Reymond, Leon J., Jr.

English

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Louisiana Law ReviewVolume 28 | Number 1December 1967Income Taxation - Property Held "Primarily forSale" - Effect of Malat v. RiddellLeon J. Reymond Jr.This Note is brought to you for free and open access by the Law Reviews and Journals at LSU Law Digital Commons. It has been accepted for inclusionin Louisiana Law Review by an authorized editor of LSU Law Digital Commons. For more information, please contact kreed25@lsu.edu.Repository CitationLeon J. Reymond Jr., Income Taxation - Property Held "Primarily for Sale" - Effect of Malat v. Riddell, 28 La. L. Rev. (1967)Available at: https://digitalcommons.law.lsu.edu/lalrev/vol28/iss1/7NOTESINCOME TAXATION-PROPERTY HELD "PRIMARILY FOR SALE"-EFFECT OF MALAT v. RIDDELLThe distinction between capital gains and ordinary incomehas spawned constant litigation and comment. Due to the con-siderable benefit of capital gains treatment,1 taxpayers frametheir transactions to qualify for these savings. Capital gains arederived from the sale of capital assets which are defined byexclusion in section 1221 of the Internal Revenue Code of 1954.2Clause one of section 1221 excludes from the category of capitalassets "property held by the taxpayer primarily for sale tocustomers in the ordinary course of his trade or business."8The application of this standard4 to real estate transactions isthe topic of this Note.The determination of whether property is held primarilyfor sale to customers is considered a question of fact.5 Factorsrecognized by the courts to bear on its resolution include: (1)the purpose for which the property was acquired;6 (2) thefrequency and continuity of sales;7 (3) the activity of the sellerin improving and selling the property,s including the extentof advertising;9 (4) the holding period;10 and (5) other factors1. The Internal Revenue Code provides for a deduction from grossincome of fifty percent of the excess of net long-term capital gains overnet short-term capital losses. However, in no case may the tax exceed 25percent of the excess. INT. RaV. CODE of 1954, H§ 1201, 1202.2. 26 U.S.C. §9 1-8023 (1954).3. Id. § 1221: "For purposes of this subtitle, the term 'capital asset'means property held by the taxpayer (whether or not connected with histrade or business), but does not include-"(1) ... property held by the taxpayer primarily for sale to customersin the ordinary course of his trade or business."4. The standard also appears in other sections of the Internal RevenueCode. See 4d. §§ 337(b)(1)(A), 341(b)(3)(B), 1031(a), 1231(b)(1)(B).5. Lakin v. Commissioner, 249 F.2d 781, 783 (4th Cir. 1957); RollingwoodCorp. v. Commissioner, 190 F.2d 263, 265 (9th Cir. 1951); George V. Sottong,25 CCH Tax Ct. Mem. 1366, 1371 (1966); Wellesley A. Ayling, 32 T.C. 704,708 (1959).6. Friend v. Commissioner, 198 F.2d 285, 287 (10th Cir. 1952); George V.Sottong, 25 CCH Tax Ct. Mem. 1366, 1371 (1966).7. Frank v. Commissioner, 321 F.2d 143, 149 (8th Cir. 1963); RollingwoodCorp. v. Commissioner, 190 F.2d 263, 266 (9th Cir. 1951); George V. Sottong,25 CCH Tax Ct. Mem. 1366, 1371 (1966).8. King v. Commissioner, 189 F.2d 122, 123 (5th Cir. 1951); George V.Sottong, 25 CCH Tax Ct. Mem. 1366, 1371 (1966).9. Scheuber v. Commissioner, 371 F.2d 996, 998 (7th Cir. 1967); Delsing v.United States, 186 F.2d 59, 61 (5th Cir. 1951).10. Scheuber v. Commissioner, 371 F.2d 996, 998 (7th Cir. 1967).[126]NOTESindicating that the sale was in the ordinary course of business."No one of these tests is considered determinative'12 and eachcase must be decided in the light of its own facts.18The interpretation of "primarily" has received recent clari-fication by the United States Supreme Court in Malat v. Riddell.14The Court granted certiorari' 5 because of a conflict among thecourts of appeal. The Second 6 and Ninth Circuits adopted theposition of the Commissioner of Internal Revenue 8 and the TaxCourt 19 in finding that "primarily" indicated only a "substantial"or "essential" purpose to hold for sale; while the Fifth2° andEighth 2' Circuits restricted the meaning to "of first importance"or "principally."In Malat, the taxpayer was a member of a joint venturewhich purchased a 45-acre tract and subdivided the interiorportion. The gain from the subdivision sales was taxed asordinary income. Confronted with mortgage and zoning prob-lems which prevented development of two frontage parcels, thetaxpayer sold out his interest in this acreage, claiming the favor-able capital gains treatment. The Commissioner assessed andcollected a deficiency claiming the property was held with a"dual purpose" of developing for rental purposes or selling,whichever proved more profitable. Therefore, the purpose tosell was a "substantial" one. Mr. Malat contended the propertywas held as an investment; sale not being contemplated untilthe difficulties were encountered. The district court and thecourt of appea 2 2 found one of the "substantial" purposes wasthat of sale, and upheld the Commissioner in denying capital11. Delsing v. United States, 186 F.2d 59, 61 (5th Cir. 1951) (licensed realestate agent); S. 0. Bynum, 46 T.C. 295, 300 (1966) (significance of timespent and income from real estate transactions).12. Scheuber v. Commissioner, 371 F.2d 996, 998 (7th Cir. 1967); RecordakCorp. v. United States, 325 F.2d 460, 461 (Ct. Cl. 1963); Frankenstein v. Com-missioner, 272 F.2d 135 (7th Cir. 1959).13. Scheuber v. Commissioner, 371 F.2d 996, 998 (7th Cir. 1967); Mauldinv. Commissioner, 195 F.2d 714 (10th Cir. 1952).14. 