Howell v. Comm'r of Internal Revenue, Docket Nos. 1538-70
| Decision Date | 31 January 1972 |
| Docket Number | Docket Nos. 1538-70,1546-70,1596-70,1597-70. |
| Citation | 57 T.C. 546 |
| Parties | WILLIAM B. HOWELL AND FAY S. HOWELL, ET AL.,1 PETITIONERS V. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Tom Watson Brown and Samuel F. Doster, Jr., for the petitioners.
James D. Burroughs, for the respondent.
Three individuals decided to acquire property as an investment. They formed a corporation in 1961 and caused it to purchase the land. The corporation had no other assets and received no income from the property. It filed an election in 1964 under sec. 1372, I.R.C. 1954, to be taxed as a small business corporation. In 1964, 1965, and 1966 the corporation sold the property in three transactions, with the first two being merely incidental to the final sale which disposed of over 90 percent of the tract of land. Held, (1) the fact that the corporation's only activity was the sale of the land does not cause the proceeds therefrom to be ordinary income when said property was not held primarily for sale in the ordinary course of its trade or business, but rather was acquired as an investment; (2) the corporation properly elected to be taxed as a small business corporation; (3) the distributions received by the shareholders from the corporation are taxable as long-term capital gain.
Respondent determined deficiencies in petitioners' income taxes for the years and in the amounts as follows:
The issues for decision are:
(1) Whether certain real property, which constituted the only property held by Hectare, Inc., and was sold by it during 1964, 1965, and 1966, was a capital asset within the meaning of section 1221, I.R.C. 1954,2 or whether such property was held by the corporation primarily for sale to customers in the ordinary course of the corporate trade or business.
(2) Whether Hectare, Inc., was entitled to the small business corporation election provided for under section 1372.
(3) Whether respondent properly determined that distributions the stockholders of Hectare, Inc., received from that corporation constituted ordinary income to the stockholders and not long-term capital gain.
Some of the facts have been stipulated and are found accordingly.
William B. and Fay S. Howell (husband and wife), George E. and Jan P. Chase (husband and wife), and Allen S. and Katharine C. Hardin (husband and wife), all resided in Atlanta, Ga., at the time their petitions in this case were filed. Each of the petitioner couples filed joint Federal income tax returns for the taxable years 1965 and 1966 with the district director of internal revenue, Atlanta, Ga.
Hectare, Inc. (Hectare), is a corporation organized under the laws of the State of Georgia on November 9, 1961, with its principal place of business at the time of the filing of its petition in this case in Atlanta, Ga. It filed Forms 1120-S, U.S. small business corporation income tax returns, for the years 1965 and 1966 with the district director of internal revenue at Atlanta, Ga.
In 1961 a real estate agent by the name of Robert Hughes (Hughes) approached William B. Howell (Howell) with respect to the purchase of certain property owned by heirs of the estate of W. A. Montgomery (hereinafter referred to as the Montgomery property). Howell was employed as a real estate agent in the same firm in which Hughes was employed. Howell was a longtime friend of Allen S. Hardin (Hardin) who was engaged in the general contracting business as an officer and project manager of Ira H. Hardin Co. This company was engaged in building commercial and industrial buildings. Howell talked with Hardin concerning the acquisition of the Montgomery property.
Hughes, Howell, and Hardin decided to purchase the Montgomery property and agreed they would form a corporation and have the corporation acquire the land. They formed Hectare which had a total of 120 shares of stock with Hardin, Howell's wife, Fay, and Hughes each owning 40 shares. Subsequently, Hughes sold 20 of his shares to Jan P. Chase and the other 20 shares to Ray H. Fechtel. During the taxable years 1965 and 1966 Hectare's stock was owned as follows:
+----------------------------------+
¦Stockholder ¦Number of shares ¦
+---------------+------------------¦
¦ ¦ ¦
+---------------+------------------¦
¦Allen S. Hardin¦40 ¦
+---------------+------------------¦
¦Fay S. Howell ¦40 ¦
+---------------+------------------¦
¦Jan P. Chase ¦20 ¦
+---------------+------------------¦
¦Ray H. Fechtel ¦20 ¦
+----------------------------------+
The charter of Hectare states:
The object of said proposed corporation is pecuniary gain and profit to the stockholders. The general nature of the business which they wish to carry on is to engage in a general investment business, investing in both real and personal property as well as other general investments.
