SCOTUS Reports

Tag: Long-Term Capital Gain

  • Marvin E. DeBough v. Commissioner of Internal Revenue, 142 T.C. No. 17 (2014): Interplay of Sections 121 and 1038 in Taxation of Reacquired Property

    Marvin E. DeBough v. Commissioner of Internal Revenue, 142 T. C. No. 17 (U. S. Tax Court 2014)

    In DeBough v. Commissioner, the U. S. Tax Court ruled that a taxpayer must recognize previously excluded gain under Section 121 when reacquiring a principal residence under Section 1038. Marvin DeBough sold his home on an installment basis, excluding $500,000 of gain under Section 121. After the buyers defaulted, DeBough reacquired the property. The court held that, absent a resale within one year as provided by Section 1038(e), previously excluded Section 121 gain must be recognized under the general rules of Section 1038. This decision clarifies the interaction between these tax provisions and impacts how taxpayers must account for gains from reacquired properties.

    Parties

    Marvin E. DeBough, Petitioner, versus Commissioner of Internal Revenue, Respondent. At the trial level, DeBough was represented by Matthew L. Fling, while the Commissioner was represented by John Schmittdiel and Randall L. Eager.

    Facts

    Marvin E. DeBough purchased his personal residence and 80 acres of mixed-use land in 1966 for $25,000. On July 11, 2006, he sold the property to Stonehawk Corp. and Catherine Constantine Properties, Inc. (the buyers) for $1,400,000 under a contract for deed. DeBough received $250,000 at the time of sale and an additional $250,000 in 2007, and $5,000 in 2008. He excluded $500,000 of gain from the sale under Section 121 of the Internal Revenue Code. In 2009, the buyers defaulted on the contract, and DeBough reacquired the property on July 29, 2009. DeBough reported $97,153 in long-term capital gains for 2009 but later amended his return to remove this gain. The Commissioner determined that DeBough should recognize $448,080 in long-term capital gains for 2009, including the previously excluded $500,000 under Section 121.

    Procedural History

    The Commissioner issued a notice of deficiency dated June 18, 2012, determining that DeBough was required to recognize $443,644 in long-term capital gains for the 2009 tax year. This amount was later recalculated to $448,080 to account for an omitted payment. DeBough timely filed a petition with the U. S. Tax Court seeking redetermination of the deficiency. The Tax Court, with Judge Nega presiding, upheld the Commissioner’s determination, requiring DeBough to recognize the previously excluded gain under Section 121 upon reacquisition of the property.

    Issue(s)

    Whether a taxpayer must recognize long-term capital gain previously excluded under Section 121 upon reacquisition of a principal residence under Section 1038 when the property is not resold within one year of reacquisition?

    Rule(s) of Law

    Section 1038 of the Internal Revenue Code provides that no gain or loss results from the reacquisition of real property sold on an installment basis if the seller reacquires the property in satisfaction of the debt secured by it. However, under Section 1038(b), gain must be recognized to the extent that money or other property received before reacquisition exceeds the gain reported as income prior to reacquisition. Section 1038(e) provides an exception for principal residences reacquired and resold within one year, treating the resale as part of the original sale transaction and allowing the Section 121 exclusion to apply.

    Holding

    The Tax Court held that DeBough was required to recognize long-term capital gain on the reacquisition of his principal residence under Section 1038, including the $500,000 gain previously excluded under Section 121, because he did not resell the property within one year of reacquisition as required by Section 1038(e).

    Reasoning

    The court’s reasoning focused on the interplay between Sections 1038 and 121. It noted that Section 1038(e) explicitly addresses the reacquisition of principal residences but limits its relief to situations where the property is resold within one year. The absence of any broader exception in Section 1038 led the court to conclude that the general rule of Section 1038(b) applies, requiring recognition of gain to the extent of money received before reacquisition, including gain previously excluded under Section 121. The court rejected DeBough’s argument that the absence of specific language mandating recapture of Section 121 gain meant that such gain should not be recaptured, citing the statutory canon of construction expressio unius est exclusio alterius. Additionally, the court emphasized that the tax treatment should reflect the economic reality of DeBough’s situation, as he had received $505,000 in cash before reacquiring the property. The decision aligns with fundamental federal income tax principles that gross income includes any accession to wealth clearly realized and over which the taxpayer has dominion.

