Redwood Empire Sav. & Loan Ass'n v. C. I. R.

• Decision Date: 11 August 1980
• Docket Number: No. 78-1775,78-1775
• Parties: 80-2 USTC P 9615 REDWOOD EMPIRE SAVINGS & LOAN ASSOCIATION, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 516

628 F.2d 516

80-2 USTC P 9615

REDWOOD EMPIRE SAVINGS & LOAN ASSOCIATION, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 78-1775.

United States Court of Appeals, Ninth Circuit.

Aug. 11, 1980.

Rehearing Denied Oct. 7, 1980.

Paul E. Anderson, San Francisco, Cal., for petitioner-appellant.

Daniel F. Ross, Tax Div., Dept. of Justice, Washington, D. C., for respondent-appellee; M. Carr Furgson, Tax Div., Dept. of Justice, Washington, D. C., on brief.

Petition to Review a Decision of The Tax Court of the United States.

Before WALLACE and FARRIS, Circuit Judges, and KARLTON, ^* District Judge.

WALLACE, Circuit Judge:

Taxpayer Redwood Empire Savings & Loan Association (Redwood) appeals from several adverse rulings of the United States Tax Court. Redwood contends that the Tax Court erred in upholding the conclusion of the Commissioner of Internal Revenue (Commissioner) that Redwood could not deduct from its taxes certain losses and payments as ordinary business expenses under the Internal Revenue Code. We affirm.

This case arises from Redwood's purchase and sale of property known as the Malibu Springs Ranch (Malibu Springs). Redwood purchased Malibu Springs in 1967 for $750,000 and sold it in 1972 for $277,539. From 1970 to 1972, Redwood also paid legal fees to defend a lawsuit involving Malibu Springs, as well as $300,000 in 1972 to settle the suit. Redwood treated its loss on the sale of Malibu Springs and its expenses in defending and settling the lawsuit as deductible ordinary business expenses. The Commissioner disallowed these deductions. The Tax Court affirmed the Commissioner's action. 68 T.C. 960 (1977).

I

The first issue is whether the Tax Court correctly determined that Malibu Springs was a capital asset, thus precluding Redwood from declaring an ordinary loss on its sale. Redwood contends that the property was not a capital asset because it was held "primarily for sale to customers in the ordinary course of (its) trade or business," I.R.C. § 1221(1). In the alternative, Redwood argues that the purchase and sale of Malibu Springs was an integral part of its business of making loans, entitling it to ordinary loss treatment under the doctrine of Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 76 S.Ct. 20, 100 L.Ed. 29 (1955).

A. Section 1221(1)

We have looked to a number of factors in determining whether properties are "held . . . primarily for sale to customers in the ordinary course of . . . business," I.R.C. § 1221, including "the nature of the acquisition of the property, the frequency and continuity of sales over an extended period, the nature and the extent of the taxpayer's business, the activity of the seller about the property, and the extent and substantiality of the transactions." Austin v. Commissioner, 263 F.2d 460, 462 (9th Cir. 1959). See Parkside, Inc. v. Commissioner, 571 F.2d 1092, 1096 (9th Cir. 1977); Los Angeles Extension Co. v. United States, 315 F.2d 1, 2-3 (9th Cir. 1963). But we have also warned that "each case must be decided upon its particular facts, and the presence of any one or more of these factors may or may not be determinative of a particular case." Austin v. Commissioner, supra, 263 F.2d at 462.

This warning is particularly apt in the somewhat unique setting of real estate held by a savings and loan association. Section 6705 of the California Financial Code authorizes savings and loan associations to invest in real property for specific kinds of residential development. ¹ The typical purpose of such investment is to further a chief business purpose of savings and loan institutions generation of loans. ² Thus, in Burbank Liquidating Corp. v. Commissioner, 39 T.C. 999, 1010 (1963), aff'd in part and rev'd in part on other grounds, 335 F.2d 125 (9th Cir. 1964), the Tax Court held that a savings and loan association's section 6705 property, acquired for sale to customers in order to generate loans, was held for sale to customers in the ordinary course of business. Id. at 1003-05, 1010. In that case the Tax Court found it unnecessary to discuss at length such potentially and normally relevant factors as the activity of the seller about the property or the frequency and continuity of the taxpayer's real estate transactions generally.