383 U.S. 569 (1966).15. Malat v. Riddell, 382 U.S. 900 (1965).16. American Can Co. v. Commissioner, 317 F.2d 604, 605 (2d Cir. 1963).17. Malat v. Riddell, 347 F.2d 23 (9th Cir. 1965); Rollingwood Corp. v.Commissioner, 190 F.2d 263, 266 (9th Cir. 1951).18. See Rollingwood Corp. v. Commissioner, 190 F.2d 263, 266 (9th Cir.1951).19. Municipal Bond Corp., 41 T.C. 20, 29 (1963); American Can Co.,37 T.C. 198, 210 (1961); Joseph A. Harrah, 30 T.C. 1236, 1241 (1958).20. United States v. Bennett, 186 F.2d 407, 410 (5th Cir. 1951).21. Municipal Bond Corp. v. Qommissioner, 341 F.2d 683, 688 (8th Cir.1965).22. Malat v. Riddell, 347 F.2d 23 (9th Cir. 1965).1967]LOUISIANA LAW REVIEWgains treatment. The Supreme Court redefined "primarily" to,mean "of first importance" or "principally." It vacated 2 andremanded the case for disposition under the new definition.24To understand the significance of this decision and the caseswhich have interpreted it, the requirements of the statute mustbe divided into the following elements: 25 (1) held "primarily"for sale, and (2) to customers in the ordinary course of busi-ness. In other words, the court must find the taxpayer in thereal estate business before it can turn to Malat for the defini-tion of "primarily held for sale.126It is here that Malat can be of service to the real estatedealer. As noted above,27 the Commissioner has in the past beenable to succeed if he could prove a "dual purpose," the inten-tion to hold for sale being at least a "substantial" one.2 8 Thedealer can now qualify for capital gains treatment by showingthat the primary purpose for owning the asset was not thatof sale.29The Tax Court was confronted with a post-Malat case in-volving "dual purpose" in Emilio Olivieri.80 It found the tax-payer and his partner, real estate developers, were undecidedwith respect to the use to be made of the particular tract andwere holding it without taking any action which would committhem to its development or to retaining it as an investment.The court held, relying on Malat, that when the property wassold neither of these purposes had become a principal purposeor one of first importance; therefore, the property was not beingheld "primarily for sale."8123. It must be remembered that the Supreme Court made no decision onthe facts. Therefore, deciding future cases by comparison of facts as InScheuber v. Commissioner, 371 F.2d 996 (7th Cir. 1967) is improper.24. Malat v. Riddell, 383 U.S. 569 (1966).25. The Tax Court has divided the second element into "for sale tocustomers" and "in the ordinary course of business," but considers theformer insignificant because all sales are made to customers. S. 0. Bynum,46 T.C. 295, 302 (1966) (concurring opinion); Eugene L. Freeland, 25 CCHTax Ct. Mem. 1473, 1479 (1966).26. See Rollingwood Corp. v. Commissioner, 190 F.2d 263, 266 (9th Cir.1951).27. See notes 16 and 17 supra and accompanying text.28. Malat v. Riddell, 347 F.2d 23 (9th Cir. 1965); American Can Co. v.Commissioner, 317 F.2d 604 (2d Cir. 1963); Rollingwood Corp. v. Commis-sioner, 190 F.2d 263 (9th Cir. 1951).29. Comment, Dual Purpose Assets and Capttal Gains, 12 S.D. L. REV.408 (1967); Supreme Court to clarify dealer's right to capital gain; will rulein Malat case, 24 J. TAXATION 22 (1966).30. 25 CCH Tax Ct. Mem. 920 (1966).31. The court gave a more liberal interpretation of Malat than necessaryto decide the case. The purposes of holding for sale and holding for invest-[Vol. XXVIINOTESIn two other cases, where a "dual purpose" was involved,the Tax Court originally determined the taxpayer's purpose metthe test of holding with sale as a "substantial" purpose. AfterMalat, the court reconsidered these cases and affirmed theirprevious decision finding that they could meet the more exactingtest of "principally" laid down by the Supreme Court.8 2With respect to the second element, sale "to customers inthe ordinary course of business," the Supreme Court decisionhas had negligible effect. 88 It is here that equity calls for achange in the requirements of the Code. With regard to section1221 (1), the Supreme Court has said:"The purpose of the statutory provision with which wedeal is to differentiate between the 'profits and losses arisingfrom the everyday operation of a business' on the onehand.., and the 'realization of appreciation in value accruedover a substantial period of time' on the other. 