    Disposition

    The Tax Court entered a decision for the Commissioner, requiring DeBough to recognize $448,080 in long-term capital gains for the 2009 tax year.

    Significance/Impact

    The DeBough decision clarifies the interaction between Sections 1038 and 121 of the Internal Revenue Code, establishing that gain previously excluded under Section 121 must be recognized upon reacquisition of a principal residence under Section 1038 if the property is not resold within one year. This ruling has significant implications for taxpayers engaging in installment sales of their principal residences, as it affects the tax consequences of reacquiring such properties upon buyer default. The decision underscores the importance of considering the specific statutory exceptions and general rules when planning and reporting tax transactions involving reacquired properties.

  • Debough v. Commissioner, 142 T.C. 297 (2014): Interaction of Sections 1038 and 121 of the Internal Revenue Code

    Debough v. Commissioner, 142 T. C. 297 (2014)

    In Debough v. Commissioner, the U. S. Tax Court ruled that a taxpayer who reacquired his principal residence after a defaulted installment sale must recognize previously excluded gain under Section 121 upon reacquisition, as mandated by Section 1038 of the Internal Revenue Code. Marvin E. Debough sold his home in 2006, excluding $500,000 of gain, but had to repossess it in 2009 after the buyers defaulted. The court clarified that without resale within one year, as stipulated in Section 1038(e), the general rule of Section 1038(b) applies, requiring recognition of gain received before reacquisition. This decision underscores the interaction between these sections and their impact on homeowners facing similar circumstances.

    Parties

    Marvin E. Debough, the petitioner, sought a redetermination of a deficiency in federal income tax assessed by the respondent, the Commissioner of Internal Revenue. Throughout the litigation, Debough was represented by Matthew L. Fling, while the Commissioner was represented by John Schmittdiel and Randall L. Eager.

    Facts

    In 1966, Marvin E. Debough purchased his primary residence and surrounding land for $25,000. On July 11, 2006, he sold this property to Stonehawk Corp. and Catherine Constantine Properties, Inc. (collectively, the buyers) under a contract for deed, with a total purchase price of $1,400,000. The sale included a down payment of $250,000, with the remaining $1,150,000 to be paid over time with interest at 5% per annum. Debough reported an adjusted basis of $742,204 in the property, which included half of the original cost, capital improvements, a stepped-up basis from his deceased spouse, and sale expenses. However, the parties later stipulated a basis of $779,704. Debough and his deceased spouse excluded $500,000 of gain from their 2006 tax return under Section 121 and reported the remaining gain on an installment basis. Debough received payments totaling $505,000 before the buyers defaulted in 2009. After serving a notice of cancellation, Debough reacquired the property on or about July 29, 2009, incurring $3,723 in repossession costs. He reported $97,153 in long-term capital gains for 2009 but later amended his return to exclude this amount. The Commissioner assessed a deficiency, determining Debough should recognize $448,080 in long-term capital gains for 2009, including the previously excluded $500,000.

    Procedural History

    The Commissioner issued a notice of deficiency to Debough on June 18, 2012, asserting a deficiency of $58,893 in federal income tax for the 2009 taxable year. Debough timely filed a petition with the United States Tax Court seeking redetermination of the deficiency. The parties stipulated facts under Tax Court Rule 122. The Tax Court, with Judge Negah presiding, considered the case and ruled in favor of the Commissioner, ordering that a decision be entered for the respondent.

    Issue(s)

    Whether a taxpayer who reacquires his principal residence after an installment sale where gain was previously excluded under Section 121 must recognize that previously excluded gain upon reacquisition under Section 1038?

    Rule(s) of Law

    Section 1038 of the Internal Revenue Code provides that no gain or loss results from the reacquisition of real property sold on an installment basis and later reacquired in satisfaction of the debt secured by the property, except to the extent of money and other property received before reacquisition. Section 1038(b) mandates recognition of gain to the extent that the amount of money and the fair market value of other property received before reacquisition exceeds the gain on the sale reported as income before reacquisition. Section 1038(e) provides an exception for reacquisition of a principal residence, allowing nonrecognition of gain if the property is resold within one year of reacquisition. Section 121 permits taxpayers to exclude up to $500,000 of gain from the sale of a principal residence if certain conditions are met.

