Turner v. Commissioner
| Citation | 1974 TC Memo 264,33 TCM (CCH) 1167 |
| Decision Date | 09 October 1974 |
| Docket Number | Docket No. 1904-70,1902-70. |
| Parties | Albert W. Turner and Therese L. Turner, et al. v. Commissioner. |
| Court | U.S. Tax Court |
Wallace E. Whitmore and W. Stephen McConnell, for the petitioners. Thomas C. Morrison, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined the following deficiencies in petitioners' Federal income tax:
The following issues remain to be decided:
(1) Whether gains from the sale of certain real estate were ordinary income or long-term capital gain;
(2) The amounts of the total contract price, gross profit, and payments in the year of sale arising from the sale of certain real estate on the installment method; and
(3) Whether certain payments by a corporation to its shareholders were taxable dividends or nontaxable repayments of their loans to the corporation.
Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference.
The individual petitioners filed their respective joint Federal income tax returns for the years in question with the district director of internal revenue, Baltimore, Maryland,3 and resided in Prince Georges County, Maryland, when they filed their respective petitions in this Court.
Albert W. Turner (hereinafter called Turner) has worked throughout his life in the construction business, particularly the building of houses in the Maryland suburbs of Washington, D.C. During his summer vacations from high school, Turner worked as a laborer in his father's house building business. After Turner's graduation from high school in 1934, he worked as a carpenter on various jobs in Prince Georges County, Maryland. In 1937, when he was twenty-one years old, Turner started his own business of building and selling houses. By 1943, he had built and sold to customers between ninety and one hundred houses in the Hyattsville, Maryland, area. In that year, Turner enlisted in the United States Navy and thereafter served thirty months in the South Pacific as a carpenter's mate with the Seabees.
Following his discharge from the Navy in 1946, Turner built eleven houses in Montgomery County, Maryland. He next purchased a tract of land in Hyattsville known as the Lewisdale subdivision and proceeded to build and sell houses there. During the course of this construction at Lewisdale, Turner incorporated his business, previously operated as a proprietorship, as his wholly-owned corporation named Albert W. Turner, Inc. This corporation continued to build and sell houses at the Lewisdale subdivision, which numbered some one hundred houses when completed. The corporation employed Herndon G. Kilby (hereinafter called Kilby) on a part-time basis as a construction supervisor of the Lewisdale project.
On April 21, 1949, Turner contracted to purchase 107.4001 acres of unimproved land in College Park, Prince Georges County, Maryland, known as the Hollywood tract. Turner considered this land suitable for immediate residential development and the eventual construction of a small shopping center. He hired and paid an engineering firm to conduct a boundary and topographic survey of the tract and prepare a preliminary plan of subdivision. In May 1949, he submitted the preliminary plan, which subdivided the tract into 595 lots, to the county planning commission and the county sewer commission for their necessary approval. Turner also applied to the sewer commission for an extension of existing water and sewer lines to service the Hollywood subdivision.
Turner meanwhile negotiated with the Veterans Administration (VA) to obtain a commitment of VA financing for the sale of houses in the Hollywood subdivision. He thought that the most successful arrangement for selling the houses would be a combination of a VA-guaranteed mortgage for the price of each house and a redeemable ground lease of each lot. Redeemable ground leases were a common form of residential real estate financing in Maryland at the time and met with the VA's approval. In order to further promote the sale of houses, Turner consented to the VA's request that he set the annual ground rent of each lot at five percent of the redemption price, rather than the six percent rate then prevailing in Maryland. In June 1949, the VA issued its commitment to Turner, and he was then able to obtain commitments from mortgage lenders to provide the necessary construction financing and purchase money financing of the Hollywood subdivision.
On June 28, 1949, Turner paid in cash the purchase price of $59,960.04 and took title to the Hollywood tract.
On September 20, 1949, Turner and Kilby formed a corporation (hereinafter called MCD) to engage in the business of residential construction. Turner and Kilby each contributed $10,000 to MCD in exchange for 50 shares each of the corporation's capital stock. The ownership of MCD thereafter remained the same, except that in 1951 Turner and Kilby each sold one share of their MCD stock to a different employee of the corporation, thereby reducing their interests to 49 percent each. Turner was president, Kilby was secretary and treasurer, and they and their respective wives were the four directors of the corporation.
At its first meeting, held on September 21, 1949, the board of directors of MCD resolved that the corporation should enter into ground leases with Turner covering specified lots in the Hollywood subdivision and should proceed to build houses thereon. At the insistence of the construction lender, however, Turner and MCD subsequently agreed to defer the creation of any ground rents on the lots until the construction mortgage was released from each lot as each house was completed and sold.
On September 30, 1949, Turner4 recorded the plat of the Hollywood subdivision and thereby dedicated to public use the streets indicated on the plat. Within the next month the county planning and sewer commissions granted their final approval to the plan of subdivision.
MCD thereafter proceeded to build houses on the lots. It hired and paid an engineering firm, the same one that Turner had previously employed, to conduct the field layout of the streets and to supervise their construction by a subcontractor. MCD also reimbursed Turner for the expenses he incurred in obtaining commitments for the construction financing and purchase money financing of the Hollywood subdivision.
Early in 1950, the county sewer commission authorized the extension of water and sewer lines to service the Hollywood subdivision. Turner subsequently tendered to the commission the refundable cash escrow deposits which it required from developers as a condition to such an extension of water and sewer lines to their subdivisions.
In the case of each house and lot in the Hollywood subdivision sold to an individual purchaser subject to a ground rent, the following transactions occurred on the date of settlement. Turner executed a ground lease of the lot to MCD for a term of 99 years, renewable forever, and redeemable at any time at the option of the lessee upon payment to the lessor of the specified redemption price. The annual ground rent was to be six percent of the redemption price of the lot. Simultaneously with the execution of the ground lease, Turner and MCD executed an agreement on behalf of themselves and their assigns that for a period of five years the ground rent was reduced to five percent of the redemption price of the lot in consideration of the lessee's promise not to redeem the ground rent until the expiration of that same period. MCD then sold the house and assigned the ground lease to the purchaser. When the homeowner desired to redeem the ground rent, he paid the redemption price to Turner and received a deed to the lot in fee simple.
The following table shows the amounts of rental income Turner received from the redeemable ground leases he created in connection with MCD's sale of houses in the Hollywood subdivision, the number of lots redeemed from ground rent in each year, and Turner's gains on such redemptions:5
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