Faris v. Commissioner, Docket No. 6635-85

CourtU.S. Tax Court
Writing for the CourtGERBER
Citation1988 TC Memo 465,56 TCM (CCH) 319
Decision Date26 September 1988
Docket Number6835-85,Docket No. 6635-85,6838-85.,6837-85
PartiesJoe E. Faris and Mary A. Faris, et al. v. Commissioner.

56 T.C.M. (CCH) 319 (1988)

T.C. Memo. 1988-465.

Joe E. Faris and Mary A. Faris, et al.1

Docket Nos. 6635-85, 6835-85, 6837-85, 6838-85.

United States Tax Court.

Filed September 26, 1988.

Robert M. Willson, P.O. Box 1678, Colorado Springs, Colo., for the petitioner. Barbara E. Horan and Randall A. Preheim, for the respondent.

Memorandum Findings of Fact and Opinion

GERBER, Judge:

Respondent determined the following deficiencies in petitioners' Federal income taxes:

 Petitioners Taxable Year Deficiency
                 Joe E. and Mary A. Faris ............................ 1977 $ 5,630
                 Docket No. 6635-85 .................................. 1978 19,936
                 1979 93,464
                 J. Ray and Dianne Faris ............................. 1978 161
                 Docket No. 6835-85 .................................. 1979 1,160
                 Michael A. and Dana Faris ........................... 1978 152
                 Docket No. 6837-85 .................................. 1979 1,436
                 Nicholas H. and Cherie S. Faris ..................... 1978 505
                 Docket No. 6838-85 .................................. 1979 1,822
56 TCM (CCH) 320

The issues2 for our consideration are: (1) Whether the amounts of $5,000 in 1978 and $114,000 in 1979 should have been reported by Joe Faris or any petitioners as commission income; and (2) whether certain promissory notes received in connection with a sale of realty had ascertainable fair market values so as to make them includable in petitioners' partnership income in the year of receipt.

Findings of Fact

Some of the facts have been stipulated, and the stipulation of facts and the exhibits are incorporated by this reference.

Each set of petitioners were husbands and wives during the years in issue and filed joint returns of income. All petitioners resided in Walsenburg, Colorado, at the time of filing their petitions herein. Petitioner Joe Faris (Joe) is the father of petitioners J. Ray (Ray), Michael A. (Michael), and Nicholas H. (Nick) Faris. Joe and his three sons were each partners3 in Faris Cattle Company (partnership), also known as Joe E. Faris & Sons. Partnership's Federal return of income was filed on the cash basis method of accounting. Petitioners,4 through partnership, were generally engaged in the business of cattle ranching. Partnership was operated as a family-owned business with the attendant informality between family member-partners. Petitioners were apparently general partners, each with authority to bind the others in partnership matters. As family members and partners, petitioners regularly acted on behalf of each other.

Petitioners and partnership were occasionally involved in real estate transactions. Joe held a Colorado real estate license since April 1956. Nick held a Colorado real estate license at varying times since October 1978, and Ray and partnership acquired licenses after the years in issue. Partnership received a real estate sales commission in connection with the purchase of land (not here in issue) from Colorado Fuel and Iron Corporation. Joe's brother-in-law owned Thach Real Estate Agency (Thach) during the years in issue.

Prior to November 19, 1975, Joe became aware that the United States Army was looking for land in southeastern Colorado for use as a site to train armored tank operators. At that time, Joe began contacting area ranches in an attempt to put together a group of ranches (land package) to offer for sale to the Federal Government. The land package was to be about 220,000 acres. One of the ranches (Kitch Ranch) contained about 47,200 acres5 and had been listed since 1974 with Harold Hancock (Hancock), a real estate broker. Hancock's listing was for an asking price of $42.50 per acre and he was to receive a 5-percent commission pursuant to an oral listing agreement. Hancock was also to be the broker with respect to the other parcels which comprised the 220,000 acre land package. Joe was familiar with the Kitch Ranch and had viewed it during 1973 or 1974 while Hancock was showing it to a potential customer.