    Holding

    The Tax Court held that Marvin E. Debough was required to recognize long-term capital gain upon the reacquisition of his property under Section 1038, including the $500,000 previously excluded under Section 121, because he did not resell the property within one year of reacquisition as required by Section 1038(e).

    Reasoning

    The court reasoned that Section 1038 applies to the reacquisition of real property sold on an installment basis and later reacquired in satisfaction of the debt secured by the property. The court noted that Congress intended for Section 1038 to prevent recognition of gain or loss based on fluctuations in the fair market value of the property upon reacquisition, but not to the extent of cash or other property received by the seller before reacquisition. The court interpreted the specific exception in Section 1038(e) for principal residences as evidence that Congress intended for the general rule of Section 1038(b) to apply in cases like Debough’s, where the property was not resold within one year of reacquisition. The court rejected Debough’s argument that the absence of a specific provision mandating the recognition of previously excluded Section 121 gain meant that Section 1038 did not apply to recapture such gain. Instead, the court found that the mandatory language of Section 1038(b) required recognition of gain to the extent of money received before reacquisition, which in Debough’s case included the $505,000 received before the buyers defaulted. The court also noted that this interpretation was consistent with the basic principles of federal income tax law, which include any accession to wealth in gross income unless specifically excluded by statute.

    Disposition

    The Tax Court entered a decision for the respondent, the Commissioner of Internal Revenue, affirming the deficiency in federal income tax for the 2009 taxable year.

    Significance/Impact

    The decision in Debough v. Commissioner has significant implications for taxpayers who sell their principal residences on an installment basis and later reacquire them due to buyer default. It clarifies that the exclusion of gain under Section 121 is not permanent if the property is reacquired and not resold within one year, as provided by Section 1038(e). This ruling emphasizes the importance of understanding the interplay between Sections 1038 and 121 and may affect the financial planning of homeowners considering installment sales of their residences. The case also reinforces the principle that statutory exclusions and deductions must be explicitly provided by Congress and cannot be inferred from silence in the tax code.

  • King v. Commissioner, 87 T.C. 1213 (1986): Deductibility of Commodity Straddle Losses for Dealers

    King v. Commissioner, 87 T. C. 1213 (1986)

    Losses on commodity straddles entered into before 1982 by commodities dealers are deductible without regard to a profit motive.

    Summary

    Marlowe King, a commodities dealer, sought to deduct losses from gold futures straddles in 1980. The IRS challenged these deductions, arguing they were sham transactions and not for profit. The U. S. Tax Court granted King’s motion for summary judgment, holding that his losses were deductible under Section 108 of the Tax Reform Act of 1984, which allows losses for commodities dealers without requiring a profit motive. Additionally, the court ruled that King’s gain from selling gold bars was long-term capital gain, not short-term as argued by the IRS, due to Section 1233 not applying to physical commodities.

    Facts

    Marlowe King, a registered member of the Chicago Mercantile Exchange, actively traded commodities and futures since 1950. In 1980, he incurred losses from disposing of positions in gold futures straddles. King also realized a gain from selling gold bars that year, which he reported as long-term capital gain. The IRS issued a notice of deficiency, disallowing the losses and recharacterizing the gain as short-term capital gain, claiming the transactions were shams and lacked economic substance.

    Procedural History

    King filed a motion for partial summary judgment in the U. S. Tax Court to address the IRS’s determinations regarding the deductibility of his straddle losses and the classification of his gold bar sale gain. The court reviewed the motion under its rules for summary judgment, considering the affidavits and arguments presented by both parties.

    Issue(s)

    1. Whether King’s losses on dispositions of gold commodity futures straddles in 1980 are deductible under Section 108 of the Tax Reform Act of 1984.
    2. Whether King’s gain from the sale of gold bars in 1980 qualifies as long-term capital gain under Section 1233 of the Internal Revenue Code.

    Holding

    1. Yes, because King’s losses are deductible under Section 108(b) as a commodities dealer without needing to establish a profit motive.
    2. Yes, because Section 1233 does not apply to physical commodities, thus King’s gain from selling gold bars is properly classified as long-term capital gain.

