Westchester Dev. Co. v. Comm'r of Internal Revenue , Docket No. 6315-72.

• Citation: 63 T.C. 198
• Decision Date: 14 November 1974
• Docket Number: Docket No. 6315-72.
• Parties: WESTCHESTER DEVELOPMENT COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

63 T.C. 198

WESTCHESTER DEVELOPMENT COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 6315-72.

United States Tax Court

Filed November 14, 1974.

Robert L. Waters, for the petitioner.

Daniel A. Taylor, Jr., for the respondent

Held, petitioner, a subdivider, recognized ordinary income on sales of portions of a tract of land which were held for sale in the ordinary course of business and capital gain on sales of the portions of that same tract which were held for investment. Held, further, additions made by petitioner to its reserve for bad debts were reasonable in amount and deductible under sec. 166(c), I.R.C. 1954, as amended. Held, further, a tract of land, purchased to be held for sale in the ordinary course of business, was similar or related in service or use to a tract which had been held for that same purpose prior to its being sold subject to threat of condemnation, sec. 1033(a), I.R.C. 1954, as amended.

FAY, Judge:

Respondent has determined deficiencies in the Federal income taxes of petitioner in the amounts of $47,224.77 and $311,871.79 for fiscal years ended February 29, 1968, and February 28, 1969, respectively.

The issues to be decided are:

(1) Whether the gain recognized by the petitioner on sales of real estate other than single-family dwelling sites was capital gain or ordinary income;

(2) Whether the additions which petitioner made to its bad debt reserve for the years in issue were reasonable in amount, and whether respondent abused his discretion in disallowing deductions claimed by reason of those additions; and

(3) Whether petitioner was entitled under section 1033¹ to delay the recognition of gain realized on the sale of land to the Spring Branch Independent School District.

FINDINGS OF FACT

Certain facts have been stipulated by the parties and are incorporated herein by this reference.

Petitioner Westchester Development Co.² was a corporation organized and existing under the laws of the State of Texas. Its principal place of business was in Houston when the petition was filed herein. For its fiscal years ended February 29, 1968, and February 28, 1969, petitioner filed its corporate income tax returns with the district director of internal revenue, Austin, Tex. Upon its incorporation and throughout the period under consideration,

petitioner's sole shareholders were E. G. McMillan and Adrian E. Kachel. Issue 1. The Sales of Real Estate Other Than Single-Family Dwelling Sites³

In 1950 E. G. McMillan (McMillan) entered the employ of Cantrell & McMillan, a firm in which he later became a partner and with which he was to remain associated until its dissolution in 1961. In the early years of his association with the firm, it engaged in commercial and industrial contracting; but after 1953 its activities were confined to residential construction. After the firm was dissolved, McMillan engaged in home construction on a joint venture basis with Adrain E. Kachel (Kachel) who also had been in Cantrell & McMillan's employ.

McMillan and Kachel formed the petitioner on March 9, 1966, intending that it acquire and develop 240 acres of undeveloped land on the western outskirts of Houston, Tex., known as the Statti tract. Petitioner acquired this tract on July 22, 1966, and having done so, was required to advise the city planning commission as to its plans for the disposition of the property which was thenceforth known as the Westchester subdivision.⁴ To this end a preliminary plat dated July 1966 was submitted to the commission.

For purposes of its development the subdivision was to be divided into three sections, identified by number in sequence from south to north. The entire first section and considerable portions of the second and third were to be subdivided into single-family dwelling sites. But portions of sections 2 and 3 which fronted on Memorial Drive and Dairy-Ashford Road⁵ were considered unsuitable for home construction due to their proximity to major thoroughfares and were consequently set aside as reserve tracts.⁶ No plan had as yet been devised for the use of the reserve tracts when the preliminary plat was submitted; but petitioner's management did contemplate that offers to purchase frontage along Memorial Drive and on Dairy-Ashford Road might be forthcoming from parties wishing to develop sites for commercial use.

Because section 1 was heavily wooded, McMillan and Kachel adjudged it ready for immediate residential construction. In order that construction might begin, a plat of the section was formally recorded on January 5, 1967.⁷ As sound planning dictated that contiguous sections be developed sequentially, a plat of section 2 was recorded on August 23 of the same year.