8 4However, in many cases, the statutory standard is unequippedto make this distinction. In S. 0. Bynum8 5 the taxpayer pur-chased a farm in 1942 for use in the nursery business. Due tofinancial reversals, he was forced to subdivide a part of it in1959 to meet his obligations. The Tax Court correctly heldunder the statute that at the time of sale the property was held"primarily for sale" and subjected the gain to treatment asordinary income. However, the gain resulted from both realizedappreciation and everyday profits, and provision should be madeto divide it between ordinary income and capital gain.86The Code provides the means for making the necessary dis-tinction between capital gains and ordinary income in dealingment are alternative. The lack of a finding that the property was heldas an investment connotes that the taxpayer has failed to shoulder theburden of proof In convincing the court that the property was not heldprimarily for sale. See TAx CT. R. 32.32. Municipal Bond Corp., 46 T.C. 219 (1966); Joan E. Heller Trust, 25CCH Tax Ct. Mem. 634 (1966). However, both of these cases were reversed onappeal because of a seeming reluctance on the part of the Tax Courtto accept the full Import of Malat. Municipal Bond Corp. v. Commissioner,67-2 U.S. Tax Cas. 9 9633 (8th Cir. 1967); Joan E. Heller Trust v. Commis-sioner, 67-2 U.S. Tax Cas. 1 9626 (9th Cir. 1967).33. Compare Lakin v. Commissioner, 249 F.2d 781 (4th Cir. 1957), withL. P. Barney, 26 CCH Tax Ct. Mem. 109 (1967).34. Malat v. Riddell, 383 U.S. 569, 572 (1966).35. 46 T.C. 295 (1966).36. The Internal Revenue Code provides limited relief when the sub-division development is on a small scale and certain requirements are met.However, this relief has very limited application. INT. Rsv. CODs oF 1954§ 1237.19671LOUISIANA LAW REVIEWwith cut timber.3 This principle could be easily adapted to thereal property area by treating the appreciation in value of theproperty while held as an investment as capital gain, and theprofits made in developing and selling as ordinary income.8Such a scheme would surely restore equity and certainty in thismuch-litigated area.Leon J. Reymond, Jr."OTHER INSURANCE" CLAUSES IN UNINSUREDMOTORIST PROVISIONSPlaintiff and Courville were guest passengers in a vehiclewhen it collided with an uninsured automobile. The uninsuredmotorist's negligence was the sole cause of the accident. Thehost's insurer deposited $10,000.00, the policy limit, of whichCourville1 was awarded $5,000.00, the host $2,000.00, and plain-tiff $3,000.00. Each claimant would have been entitled to a largerrecovery but for the size of the policy limit. Plaintiff thenbrought suit against his own insurer, under his policy's un-insured motorist provisions. Defendant insurer argued that underthe "other insurance" clause in plaintiff's policy 2 its liabilitywas extinguished by the host's insurer's payment of $3,000.00,since the uninsured motorist limits of both plaintiff's and thehost's policies were identical. The district court allowed plaintifffull recovery ($5,000.00) under his policy. Held, amended and37. The Internal Revenue Code treats the application in value of thestanding timber as capital gain to be considered realized when the timberis cut, and the profits made in selling the cut timber as ordinary income.Id. § 631(a).38. SURREY & WARREN, FEDERAL INcoME TAXATION, CASES AND MATERIALS695 (1960); Dakin, The Capital Gains Treasure Chest: Rational Extension orExpedient Di8tortionf, 14 LA. L. REv. 505, 522 (1954). A similar effect couldbe created by the taxpayer by the establishment of another entity to acquirethe property for development if he already holds the land for investmentpurposes. Berge, Special Tax Problems of Participants in Real EstateDevelopments, 45 TAXES 161, 163 (1967).1. Courville was denied recovery under his own policy's uninsuredmotorist coverage in the companion case of Courville v. State Farm Mut.Auto. Ins. Co., 194 So.2d 797 (La. App. 3d Cir. 1967), writs refused, 197 So.2d79 (1967).2. The clause contained the following language: "Other Insurance. Withrespect to bodily injury to an insured while occupying an automobile now(sic) owned by the named insured, the insurance under Part IV shallapply only as excess insurance over any other similar insurance availableto such insured and applicable to such automobile as primary insurance,and this insurance shall then apply only in the amount by which the limitof liability for this coverage exceeds the applicable limit of liability of suchother insurance." LeBlanc v. Allstate Ins. Co., 194 So.2d 791, 792 (La. App.3d Cir. 1967).[Vol. XXVIII

Income Taxation - Property Held  Primarily for Sale  - Effect of Malat v. Riddell

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Income Taxation - Property Held Primarily for Sale - Effect of Malat v. Riddell

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