50 T.C.M. (CCH) 345
REDWOOD EMPIRE SAVINGS AND LOAN ASSOCIATION, ET AL.,  Petitioner
COMMISSIONER OF INTERNAL REVENUE, Respondent
Nos. 11948-77 11949-77 11950-77.
United States Tax Court
July 8, 1985
P, a California savings and loan association, purchased unimproved real property in 1962. At the time of purchase, P entered into a take-out loan commitment and repurchase agreement with D. D defaulted on his obligations. In 1964 P transferred the property to G for $265,000 and then reacquired the property from G for $175,725.50 in 1965. P sold the property to the State of California for $55,349 in 1974 and claimed an ordinary loss on the sale. R determined the loss to be a capital loss.
HELD, property sold by P was not property held for sale to customers in the ordinary course of P's business, and loss on the sale thereof was a capital loss.
PAUL E. ANDERSON, for the petitioners.
ROBERT W. TOWLER, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies in petitioner's corporate income taxes for the following calendar years:
After concessions, the issue for decision is whether certain unimproved real property was held by petitioner as a capital asset at the time of its sale or as property primarily held for sale to customers in the ordinary course of its trade or business under section 1221(1). 
FINDINGS OF FACT Certain facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Respondent issued statutory notices of deficiencies to Redwood Savings and Loan Association, Financial Savings and Loan Association of Northern California (successor-in-interest to Redwood Empire Savings and Loan Association) and Financial Savings and Loan Association of Northern California (formerly Redwood Empire Savings and Loan Association). Petitioners are one and the same and will be referred to as petitioner. Petitioner is a California corporation. Its principal office was located in Chico, California, at the time the petition was filed herein. During the period 1961 through 1975, petitioner was a California savings and loan association as defined in the California Financial Code section 5004 (West 1968). Petitioner's accounts were insured by the Federal Savings and Loan Insurance Corporation (FSLIC) under 12 U.S.C. sec. 1726. The FSLIC is an independent corporate instrumentality and agency of the United States under the direction and control of the Federal Home Loan Bank Board. Petitioner, as a California savings and loan association, insured by FSLIC, was subject to the provisions of the California Financial Code section 5000, et seq., and regulations of the Federal Home Loan Bank Board. During the years 1962 through 1975, petitioner's principal office was located at 700 South State Street, Ukiah, California. From January 1, 1964 through February 4, 1968, petitioner had 15,000 shares of stock outstanding. Mendocino Financial Corporation owned 14,450 of those shares. Mendocino Financial Corporation had 15,000 shares of stock outstanding of which 14,300 shares were owned by Henry Kersting (Kersting). Kersting was chairman of the Board of Directors for both petitioner and Mendocino Financial Corporation from January 1, 1964, through December 31, 1966, and was also president of Mendocino Financial Corporation during that period. At the time the transactions in issue occurred, the function of a savings and loan association was to encourage thrift and home ownership. Interest would be paid on the deposits that were made, and then the association would lend those funds out in the form of mortgages on residential property. Profitability of the association was determined by the differential between the interest paid by it on deposits and the interest paid to it on the loans it made. Under the California Financial Code (CFC), savings and loan associations were permitted to own the following types of real estate: (1) association premises; (2) property acquired pursuant to section 6705 CFC; and (3) property acquired under section 6707 CFC in settlement of loans either through foreclosure or deed in lieu of foreclosure. Section 6705 CFC permits a savings and loan association to acquire unimproved land for the purpose of providing housing for veterans and the elderly and for urban renewal or improvement. In addition, a savings and loan association may purchase unimproved real property pursuant to section 6705 CFC in order to: (1) obtain appreciation in value; (2) develop property and obtain profits from the sale of the developed property either as one property or in parcels; or (3) to generate loans for itself. A savings and loan association may generate loans for itself in a number of ways. For instance, a savings and loan association may purchase unimproved real estate and subdivide it. The association can then either sell unimproved lots and finance the construction, or build on the property and finance the purchase of the improved property. It may also purchase subdivided property and finance the resale of the individual lots. An alternative method for generating potential loans is through ‘ take-out‘ commitments which are issued by a savings and loan association to an individual financier in which the association agrees to make a loan to the borrower in the future. Take-out commitments are ordinarily utilized in transactions where lots are sold to a builder who will secure a construction loan, build and then sell with the savings and loan association furnishing the new loan to the subsequent purchaser. In lieu of take-out commitments, an association may ‘ warehouse‘ real property. Warehousing may be described as the situation where the association acquires property in connection with an agreement with a developer whereby the developer will acquire the property from the association at an agreed upon future date for a price provided in the agreement. The profit generated from the sale stands in the place of the interest and points normally earned on a loan. Warehousing enables a savings and loan association to circumvent certain state law restrictions on financial institutions limiting the maximum loan amount that may be made on unimproved real property to 70 percent of the fair market value. In effect, by warehousing, a savings and loan association can finance 100 percent of the acquisition of unimproved property. Warehousing agreements can be utilized in conjunction with take-out commitments. Investment in section 6705 CFC property is limited to five percent of the savings and loan association's net worth. In addition, real property purchased pursuant to section 6705 CFC, other than a lessor's interest pursuant to section 6705.3 CFC, may not be held by an association for more than five years, except with the approval of the state savings and loan commissioner. In 1962, petitioner purchased a 60-acre tract of unimproved real estate known as the Wildcat Canyon property for $260,000. The property was located approximately 100 miles from petitioner's principal office. At about the time of the purchase, petitioner entered into a take-out loan commitment and repurchase agreement with Michael Grayson (Grayson), a developer. Under the take-out loan commitment, petitioner obligated itself for nine months from September 14, 1962, to accept applications for 25 conventional construction loans to be drawn on the following terms:
| $24,000.00 per loan/per lot |
| 6 3/4 percent interest rate |
| 24-year monthly amortized term. |
Under the repurchase agreement, Grayson was to pay $272,000 by May 15, 1963, and meet certain other conditions including depositing $500,000 with petitioner. Petitioner made no construction loans pursuant to the take-out loan commitment. In addition, Grayson neither purchased the property nor deposited $500,000 on account with petitioner. In a letter dated May 2, 1963, petitioner informed Grayson that he was in default under the agreement. Nevertheless, petitioner agreed to honor the agreement and sell the property to Grayson if he tendered $272,000 plus delinquent interest on the promised $500,000 by May 15, 1963. However, Grayson again failed to perform under the agreement. In a letter dated September 4, 1963, petitioner advised Grayson that the property would be sold on the open market, and that any obligations between the parties were deemed terminated. In 1964, the Federal Home Loan Bank Board (FHLBB) conducted an examination of petitioner as of close of business August 28, 1964. The FHLBB report of the examination characterized the Wildcat Canyon property as real estate owned for development (section 6705 CFC property), rather than as real estate owned as a result of foreclosure (section 6707 CFC property). In addition, the report noted under the heading of ‘ STATEMENT OF MANAGEMENT RELATIVE TO PROPOSED USE OF UNIMPROVED LAND: Wildcat Canyon to be held until it can be sold for at least $275,000.‘ In a report of examination prepared by the office of the savings and loan commissioner of the State of California, as of December 7, 1964, the Wildcat Canyon property was described as real property...