On January 23, 1962, Hectare acquired the Montgomery property which consisted of 42.86 acres of unimproved land located along the corner of and bordering on Oakcliff Road and Pleasantdale Road in DeKalb County, Ga. One hundred and eight thousand, six hundred and forty-two dollars of the purchase price was by a note given to the Montgomery heirs secured by a warranty deed to secure debt. This warranty deed contained provisions for release of acreage on the payment of $3,500 or $4,000 per acre depending upon its location within the tract. The Montgomery property was located contiguous to and across the street from land being developed by Atlanta DeKalb Industrial Park, Inc., a corporation of which Ira H. Hardin was president. This development which commenced in 1960 was for office and warehouse use.
Hardin was president of Hectare and Howell was vice president. In 1964 it was decided that Hectare would borrow $110,000 from the First National Bank of Atlanta to pay the sum owing to the Montgomery heirs. Arrangements for this loan were made on behalf of Hectare by Howell. The First National Bank of Atlanta was represented in the loan negotiations by Arthur H. Huber (Huber) who at the time was vice president and loan officer. Howell and Huber were personal friends and Huber was aware of the personal net worth of the Howells, the Hardins, and the Chases. Howell told Huber that the land had been purchased for resale. Although the property was vacant land, Huber was of the opinion that it could be considered as improved property under banking regulations since it was bordered by improved roads, had utility lines contiguous to it, and had a sewer running through it. The bank made the $110,000 loan to Hectare on March 24, 1964, and the note to the bank was personally endorsed by Hardin, Howell, and Jan D. Chase.
On December 30, 1964, Hectare sold 0.9 acre of the Montgomery property to Cobb Enterprises, Inc., and at the same time Atlanta DeKalb Industrial Park conveyed 0.29 acre of adjacent land to Cobb Enterprises, Inc., by the same warranty deed. On May 6, 1965, Howell, in a conversation with Huber, told Huber of the sale of the 0.9 acre and informed Huber that a number of prospective buyers had been looking at the Hectare property and that the offering price had been increased to $12,000 per acre.
On December 15, 1965, Hectare sold 2.2 acres of the Montgomery property to William T. Newman. Newman is a general contractor and a personal friend of Howell.
On January 14, 1966, Hectare sold the remaining 39.74 acres of the Montgomery property to Pleasantdale Corp. Pleasantdale Corp. was controlled by an individual who was a friend of Howell. The sale to Pleasantdale Corp. was arranged by John Maddox, a real estate agent. Maddox approached the officers of Hectare with respect to the purchase of the property as had the purchasers of the 0.9 acre and the 2.2 acres. However, Hectare paid John Maddox a commission on the sale of the 39.74 acres since such a commission was customary under the circumstances.
Newman constructed two buildings on the 2.2 acres which he purchased from Hectare, and Pleasantdale Corp. developed the property which it purchased.
Hectare held stockholders and directors meetings, filed its annual State registration forms and its State and Federal income tax returns, and declared and paid ad valorem taxes on the Montgomery property. It never received any rent or other income from use of the Montgomery tract during the time it owned the property. None of the individual stockholders of Hectare nor any of their spouses have ever participated together in any real estate investment ventures, except for their investment in Hectare, either before, during, or after the formation of Hectare. None of the stockholders of Hectare had been extensively engaged in dealing for his own account in real estate as distinguished from acting as a real estate agent or broker prior to or after the formation of Hectare, either individually or as a joint venturer. Hardin had at one time participated in a group that developed a shopping center and in 1969 or 1970 was involved in several joint venture developments. Howell was a joint venturer in a tract of real property with respect to which he reported a gain of $2,060.45 on his 1965 income tax return. Most of Howell's income was from dividends...
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