Harcum v. United States
| Citation | 164 F. Supp. 650 |
| Decision Date | 09 May 1958 |
| Docket Number | Civ. A. No. 2410. |
| Parties | R. L. HARCUM and Mary W. Harcum, Plaintiffs, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — Eastern District of Virginia |
Leroy T. Canoles, Jr., Paul M. Lipkin, Norfolk, Va., for plaintiffs.
L. S. Parsons, Jr., U. S. Atty., John M. Hollis, Asst. U. S. Atty., Norfolk, Va., for defendant.
Plaintiffs instituted this action to recover taxes paid under allegedly erroneous assessments for the years 1949, 1950, 1951 and 1952, in which it is contended by the taxing authority that (1) plaintiffs were engaged in the business of buying and selling real estate and hence are not entitled to compute their profits from the sale of real estate on the basis of capital gains, and (2) a deposit under a lease as security for its performance is taxable as income during the year received. Plaintiff, Mary W. Harcum, is a housewife and a nominal party for the purpose of this proceeding. All reference to the plaintiff-taxpayer will be to R. L. Harcum.
Disposing of the security deposit, it is sufficient to state that by lease dated January 23, 1950, plaintiff and his co-owner received the sum of $1,000 as lessors of certain real estate; the pertinent provisions of said lease being contained in paragraph 16 as follows:
In Clinton Hotel Realty Corp. v. Commissioner, 5 Cir., 128 F.2d 968, the point in question was decided adversely to the Commissioner. The mere fact that the lessor is not required to hold the fund as a special deposit does not in itself destroy the character of the deposit as security. As it is conceded that the lessees have not defaulted under the terms of the lease, the amount received by the lessors is not taxable as income until such a default occurs, or until the last three and a fraction months of the term of the ten year lease. See, also, Warren Service Corp. v. Commissioner, 2 Cir., 110 F.2d 723; Clarkson Lindley Trust, 42 B.T.A. 509, affirmed 8 Cir., 120 F.2d 998; Estate of George E. Barker, 13 B.T.A. 562; John Mantell. 17 T.C. 1143; Bradford Hotel Operating Co., 26 T.C. 454. The fact that taxpayer operated on a cash, rather than on an accrual, basis does not lend support to defendant's position. In the absence of a default the lessors are obligated to credit the security deposit against rent during the last three months of 1959 and a fraction of the month of January, 1960.
This brings us to a consideration of plaintiff's profits from sales of real estate as ordinary income as contrasted with capital gains. In 1939, plaintiff acquired 84 acres of farm land in Princess Anne County for the sum of $5,500, which property he proceeded to clear for farming purposes. The acreage was shown on a plat recorded in 1893 indicating lots and blocks but never treated as such. There were a total of approximately 478 small 35-foot lots on the recorded plat. Plaintiff endeavored to farm the acreage and, in 1941, actually moved his residence to the property in question. Because of difficulties in securing farm labor, he abandoned his farming efforts in 1947 and moved to another locality. Before doing so, however, plaintiff constructed a barn, spread oyster shells on the farm roads, erected fences, graded the main road, and caused a sewer pipe to run to his farmhouse. These improvements, other than the barn, cost less than $2,000 during a period of ten years. During all of this time, as well as for the taxable years in question, plaintiff operated a profitable and substantial oil distributing business in the City of Norfolk, to which he devoted his entire time. Subsequent to the taxable years in controversy, plaintiff has retired, but we are not concerned with his present status.
The only purchases by taxpayer for the benefit of the subject property were in 1951 for the purpose of clearing title to his then owned real estate, which lots so acquired he believed that he already owned. Two dwelling houses were erected by the taxpayer in 1948 for two of his employees.
The pattern of sales reveals the following: in 1945 taxpayer made his first sales off the recorded plat, one sale being to a nephew and the other to an employee; thereafter a majority of the sales originated with the members of his family or employees, as plaintiff did not retain or secure the services of a real estate agent, nor did he solicit the sale of the lots; his efforts being limited to the erection of a sign which fell down a few months thereafter and was never replaced. Plaintiff did, however, restrict the size and price of houses to be constructed by purchasers, and endeavored to "spot" the houses being built by plaintiff's nephew. Sales subsequent to 1945 were as follows:
1946 - 9 sales covering 40 lots
1947 - 7 sales covering 32 lots
1948 - 12 sales covering 41 lots
1949 - 12 sales covering 31 lots
1950 - 9 sales covering 28 lots
1951 - 7 sales covering 21 lots
1952 - 20 sales covering 54 lots
These sales were reported by taxpayer as sales of capital assets. Plaintiff, in addition to his sales from the platted property in controversy, purchased and sold other properties in Tidewater, Virginia, but it is not contended that these other transactions should be treated as items of ordinary income.
Section 117(a) (1) of the Internal Revenue Code of 1939 (26 U.S.C.A., 1952 Ed., § 117) defines the term "capital assets" as follows:
"The term `capital assets' means property held by the taxpayer (whether or not connected with his trade or business), but does not include * * * 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 determinative question is whether the taxpayer held the lots during the taxable years in controversy "primarily for sale to customers in the ordinary course of his trade or business". The question must be answered in the negative.
The factual situation is substantially similar to Frieda E. J. Farley, 1946, 7 T.C. 198, in which the "frequency and continuity" test is discussed at length. Cases applying this test to real estate transactions involved elements of development and substantial sales activity, as contrasted with the passive posture role. The fact of gradual liquidation of an asset is frequently disregarded where the active elements of development and sales activities are absent.
The issue is, of course, essentially one of fact. D. L. Phillips, 24 T.C....
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