee would complete payments on his contract, the numerous and substantial safeguards against loss erected by Ehlers more than counter-balanced this factor. The evidence showed taxpayer systematically screened the contracts offered him, accepting only around 25 per cent, inspected and appraised the property involved for actual market value, checked the credit of the purchasers who would become his payors, obtained in almost all cases a first lien on the property, and never paid more than what he believed to be the actual market value of the property (sometimes only 50 per cent of the remaining balance on the contract). Due to these factors, along with the provision that in event of default he had the right to foreclose and claim the property without returning prior payments, Ehlers sustained losses on only about twelve of his 300 to 400 land contract transactions.

There exists substantial evidence which supports the findings of the District Court. See Fed.R.Civ.P. 52(a). We sustain the lower court's finding that the taxpayer should have allocated a portion of each payment on the land contracts to income for the year in which it was received.⁵

Appellant complains of the use of the net worth method for determining the extent of his deficiencies and alleged fraud for the years 1948 through 1958. First, it is argued before the net worth system can be used to reconstruct income the government must show either that taxpayer failed to have any bookkeeping system or that an inadequate method was employed. The fallacy of this argument was fully demonstrated by the trial court,⁶ relying upon Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954). The observation of the Court of Appeals for the Seventh Circuit...