Estate of Freeland v. CIR, 21795

• Decision Date: 06 May 1968
• Docket Number: No. 21795,21795
• Citation: 393 F.2d 573
• Parties: ESTATE of Eugene L. FREELAND, Deceased, by Security First National Bank, a national banking association, Executor, and Vera Good Freeland, by L. N. Turrentine, Conservator, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Margaret C. LOWTHIAN, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

393 F.2d 573 (1968) ESTATE of Eugene L. FREELAND, Deceased, by Security First National Bank, a national banking association, Executor, and Vera Good Freeland, by L. N. Turrentine, Conservator, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Margaret C. LOWTHIAN, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

Nos. 21795, 21795-A.

United States Court of Appeals Ninth Circuit.

March 8, 1968.

As Modified on Denial of Rehearing May 6, 1968.

George T. Altman (argued), Beverly Hills, Cal., Adam Y. Bennion (argued), Los Angeles, Cal., James W. Archer, Thomas F. Greaves, Frank Kockritz, Gray, Cary, Ames & Frye, Charles E. Burch, Jr., John B. Gregory, San Diego, Cal., for appellant.

Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, David O. Walter, Marco S. Sonnenschein (argued), Lester Uretz, Washington, D. C., for appellee.

Before BARNES, JERTBERG and ELY, Circuit Judges.

BARNES, Circuit Judge:

On December 30, 1966, the Tax Court of the United States held in two related decisions that deficiencies existed in the federal income tax of Eugene L. Freeland and Vera G. Freeland, husband and wife, for the years 1956-1961, and in that of Margaret C. Lowthian for the years 1956-1960. Eugene L. Freeland is now deceased, and his estate, along with Vera G. Freeland, now petitions this court under 26 U.S.C. § 7482 (1964), seeking review of the Tax Court's decision relating to them. Margaret C. Lowthian also petitions under the same statute for review of the decision in her case, and the two petitions have been consolidated for argument and decision.

In November 1956 the Freelands and Miss Lowthian (hereinafter referred to as "petitioners") sold their respective interests in a partnership, the Sam Berger Investment Company, the assets of which comprised approximately 4000 acres of land in San Diego, California. They reported the resulting gain on the installment basis as long-term capital gain, a tax treatment which was at first accepted by the District Director of Internal Revenue. In 1962, however, the District Director approved reopening with respect to 1956. (Subsequent years are here involved because of utilization of the installment basis). On July 29, 1964, the Commissioner of Internal Revenue issued statutory deficiency notices, asserting that the income from the sale of petitioners' partnership interests was ordinary income.¹ This position was sustained by the Tax Court, and the correctness of that ruling represents the major issue now before us.

The general statutory rule governing sales of partnership interests is stated in section 741 of the Internal Revenue Code, 26 U.S.C. § 741 (1964):

"In the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner. Such gain or loss shall be considered as gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751 26 U.S.C. § 751, as amended (Supp. II 1967) (relating to unrealized receivables and inventory items which have appreciated substantially in value)."

The exception referred to, which is the basis for the Tax Court's decision, reads as follows:

"§ 751. Unrealized receivables and inventory items.

"(a) Sale or exchange of interest in partnership.

"The amount of any money, or the fair market value of any property, received by a transferor partner in exchange for all or a part of his interest in the partnership attributable to —

"* * *

"(2) inventory items of the partnership which have appreciated substantially in value,

shall be considered as an amount realized from the sale or exchange of property other than a capital asset.

"* * *

"(d) Inventory items which have appreciated substantially in value.

"* * *

"(2) Inventory items.

"For purposes of this subchapter the term `inventory items\' means —

"(A) property of the partnership of the kind described in section 1221(1) 26 U.S.C. § 1221(1) (1964) * * *"

The property described in section 1221(1) includes

"stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * *."

Thus the basic issue here is whether the land owned by the petitioners' partnership was "held * * * primarily for sale to customers in the ordinary course of its trade or business." The Tax Court found that it was, and it is this finding which petitioners dispute.

