Morse v. United States, 350-63.

• Decision Date: 20 January 1967
• Docket Number: No. 350-63.,350-63.
• Citation: 371 F.2d 474
• Parties: Theodore MORSE and Claire Morse v. The UNITED STATES.
• Court: U.S. Claims Court

371 F.2d 474 (1967)

Theodore MORSE and Claire Morse v. The UNITED STATES.

No. 350-63.

United States Court of Claims.

January 20, 1967.

George T. Altman, Beverly Hills, Cal., attorney of record, for plaintiffs.

Mitchell Samuelson, Washington, D. C., with whom was Asst. Atty. Gen. Mitchell Rogovin, for defendant. Lyle M. Turner and Philip R. Miller, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON, and NICHOLS, Judges.

OPINION

PER CURIAM:

This case was referred to Trial Commissioner Mastin G. White, with directions to make findings of fact and recommendation for conclusions of law. The commissioner has done so in an opinion and report filed on November 4, 1965. Exceptions to the commissioner's report were filed by the defendant. The parties have filed briefs and the case has been argued orally. Since the court is in agreement with the opinion, findings and recommendation of the commissioner, with modifications, it hereby adopts the same, as modified, as the basis for its judgment in this case, as hereinafter set forth. Therefore, plaintiffs are entitled to recover on the claim relating to the taxability of the proceeds from the sale of the partnership interest and judgment is entered for plaintiff to that effect with the amount of recovery to be determined pursuant to Rule 47(c) (2); and since plaintiffs are not entitled to recover on the other claims asserted in the petition, the petition is dismissed as to such claims.

Commissioner White's opinion,¹ as modified by the court, is as follows:

The plaintiffs, who are a husband and wife residing in Beverly Hills, California, seek in this action to recover a refund of income tax paid for the calendar year 1958. Since the plaintiff Claire Morse is a party to the action merely because she signed a joint Federal income tax return for 1958 with her husband, and she was not otherwise involved in the transactions which gave rise to the litigation, the term "plaintiff" will generally be used throughout the opinion in the singular as referring to the plaintiff Theodore Morse.

The plaintiff has been engaged for many years as part owner and executive in the business of manufacturing women's lingerie. Allen R. Balton has been a partner of the plaintiff in the lingerie business for the past 15 years.

SALE OF PARTNERSHIP INTEREST

In 1958, the plaintiff received $7,605.42 as the result of a transaction which occurred on October 31, 1957, and which involved the sale by the plaintiff, on the installment basis, of a .723 percent interest in a partnership known as the Sam Berger Investment Company. In his income tax return for 1958, the plaintiff treated this amount as a capital gain. However, when the plaintiff's return for 1958 was audited by the Internal Revenue Service, it assessed a deficiency against the plaintiff with respect to this item, on the ground that the $7,605.42 constituted ordinary income rather than a capital gain. One of the issues in the present case is whether the $7,605.42 constituted a capital gain, as contended by the plaintiff, or ordinary income, as contended by the defendant.

An interest in a partnership is a capital asset, and ordinarily the sale of such an interest above or below the cost basis results in a capital gain or a capital loss. Kinney v. United States, 228 F.Supp. 656, 662 (W.D.La.1964). The controlling statutory provision is Section 741 of the Internal Revenue Code of 1954 (68A Stat. 248), which states in pertinent part as follows:

In the case of a sale * * * 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 * * * of a capital asset, except as otherwise provided in section 751 (relating to * * * inventory items which have appreciated substantially in value).

Therefore, the gain which the plaintiff realized in 1958 from the disposition on October 31, 1957, of his .723 percent interest in the Sam Berger Investment Company should be regarded as a capital gain, unless "otherwise provided in section 751."

Section 751 of the Internal Revenue Code of 1954 provides in subsection (a), inter alia, that the amount of any money received by a transferor partner in exchange for his interest in a partnership that is "attributable to * * * 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" (68A Stat. 250).

The evidence in the record clearly shows that the money which the plaintiff received in exchange for his .723 percent interest in the Sam Berger Investment Company was attributable to land which the partnership owned, it being the sole objective of the persons who purchased such interest (and the interests of other partners) to acquire the ownership of the partnership's land. Therefore, it is necessary to determine whether the land in question came within the category of "inventory items of the partnership" and, if so, whether the land had "appreciated substantially in value."