On November 19, 1975, the owners of the Kitch Ranch entered into a written agreement (November agreement) with Faris Land and Cattle Company (Faris Land), a Colorado corporation of which Joe was president. The agreement was negotiated by Joe for Faris Land and Hancock for the Kitch Ranch owners. Pertinent terms of the November agreement included: (1) The owners of Kitch Ranch were "desirous of entering into a transaction involving the sale of approximately 220,000 acres of land * * * to a responsible and financially capable buyer." (2) Faris Land was to use its best efforts to locate and negotiate a sale. (3) Kitch Ranch owners would accept $55 per acre for the first year of the November agreement and $60 per acre thereafter. (4) The Kitch Ranch owners and Faris Land would equally divide any amount received in excess of the $55 or $60 amounts. (5) If Kitch Ranch owners received any offers, other than as contemplated by the November agreement, Faris Land was to have 10 days within which to purchase Kitch Ranch for the appropriate

56 TCM (CCH) 321
amount per acre, as set forth in the November agreement. (6) Faris Land had the exclusive right to arrange for the sale to the Government and to select a licensed broker to handle the transaction. (7) The November agreement was to be effective for 2 years and if the Kitch Ranch was sold within the period of the November agreement, Faris Land was to receive a 10-percent commission on the gross sales price. On October 5, 1976, the November agreement was extended for 3 additional years until November 19, 1980

Following the November agreement, Joe made presentations to the Department of the Army in Washington, D.C., aerial presentations to Government representatives, and otherwise attempted to interest the Government in the land package. Joe's efforts to interest the Government continued from 1976 through 1983.

Hancock received a bona fide offer of $42.50 per acre on the Kitch Ranch during the autumn of 1976. Hancock offered Faris Land, through Joe, its right of first refusal, which would have been at a price of either $55 or $60 per acre during autumn 1976. Faris Land did not exercise its right of first refusal. In order to protect the potential for realization of income under the November agreement, Joe devised a plan to seek an option on the Kitch Ranch. By offering the Kitch Ranch owners money and other potential benefits in exchange for the option, the $42.50 offer was forestalled. Nick and Don J. McDavid (McDavid), on October 5, 1976, entered into a Joint Venture Agreement to acquire an option to purchase the Kitch Ranch. McDavid was a friend of Nick's and purportedly had sufficient monetary resources to assist petitioners in acquiring the Kitch Ranch. The joint venturers were to contribute $100,000 (McDavid — $84,000 and Nick — $16,000) and share profits in a 70percent/30-percent ratio for McDavid and Nick, respectively. The purpose of the joint venture was to obtain the Kitch Ranch and sell it to the Army. The joint venturers' interests were not assignable without consent of the other party.

The Option to Purchase Agreement (option agreement), dated October 5, 1976, was between the Kitch Ranch owners as "optionors" and McDavid and Nick, "optionees." The option agreement was negotiated mainly between Joe and Hancock. In exchange for $300,0006 from Nick and McDavid, the Kitch Ranch owners granted a 3-year option to purchase at $45 per acre plus 25 percent of any excess over $60 per acre received by McDavid and Nick if sold to the Army under the November 19, 1975, agreement. The option agreement called for 10 percent of the option payments to be paid over to Hancock to be distributed 75 percent to Thach (the procuring broker) and 25 percent to Hancock.7 In the event of the exercise of the option, Hancock was "authorized to retain for distribution, as commission at closing TEN (10) percent of the purchase price less any option payment made previously." This 10-percent commission was also to be split 75 percent/25 percent between Thach and Hancock, respectively. Of the first $100,000 option payment (which was made October 5, 1976), 90 percent went to the Kitch Ranch owners, $7,500 to Jeannette F. Thach and $2,500 was retained by Hancock. Five thousand dollars of Thach's "commission" found its way back to petitioners.

Although at the time of the execution of the option agreement Hancock had the Kitch Ranch listed at $42.50 per acre with a 5-percent broker's commission,8 Joe requested that the option price be set at $45.00 per acre and the broker's commission at 10 percent. The $2.50 per acre increase was to be paid to the Kitch Ranch owners and channeled back to petitioners. None of the other participants had any objection to Joe's requested increase of the purchase price and commission. The channeling back to petitioners was accomplished by means of the 75-percent/25-percent split between the real estate brokers.9

McDavid and Nick made the second option payment, presumably timely and in accord with the option agreement, but thereafter, on or about October 18, 1978, it became apparent that McDavid would not fulfill his obligation with respect to the third and final $100,000 option payment. On October 18, 1978, Joe agreed to purchase McDavid's interest in the option agreement for $168,000 (already paid by McDavid) plus a percentage of the profit on the eventual sale of the Kitch Ranch. The third and final $100,000 option payment was made with a January 9, 1979, cashier's check. The source of the $100,000 cashier's check was $65,000 from partnership's checking account and $35,000 which was part of the proceeds of a loan to Joe.10

On May 18, 1979, the option to purchase the Kitch Ranch was exercised in the names of Joe

56 TCM (CCH) 322
and Nick for $45 times 47,200 acres or $2,124,000.11 The $300,000 option payments were applied to the purchase price and the balance was from a $2,000,000 Federal Land Bank of Wichita (land bank) loan...

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