Because Redwood recorded its purchase of Malibu Springs under section 6705, it contends, relying on Burbank Liquidating, that the property was necessarily held primarily for sale to customers in the ordinary course of its business of making loans. We agree with the Tax Court's statement in the case before us, however, that "the mere fact that an association justifies acquisition of real property under section 6705, and labels it section 6705 property, does not automatically qualify it as property held primarily for sale to customers in the ordinary course of its business. For tax purposes at least that would depend on the actual purpose for which the property was acquired, held, and sold." 68 T.C. at 970. Moreover, even if legitimate section 6705 property were inherently business property, as Redwood contends, the Tax Court specifically found that Redwood neither acquired nor developed Malibu Springs for any of the purposes authorized by the statute. Id. at 975.

The objective evidence of the circumstances surrounding the acquisition of Malibu Springs supports the Tax Court's finding that Redwood did not acquire the property to generate loans. While the ultimate question concerns Redwood's purpose in holding the property at the time of sale, Parkside, Inc. v. Commissioner, supra, 571 F.2d at 1097 (Kennedy, J., dissenting); Biedenharn Realty Co. v. United States, 526 F.2d 409, 420-22 (5th Cir.), cert. denied, 429 U.S. 819, 97 S.Ct. 64, 50 L.Ed.2d 79 (1976), the original purpose for acquiring the property is clearly a relevant factor in determining the purpose for which it is held.

The Tax Court found that Redwood acquired Malibu Springs as part of a scheme to defraud prior owners of the property. Its 1967 acquisition of the property was the final step in a complicated series of transactions engineered by the chairman of Redwood's board of directors, Henry Kersting. In 1964, Kersting arranged for the Gamms, his parents-in-law, to purchase Malibu Springs from the Rodas for $600,000. The Gamms paid $60,000 in escrow, and Kersting, his wife, and the Gamms executed a promissory note for the balance. The Rodas did not retain a security interest in the property. Instead, as sole security for the note, Kersting pledged the stock he owned in Mendocino Financial Corporation, even though this stock had previously been pledged as security for a loan of $1,500,000. The note to the Rodas was never paid.

The Gamms were residents of Germany and were apparently involved only as a front for Kersting. During the years from 1964 to 1967, Malibu Springs went from the Gamms to Redwood twice, so that Redwood's 1967 purchase of Malibu Springs was actually a reacquisition of the property. The Tax Court concluded that, after Redwood's 1967 purchase,

the Gamms (or Kersting) had $750,000 of (Redwood's) cash, the Rodas had received only $60,000 of their sales price from the Gamms (or Kersting), and (Redwood) owned (Malibu Springs) for which it had paid a price apparently far in excess of its value. Looking at the above transactions objectively suggests that the principal purpose for the acquisition of the property by (Redwood) was to permit Kersting to bilk the Rodas out of their property for $60,000 and to permit Kersting to withdraw $750,000 in cash from (Redwood) in exchange for the property for which he had actually paid only $60,000.

68 T.C. at 973.

Although Redwood seeks to characterize this finding as conjectural, it has not demonstrated that it was clearly erroneous. ³ Redwood suggests further that even if the property were acquired to perpetuate a fraud, it does not follow that it was acquired as a capital investment rather than for sale to customers. But Redwood's argument ignores that transactions receive capital treatment unless the property sold or purchased falls within one of the five exceptions to section 1221's broad statutory definition of a capital asset. Property acquired and held for purposes not provided for in the limited exceptions to section 1221 is considered capital.

Moreover, other objective evidence supports the Tax Court's finding that the property was not acquired primarily for sale to customers. The property was 500 miles from Redwood's principal office. To make loans on the sale of such far-off lots would have required approval of the Federal Home Loan Bank Board (FHLBB). See 68 T.C. at 966. The Tax Court believed it unlikely that many purchasers would have carried loans with such a distant lending agency. Finally, as we observed earlier, the Tax Court found that there was no evidence that Redwood ever considered developing the lots for the purposes specified in section 6705; and any other development would have been outside the scope of Redwood's authorized business.

Redwood objects to the Tax Court's reliance on the distance between Malibu Springs and its principal office. Redwood first contends that FHLBB permission to grant loans is largely a formal matter. It bases this assertion on the fact that it did obtain permission to finance this very sale of Malibu Springs. But the record shows that Redwood sought permission to finance the buyer's purchase of the property as a step in salvaging its business, not as an ordinary part of its operations. FHLBB merely replied that advance approval was unnecessary in a bona fide salvage operation.

Redwood next contends that the actual financing of the sale of Malibu Springs negates the Tax Court's inference that Redwood would not have acquired property to develop for loan purposes so far from its home. However, Redwood's eventual financing of the sale of the property to a single buyer hardly proves that Redwood purchased such...