Subsection (d) of Section 751 of the 1954 Code defines "inventory items" to mean (among other things) "property of the partnership of the kind described in section 1221(1)" (68A Stat. 251); and Section 1221(1) of the 1954 Code expressly declares in pertinent part that "property held * * * primarily for sale to customers in the ordinary course of * * * trade or business" is outside the scope of the term "capital asset" (68A Stat. 321).

Accordingly, in determining whether the money which the plaintiff received in exchange for his .723 percent interest in the Sam Berger Investment Company should be regarded as ordinary income (the defendant's view) or as a capital gain (the plaintiff's view), it is necessary to consider in the first instance whether the land which the partnership owned on October 31, 1957 (the date when the plaintiff's interest in the partnership was sold) was "held * * * primarily for sale to customers in the ordinary course of * * * trade or business." If this primary question is answered in the affirmative, the land must be regarded as falling within the category of "inventory items," and it will then be necessary to consider the further question of whether the land of the partnership had "appreciated substantially in value." On the other hand, if the primary question is answered in the negative, it will not be necessary to consider the second question.

Whenever the question of whether land was held primarily for sale to customers in the ordinary course of trade or business is raised in a tax case, the question is treated as one of fact (Friend v. Commissioner of Internal Revenue, 198 F.2d 285, 287 (10th Cir. 1952); United States v. Rosebrook, 318 F.2d 316, 319 (9th Cir. 1963)); and such question is to be answered upon the basis of a careful analysis of the facts of the particular case (Lazarus v. United States, 172 F. Supp. 421, 424, 145 Ct.Cl. 541, 545 (1959)). This requires in the present case a rather detailed statement of a complicated series of events and transactions that began in 1953.

During the period 1953-1954, six corporations designated as Hilltop Homes, Inc., Hilltop Ranchos, Inc., Hilltop Estates, Inc., Hilltop Park, Inc., Hilltop Vista, Inc., and Country Club Park Construction Co., Inc., were formed in the State of California for the purpose of acquiring real estate, developing real estate, and selling and dealing in real estate. Prior to the formation of these corporations, the individual investors who were planning to organize them executed a joint venture agreement under the date of August 28, 1953, in the names of the six prospective corporations. The purpose of the joint venture was to develop 600 homes on approximately 160 acres of land in Chula Vista, California. The joint venture was referred to in the agreement of August 28, 1953, as the "Country Club Park joint venture," and it will be similarly referred to hereafter in this opinion.

Sam Berger was instrumental in the formation of the several corporations previously mentioned and in the creation of the Country Club Park joint venture, and he held a 30 percent interest in them. Other persons were involved as shareholders in the various corporations comprising the Country Club Park joint venture, and some of them who played roles of varying importance in subsequent events were Jack Barenfeld, Samuel Glaser, and Allen R. Balton.

The plaintiff, from time to time between December 1953 and March 1954, invested in the corporations making up the Country Club Park joint venture. His participation was secured through his partner in the lingerie business, Allen R. Balton. The plaintiff's total investment amounted to $11,250 and his proportion of the capital stock was 3 1/3 percent.

The Country Club Park joint venture proceeded to develop the 160 acres of land in Chula Vista previously mentioned, by subdividing the land and constructing on it homes for sale. From time to time during this development program, the plaintiff and the other stockholders in the six corporations comprising the joint venture advanced money for the benefit of the joint venture. These advances were in addition to the initial capitalization of the several corporations, and they were usually made by the stockholders in proportion to their stock ownership.

On or about August 6, 1954, while the subdivision of the 160-acre tract of land in Chula Vista and the construction of homes thereon by the Country Club Park joint venture were in progress, a partnership was formed between Sam Berger and E. L. Freeland for the purpose of purchasing approximately 4,500 acres of land in San Diego, California.

On August 6, 1954, Sam Berger purchased, through escrow, on behalf of himself or his nominee, the 4,500 acres of land mentioned in the preceding paragraph. The land was acquired from the Kensington Heights Company...