Under the plan devised by McMillan and Kachel for the development of the Westchester subdivision, it was not contemplated that petitioner actually become engaged in the construction of homes. Rather, petitioner was to subdivide into single-family dwelling sites the portions of the tract which were suitable for that use. These residential lots were then to be sold to construction companies who would build homes on them. Petitioner was to provide the construction companies with such financing as was necessary for their participation in the project and in consideration thereof was to share in the profits realized by the companies on the sales of the homes which they built in the subdivision. Petitioner's management and staff, together with the builders working at the subdivision, also entered into an active advertising campaign to encourage the sale of the single-family residential properties available in sections 1 and 2. During the period under consideration, marked progress was made in developing the subdivision according to the aforesaid design.

Certain portions of the subdivision, sold in the years now before us, were not sold as single-family dwelling sites. These transactions have given rise to the instant litigation. Before undertaking to describe them in detail we note that none of these transactions received its original impetus from petitioner; rather in each case petitioner was approached by the purchaser, either directly or through a representative. Such solicitation of purchasers as was engaged in by petitioner was aimed solely at promoting sales of single-family dwelling sites in the subdivision.

On July 17, 1967, the northeast corner of section 2 located in reserve C⁸ of that section, was sold to the Mobil Oil Co. which wanted the property, located at the intersection of Memorial Drive and Dairy-Ashford Road, as a site for a service station.

On December 6, 1967, petitioner sold two tracts in section 3 to Pitcock & Williams, a firm of apartment house developers who planned to construct a multiple-dwelling complex on the land which they acquired. One of the tracts sold to Pitcock & Williams had been designated as blocks 21 to 24, section 3, on the preliminary plat and the other as a portion of reserve D, section 3. Until the time of this transaction, McMillan and Kachel had anticipated that blocks 21 to 32, section 3, would be subdivided and sold as single-family dwelling sites; but the purchase of blocks 21 to 24, section 3, by a firm of apartment house developers caused McMillan and Kachel to reassess these plans.

On June 11, 1968, petitioner formally recorded a plat for section 3, on which none of the section appeared subdivided into single-family dwelling sites. Petitioner was at that time engaged in negotiating terms with John Clayton Builder, Inc. (Clayton), for the construction of an apartment house complex for petitioner's own account on a site in the northwest corner of the subdivision, which had been designated as residential blocks 28, 29, and 30, section 3, on the preliminary plat. Initial plans for the project were completed in October 1968, and final plans in January 1969. A partnership to further the project was formed by petitioner and Clayton on February 20, 1969. During this same period petitioner also entertained the idea of constructing an apartment house project in conjunction with one James Powers on a site in reserve tracts E and F, section 3. Preliminary plans for the project were prepared in the fall of 1968, and final plans were completed in February 1969.

Petitioner's purpose in recording the plat of section 3 on June 11, 1968, had been to facilitate the realization of plans such as these. None of the apartment house projects planned by petitioner was ever to be built, however, due to difficulties encountered by petitioner in obtaining the necessary financing.

On March 28, 1968, reserve A, section 2, was purchased by Bill Beck (Beck), a Dallas apartment house builder. Wishing to expand into the Houston area, Beck had approached petitioner through a real estate agent. At Beck's insistence, petitioner also granted him an option to purchase blocks 25 and 26, section 3, ⁹ and another to purchase a portion of reserve F, section 3. Blocks 25 and 26 were purchased by Beck's nominee on July 26, 1968, pursuant to an exercise of the first option.¹⁰

In the fall of 1967 petitioner's management first considered building a shopping center on a site in reserve F, section 3, which enjoyed easy access to Memorial Drive. A leasing agent was contacted as were an architect and several prospective tenants. Discussions were also conducted with parties who might have been willing to finance the project. While this possibility was being explored, Humble Oil & Refining Co. (Humble) expressed an interest in purchasing the southeast corner of reserve F, section 3. At first petitioner was hesitant to sell the lot to Humble because its plans for the development of the contiguous property were as yet incomplete; but it did eventually agree to the sale which took place on April 1, 1968.

The American Savings & Loan Association (American) owned a two-elevenths undivided interest in the site on which petitioner proposed to build its shopping center, and in reserve...