    Court’s Reasoning

    The court applied Section 108 of the Tax Reform Act of 1984, which allows commodities dealers to deduct losses on straddles entered into before 1982 without needing to prove a profit motive. The IRS’s arguments that the transactions were shams were unsupported by specific facts, failing to meet the court’s requirements for summary judgment opposition. For the gold bar sale, the court interpreted Section 1233 narrowly, ruling that it only applies to stocks, securities, and commodity futures, not physical commodities like gold bars. The legislative history and statutory language supported this interpretation, leading to the conclusion that King’s gain was long-term.

    Practical Implications

    This decision clarifies that commodities dealers can deduct straddle losses without proving a profit motive if the transactions were entered into before 1982, impacting how similar cases involving pre-1982 commodity transactions are analyzed. It also establishes that Section 1233 does not apply to physical commodities, affecting the classification of gains from such assets. This ruling may influence future tax planning strategies for commodities dealers and the IRS’s approach to challenging such deductions and classifications. Subsequent cases have cited King v. Commissioner when addressing the deductibility of losses and the classification of gains under similar circumstances.

  • Anders v. Commissioner, 68 T.C. 474 (1977): Tax Treatment of Option Sales and the Sham Transaction Doctrine

    Anders v. Commissioner, 68 T. C. 474 (1977)

    The sale of an option to purchase land can be recognized for tax purposes if the transaction has economic substance and the parties act in their own interests.

    Summary

    Claude and Joyce Anders, along with Wade and Ethel Patrick, held an option to purchase 82. 199 acres of land. They sold the option to their accountant, J. B. Holt, who then exercised it and sold portions of the land to various buyers. The IRS argued the transaction was a sham, but the Tax Court found the sale of the option had economic substance. The Anders and Patricks reported the gain as long-term capital gain, which was upheld. However, the Patricks were found liable for a negligence penalty due to unreported income in 1968 and 1969.

    Facts

    In 1963, the Anders and Patricks acquired an option to purchase 82. 199 acres of land in Tennessee, which they could exercise by October 31, 1968. In May 1968, they received an offer to buy part of the land but instead sold the entire option to their accountant, J. B. Holt, on May 31, 1968. Holt exercised the option, bought the land, and subsequently sold portions of it to various buyers, paying the Anders and Patricks from the sale proceeds. The Anders and Patricks reported the gain from the option sale as long-term capital gain in their 1968 tax returns.

    Procedural History

    The IRS issued notices of deficiency to the Anders and Patricks, disallowing the long-term capital gain treatment and asserting they sold the land directly, resulting in short-term capital gain. The Anders and Patricks petitioned the U. S. Tax Court. The court consolidated the cases and held a trial, ultimately ruling in favor of the Anders and Patricks on the option sale issue but upholding the negligence penalty against the Patricks for unreported income.

    Issue(s)

    1. Whether the sale of the option to Holt was a bona fide transaction, allowing the Anders and Patricks to report the gain as long-term capital gain.
    2. Whether the Patricks are liable for the negligence penalty under section 6653(a) for unreported income in 1968 and 1969.

    Holding

    1. Yes, because the transaction had economic substance and Holt acted in his own interest in exercising the option and selling the land.
    2. Yes, because the Patricks conceded unreported income in 1968 and 1969 and failed to offer an explanation.

    Court’s Reasoning

    The Tax Court found that the Anders and Patricks sold the option to Holt in a bona fide transaction. The court emphasized that Holt exercised the option and sold the land for his own account, not as an agent for the Anders and Patricks. The court rejected the IRS’s argument that the transaction was a sham, noting that Holt stood to gain significantly from the land sales and that all legal documents reflected Holt’s ownership. The court applied the economic substance doctrine, finding that the transaction had both objective economic substance and a subjective business purpose. The court also considered that the Anders and Patricks held the option for over 6 months, satisfying the holding period for long-term capital gain under section 1222(3). Regarding the negligence penalty, the court upheld it against the Patricks due to their concession of unreported income without explanation.

