Willis v. C.I.R.

• Decision Date: 07 June 1984
• Docket Number: No. 83-1622,83-1622
• Citation: 736 F.2d 134
• Parties: 84-2 USTC P 9555 Gordon C. WILLIS and Jean H. Willis, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 134

736 F.2d 134

84-2 USTC P 9555

Gordon C. WILLIS and Jean H. Willis, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 83-1622.

United States Court of Appeals, Fourth Circuit.

Argued Feb. 6, 1984.

Decided June 7, 1984.

Robert J. Tyrrell, Bethesda, Md. (Ash, Bauersfeld, Burton, Hendricks & Tyrrell, Bethesda, Md., on brief), for appellants.

Lisa A. Prager, Tax Div., Dept. of Justice, Washington, D.C. (Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Ann Belanger Durney, Tax Div., Dept. of Justice, Washington, D.C., on brief), for appellee.

Before WINTER, Chief Judge, WIDENER, Circuit Judge, and PECK, ^* Senior Circuit Judge.

JOHN W. PECK, Senior Circuit Judge:

Gordon C. Willis (Taxpayer) brings this appeal from an adverse decision of the United States Tax Court. He challenges the court's finding of a deficiency in his 1976 federal income tax return (tax return) and its direction to pay an addition to tax according to Sec. 6651(a)(1) of the Internal Revenue Code of 1954 ¹ (IRC) due to his late filing of the return.

In April, 1976, Charles Caveness, a real estate developer, met with Bill Walters, a realtor from Charleston, South Carolina. Knowing that Caveness was interested in real estate development, Walters introduced him to Hal Ravenel who was connected with Sea Pines Company, a parent corporation of Isle of Palms Beach and Racquet Club Company, Inc. (Racquet Club), formerly known as the Charleston Beach and Racquet Club Company, Inc. Racquet Club, which was experiencing financial difficulties, owned 1500 acres of extremely valuable land located near Isle of Palms, South Carolina, consisting of some 2.5 miles of beach front property, 800 acres of which were immediately suitable for residential development. During a series of meetings, the three men discussed the chances of Caveness getting an option to purchase the Isle of Palms property. As a result of the discussions, Ravenel introduced Caveness to Raymond Finch, a principal in Finch Properties, a real estate partnership. Finch Properties owned twenty-seven per cent of the outstanding stock of Racquet Club and held a note and mortgage of Sea Pines on the 1500 acres of land with a face value of $2,639,028.75. Since Finch had not previously done business with Caveness, but was familiar with Ravenel, Finch granted Ravenel an exclusive sales listing, permitting him to present offers to purchase Finch Properties' interest in Racquet Club. The terms of this agreement, dated April 7, 1976, provided that Ravenel could sell an option to purchase the assets of Finch Properties until April 19, 1976 at 5:00 p.m. The option itself was available for up to thirty-seven days at a rate of $1,000 per day. Should the payments not be made, the option would lapse. Such payments were not refundable. Ravenel thereupon apparently entered into an agreement with Caveness by which Caveness purchased the option, but the form of the agreement does not appear in the record.

Interested in entering into this option agreement, Caveness contacted Taxpayer. Caveness and Taxpayer had been long-time business associates, having, among other things, jointly participated in a manufacturing enterprise. Taxpayer, the owner and president of Rockydale Quarries Corporation (Rockydale), was heavily involved in real estate investments and became interested in the land acquisition proposal. Caveness showed Taxpayer aerial photographs of the 1500 acre tract of land and informed Taxpayer that he held an option to purchase the land from Finch Properties. Caveness and Taxpayer testified at the hearing before the Tax Court that they could not recall whether Caveness had shown Taxpayer a copy of the April 7, 1976 exclusive sales listing or the agreement between Ravenel and Caveness prior to May 24. The parties thereafter entered into an agreement dated April 19, 1976, transferring a one-half interest in an option "to purchase approximately 1500 acres of ocean front property near Charleston, South Carolina, known as the Isle of Palms, from Finch Properties...." Taxpayer was to pay $7,000 per week for five weeks in order to preserve the option. Both parties agreed to share equally any profits derived from development of the 1500 acres.

Taxpayer made the weekly payments required by this agreement to the South Carolina National Bank by cashier's check, placed in escrow for Finch Properties. Such payments occurred on April 19, April 23, May 3, May 10, May 19, and May 26, 1976.