The question thus posed is established by prior decisions as one of fact. E. g., Richards v. Commissioner of Internal Revenue, 81 F.2d 369, 370, 106 A.L.R. 249 (9th Cir. 1936). Its determination depends upon a fairly complex series of events — a context fully set out in the Tax Court's findings of fact. There is no real challenge to those findings insofar as they relate to this background, and we therefore adopt them as our statement of facts:

"Petitioners reside in San Diego County, California, and they filed their respective tax returns for the years in question with the district director of internal revenue at Los Angeles, California.

"At all times material Lowthian was Eugene L. Freeland's secretary and business associate. Her participation in the transactions involved herein was through and with Freeland. * * *

"From 1923 through the time of trial, Freeland has been a full time civil and structural engineer living and working in San Diego County, California. He is licensed to practice by California and certain other states and has been and continues to be a member of numerous professional engineering associations and societies. During the years involved herein, he was a senior member of a civil engineering firm and a structural engineering firm.

"Freeland's practice has included land surveying, the design of municipal improvements, the subdivision of land, and the design of buildings and structures. He rendered professional services in some of the larger real estate developments in the San Diego area and included among his clients some of the area's most active real estate subdividers and developers. Because of the rapid growth of San Diego County prior to and during the years in question, and because of his excellent reputation, Freeland's practice has been financially successful. The growth of San Diego County has also resulted in a continuing and substantial appreciation in real estate values.

"Among the many land developers employing Freeland and/or his civil engineering firm (hereafter referred to as the `engineering partnership') were George T. Forbes and Theodore M. Jacobs, doing business as Kensington Heights Company. In the late 1940's and again in 1951 and 1953, the engineering partnership rendered services to Kensington with respect to the so-called Waring Ranch property in the form of surveying the land, preparing boundary, topographical and master plan maps thereof, and representation before the City of San Diego Planning Commission and other city departments in its efforts to have the land annexed to the City of San Diego so as to make it more salable. Four hundred acres were annexed in 1951 and subsequently sold by Kensington. An additional 1,300 acres were annexed in 1952 or 1953 and sold by Kensington to Bollenbacher & Kelton, Inc., subdividers and developers. The engineering partnership was then employed by Bollenbacher & Kelton, Inc., to do the engineering work on the subdivision and development of the 1,300 acres.

"In 1953, efforts were made by Kensington to have the City of San Diego annex the remaining 4,500 acres. At the time of the annexation proceedings, the engineering partnership prepared a master plan map of the area, which indicated the lines along which development might feasibly proceed. The City of San Diego annexed the 4,500 acres in December of 1953. The 4,500 acres contained a lake, some canyons, and a mountain rising about 1,100 feet above the surrounding terrain.

"Shortly before the annexation, Kensington sought Freeland's help in finding a buyer for the 4,500 acres. Freeland contacted several clients who were not interested because they thought that development and subdivision of the area was too remote in time.

"In April 1954, Kensington gave Freeland a verbal option on the land. Freeland and one of his developer-clients, Sam Berger, decided to form a partnership to purchase the land. On August 6, 1954, they entered into an agreement to form the partnership, the terms of which were to be reduced to writing in the near future. Under the agreement, Berger was to enter into an escrow in his own name for the purchase of the land from Kensington. Before the close of the escrow, Berger was to nominate the partnership to take title to the land.

"Berger negotiated the terms for the purchase with Kensington. In the course of the discussions, Berger indicated that the whole 4,500 acres would be developed as soon as possible and that he had $20,000,000 in financing available, which was not in fact the case. Berger also told Kensington that the purchase price would be paid off in about three years.

"On August 6, 1954, Berger entered into an escrow agreement with Kensington. The agreement provided for a total consideration of $4,676,666.66 (computed on the basis of $800 per acre plus interest at 3 1/3 percent), payable $100,000 down and the balance in 20 annual installments. The purchase price was to be evidenced by an installment promissory note, the first installment of $180,000 to become due on August 6, 1955, with the remaining installments due annually thereafter in increasing annual amounts of $6,000 until the 19th installment in the amount of $288,000. The 20th and final installment was to be the remaining balance of $130,666.66. The escrow agreement contained provisions for the release of 150 acres against each annual payment, for the privilege of prepayments with appropriate...