Cohn v. Commissioner, 21 T.C. 90 (1953)

The court determined whether the sale of multiple dwelling houses by a real estate construction company resulted in ordinary income, because they were held primarily for sale, or long-term capital gains because they were held for investment.

Summary

The United States Tax Court considered whether a construction partnership’s sale of 69 multiple-unit houses resulted in ordinary income or capital gains. The partnership, Security Construction Company, built houses for sale. During wartime restrictions, the company built defense housing, including the 69 multiple-unit houses that were rented for a period. The court had to determine if these houses, sold in 1945, were held primarily for sale in the ordinary course of business (ordinary income) or if they were capital assets (capital gains) because they were held for investment. The court, emphasizing the partnership’s primary business of building and selling houses, determined that the houses were held primarily for sale and therefore the income from the sales was considered ordinary income.

Facts

Edgar and Daniel Cohn formed Security Construction Company in 1942, with the primary business listed as real estate. The company built and sold single-family houses in 1942 and 1943. In 1943, the partnership received authorization and priorities to build multiple-unit houses under wartime regulations. The 69 multiple-unit houses in question were completed in 1944 and rented under one-year leases. In January 1945, the partnership listed the houses for sale, with the first sale occurring later in the month. By October 1945, all 69 houses were sold. The partnership reported the gains from the sales on an installment basis.

Procedural History

The Commissioner of Internal Revenue determined deficiencies in the Cohns’ income tax for 1945 and 1946, arguing that the gains from the sale of the houses were ordinary income. The Cohns contested this, claiming the houses were capital assets, and the gains should be treated as capital gains. The case went before the United States Tax Court.

Issue(s)

1. Whether the 69 houses sold in 1945 by the Security Construction Company were held primarily for sale to customers in the ordinary course of business.

Holding

1. Yes, because the court concluded the 69 houses were held primarily for sale to customers in the ordinary course of business, rather than for investment.

Court’s Reasoning

The court recognized that the key issue was one of fact. The petitioners had the burden of proving that the Commissioner’s determination was incorrect. The court analyzed whether the properties were acquired for sale or investment and whether the partnership was engaged in the business of renting residential property distinct from its original business of building and selling houses. The court considered the frequency and continuity of sales, the activities of the partners and their agents, and the purpose for which the property was held. The court emphasized that the partnership’s primary business was building and selling houses. The court found that the renting of the units was incidental to the sale and that the partners never changed their primary business purpose of building for sale. The court rejected the argument that the houses were capital assets, concluding they were held primarily for sale.

Practical Implications

This case emphasizes the importance of determining the primary purpose for which a property is held to ascertain the proper tax treatment of sales. The case demonstrates that, even if a taxpayer rents property for a period, it can still be considered property held for sale if the renting is incidental to the overall goal of selling the property in the ordinary course of business. The frequency of sales, the continuity of the business, and the intent of the taxpayer are all significant factors in determining whether profits from the sale of real estate are taxed as ordinary income or capital gains. A real estate developer or investor seeking to minimize taxes must structure their activities to clearly establish the intended purpose and use of the property.