    Practical Implications

    This decision clarifies that the sale of an option can be recognized for tax purposes if it has economic substance and the parties act independently. Taxpayers should ensure that any intermediary acquiring an option has a genuine interest in the underlying property. The case also highlights the importance of reporting all income to avoid negligence penalties. Subsequent cases have applied this ruling to similar option sales, emphasizing the need for economic substance and independent action by the option buyer. For legal practitioners, this case underscores the importance of structuring transactions to withstand IRS scrutiny under the sham transaction doctrine.

  • Estate of Diecks v. Commissioner, 65 T.C. 117 (1975): Determining Long-Term Capital Gain in Collapsible Corporations

    Estate of C. A. Diecks, Deceased, Moninda Diecks Coyle, Executrix, Petitioner v. Commissioner of Internal Revenue, Respondent, 65 T. C. 117 (1975)

    A corporation classified as collapsible under IRC Section 341(b) may still yield long-term capital gains to shareholders upon stock sale if the net unrealized appreciation in its subsection (e) assets is less than 15% of its net worth.

    Summary

    In Estate of Diecks v. Commissioner, the Tax Court addressed whether the sale of stock in Cable Vista, Inc. , a subchapter S corporation, resulted in ordinary income or long-term capital gains for the shareholder, Clifford Diecks. The court found Cable Vista to be a collapsible corporation as defined by IRC Section 341(b) because it was formed for producing property and sold before realizing taxable income. However, the court also determined that the net unrealized appreciation in Cable Vista’s subsection (e) assets was zero, thus falling under the exception in IRC Section 341(e)(1). Consequently, Diecks’ gain was treated as long-term capital gain. Additionally, the court ruled that Diecks must recapture previously claimed investment credits upon selling his stock.

    Facts

    In 1963, Cable Vista, Inc. , was formed by five shareholders, including Clifford Diecks, to operate a cable TV system in Elizabethtown, Kentucky. The corporation elected subchapter S status, allowing shareholders to claim investment credits. Cable Vista incurred operating losses from 1963 to 1965. In November 1965, the shareholders agreed to sell their stock to Ameco Co. for $152,500 before Cable Vista had realized any taxable income. Diecks, who owned 20% of the stock, reported his gain from the sale as long-term capital gain. The IRS argued the gain should be treated as ordinary income under the collapsible corporation rules of IRC Section 341.

    Procedural History

    The IRS determined deficiencies in Diecks’ federal income tax for 1965 and 1966, arguing that Cable Vista was a collapsible corporation and that Diecks should have reported his gain as ordinary income. Diecks’ estate challenged this determination in the U. S. Tax Court, which held that although Cable Vista was collapsible, the exception in IRC Section 341(e)(1) applied, allowing Diecks’ gain to be treated as long-term capital gain. The court also ruled on the recapture of investment credits.

    Issue(s)

    1. Whether Clifford Diecks should have reported gain on the sale of stock in Cable Vista, Inc. , as ordinary income rather than capital gain under IRC Section 341.
    2. Whether Diecks must recapture the investment credit claimed as a shareholder of Cable Vista, Inc. , upon the sale of his stock.

    Holding

    1. No, because although Cable Vista was a collapsible corporation, the net unrealized appreciation in its subsection (e) assets was zero, thus falling under the exception in IRC Section 341(e)(1), allowing the gain to be treated as long-term capital gain.
    2. Yes, because Diecks disposed of all his stock in Cable Vista before the end of the estimated useful life of the investment credit property, requiring recapture of the credit under IRC Section 47.

    Court’s Reasoning

    The court first determined that Cable Vista was a collapsible corporation under IRC Section 341(b) because it was formed for producing property and sold before realizing taxable income. However, the court applied the exception in IRC Section 341(e)(1), which states that if the net unrealized appreciation in subsection (e) assets (non-capital assets) is less than 15% of the corporation’s net worth, the collapsible corporation rules do not apply. The court found that Cable Vista’s only subsection (e) assets were subscription contracts with no unrealized appreciation, thus qualifying for the exception. Regarding the investment credit, the court followed the regulations requiring recapture when a shareholder disposes of all their stock before the end of the investment credit property’s useful life, as confirmed by retroactive application of the regulations in Charbonnet v. United States.