The parties agree that sometime after April 19, 1976, Caveness, following repeated requests from Taxpayer, showed Taxpayer a copy of the April 7, 1976 exclusive sales listing. Recognizing that it did not provide for an option to purchase the land, Taxpayer sent Caveness back to Finch to secure such an agreement. Caveness entered into an agreement with Finch dated May 24, 1976, granting him an option to purchase the stock and other assets of Finch Properties, effective May 24, 1976. Paragraph 10 of the agreement between Caveness and Finch provided that any payments made prior to the effective date of the Option and Agreement would be included as a part of the sales price. The agreement also specified that the life of the option could be extended at a rate of $7,000 per week. After the above-mentioned May 26, 1976 payment, however, no additional payments to Finch Properties were made and the unexercised option lapsed.

In his 1976 federal income tax return ² Taxpayer deducted the six payments to Finch, totalling $42,000, plus $14 spent in the purchase of the cashier's checks, as an ordinary business loss. Though it was required to be filed on or before July 15 1977, ³ the return was not acknowledged by the IRS until July 27, 1977.

The IRS determined a deficiency in Taxpayer's 1976 tax return, finding that the deduction taken for failure to exercise the option should have been reported as a capital loss rather than as an ordinary business loss. The IRS declared that the option was actually to purchase capital assets from Finch Properties, including stock, contractual rights, and the mortgage on the 1500 acres of land, rather than land purchased as part of a profit-seeking venture. IRS also assessed Taxpayer an addition to tax pursuant to IRC Sec. 6651(a)(1) for late filing of his tax return.

At the Tax Court hearing, Taxpayer testified that he had been led to believe he was purchasing from Caveness an option to acquire the Isle of Palms property rather than an option to purchase capital assets from Finch Properties. He stated that the April 19, 1976 agreement between himself and Caveness, which expressly described the Isle of Palms property as that property covered by the option, as well as several cashier's checks with the notation "land option", supported his position. On cross-examination, when asked why he had not attempted to get his money back once the true nature of the option became clear, Taxpayer declared that pursuant to his agreement, the payments would constitute a portion of the sale price had the option been exercised. Concerning his failure to timely file his 1976 tax return, Taxpayer testified that the ministerial inadvertence of his trusted employee, Lynwood W. Lucas, had caused the delay, and therefore such inadvertence constituted reasonable cause under IRC Sec. 6651(a)(1).

The Tax Court disagreed with both of Taxpayer's arguments. Viewing the transaction among Caveness, Ravenel, Finch, Walters, and Taxpayer as a whole, the court declared that Taxpayer had indeed purchased an option to acquire capital assets, thus entitling him to deduct only a capital loss. The Tax Court further held that even though Taxpayer's failure to timely file his tax return was not due to willful neglect, Taxpayer failed to show reasonable cause to excuse his late filing. Taxpayer now appeals to this court pursuant to IRC Sec. 7482(a).

Section 165(a) of the IRC permits an individual taxpayer to deduct ordinary business losses sustained during the tax year which are not otherwise compensated for by insurance. Such deductions, however, are limited by IRC Sec. 165(c) & (f). Section 165(c)(2), relied on by Taxpayer, permits deduction of losses sustained in transactions entered into for profit. Such losses are considered ordinary losses. In the case of capital assets, IRC Sec. 165(f), combined with IRC Sec. 1211, allows a taxpayer to deduct only a capital loss. The IRC treats a loss incurred when an option is unexercised as either an ordinary loss, or as a capital loss, depending upon the character of the property covered in the option. On one hand, as Taxpayer argues, if the property is land, acquired as part of a profit-seeking venture, the loss resulting from the failure to exercise that option is an ordinary loss. If, as the IRS determined, and the Tax Court found, Taxpayer actually had an option to acquire capital assets, he may deduct only the dollar value of the capital loss.

Whether a taxpayer is entitled to an ordinary or capital loss is a question of fact depending on the circumstances in the particular case. The primary focus is on the character of the property itself and the true substance of the overall transaction, rather than the form assigned to it by the parties. The taxpayer has the burden of proving entitlement to ordinary loss treatment as well as overcoming the presumption that he did not acquire an option to purchase capital assets where the IRS has so determined. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933). Our function on review is limited to a determination of whether the Tax Court's finding of a capital loss is clearly erroneous. Commissioner v. Duberstein, 363 U.S. 278, 290-91, 80 S.Ct. 1190, 1199, 4 L.Ed.2d 1218 (1960); NCNB Corp. v. United States, 684 F.2d 285, 287 (4th Cir.1982); IRC Sec. 7482(a).

The record in this case clearly shows that Taxpayer thought he was acquiring an option to purchase the Isle of Palms property, rather than acquiring...