    Practical Implications

    This decision clarifies that even if a corporation meets the definition of a collapsible corporation under IRC Section 341(b), shareholders may still receive long-term capital gain treatment on stock sales if the net unrealized appreciation in the corporation’s subsection (e) assets is negligible. This ruling is significant for tax planning in businesses structured as subchapter S corporations, particularly those involved in ongoing production. It emphasizes the importance of analyzing the nature of corporate assets and their unrealized appreciation when planning stock sales. Additionally, the decision reaffirms the requirement to recapture investment credits upon the sale of stock in a subchapter S corporation, affecting how shareholders account for these credits in their tax planning. Subsequent cases have applied this ruling to similar situations involving collapsible corporations and the recapture of investment credits.

  • Knox v. Commissioner, 4 T.C. 208 (1944): Defining ‘Complete Liquidation’ Under Tax Law

    4 T.C. 208 (1944)

    A plan to liquidate a corporation ‘immediately,’ where the corporate assets are readily marketable and the plan is feasible, satisfies the statutory requirement of specifying a time within which the liquidation is to be completed for long-term capital gain treatment.

    Summary

    Knox concerned whether gains from corporate distributions qualified as long-term capital gains under Section 115(c) of the Internal Revenue Code. The Tax Court held that a plan for ‘immediate liquidation’ satisfied the statutory requirement of specifying a time frame for complete liquidation, despite the lack of a fixed deadline in the formal resolutions. The Court emphasized that the intent for immediate action, coupled with the feasibility of the plan and actual liquidation within a reasonable timeframe, met the statute’s purpose.

    Facts

    David and Gertrude Rose, holding over two-thirds of a corporation’s stock, wanted to liquidate their shares quickly. A meeting was held on September 10, 1940, where the directors resolved to sell corporate assets. The corporation sold its assets within two months. The final distribution to shareholders was delayed until June 15, 1942, pending resolution of escrow notes from the sale. The Commissioner argued that the lack of a specified liquidation timeframe meant the gains should be treated as short-term capital gains, taxable at a higher rate.

    Procedural History

    The Commissioner determined that the gain was short term and taxable to the extent of 100 percent. The Taxpayer petitioned the Tax Court, arguing that the gain was a long-term capital gain, recognized only to the extent of 50 percent. The Tax Court ruled in favor of the taxpayer, finding that the distribution was made pursuant to a plan requiring immediate liquidation.

    Issue(s)

    Whether a plan for ‘immediate liquidation’ of corporate assets, without a fixed completion date, constitutes specifying a time within which the liquidation is to be completed as required by Section 115(c) of the Internal Revenue Code for treatment as a long-term capital gain.

    Holding

    Yes, because the intent for immediate liquidation, coupled with the feasibility of the plan and actual liquidation within a reasonable timeframe, satisfies the statutory requirement, even without a specified deadline in the formal resolutions. The Court noted that “a plan to liquidate immediately necessarily means that the liquidation will be undertaken at once.”

    Court’s Reasoning

    The Tax Court reasoned that while the formal resolutions lacked a specific timeframe, the testimony and actions of the directors and stockholders demonstrated a clear intent for immediate liquidation. The Court emphasized that liquidation is a question of fact, and the adoption or failure to adopt a formal resolution is not determinative. The Court considered the surrounding circumstances, including the shareholders’ desire to liquidate quickly, the ready marketability of the assets, and the actual liquidation occurring within two months. The delay in final distribution was due to unresolved escrow notes, but the Court found the overall plan contemplated completion within the statutory period. The Court stated that, “It seems to us that a plan to liquidate immediately necessarily means that the liquidation will be undertaken at once.”

    Practical Implications

    Knox provides guidance on interpreting the ‘complete liquidation’ requirements under tax law. It clarifies that the absence of a rigid timeline in formal liquidation plans is not necessarily fatal, as long as the intent for immediate liquidation is evident and the liquidation is carried out expeditiously. This decision emphasizes a practical, fact-based approach, considering the surrounding circumstances and actions of corporate actors. It suggests that tax advisors should document the intent and feasibility of immediate liquidation plans to support long-term capital gain treatment. Later cases may distinguish Knox based on differing factual scenarios, such as a lack of demonstrable intent for immediate liquidation or unreasonable delays in executing the plan.