Azar Nut Company v. Commissioner of Internal Revenue
931 F.2d 314, 67 A.F.T.R.2d (RIA) 987, 1991 U.S. App. LEXIS 9733 (1991)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
A loss incurred from the sale of property acquired by a taxpayer with a business purpose is considered a capital loss if the property was not actively 'used in' the taxpayer's trade or business post-acquisition, and thus does not qualify for exception under I.R.C. § 1221(2). Additionally, the expenditure to acquire such property is capital in nature and not deductible as an ordinary business expense under I.R.C. § 162(a).
Facts:
- Edward and Phillip Azar, owners of Azar Nut Company, sought a high-level executive to succeed them as they approached retirement age.
- Azar hired Thomas L. Frankovic as Executive Vice President and Chief Operating Officer after a nationwide search.
- During contract negotiations, Frankovic insisted that he would not accept employment unless Azar agreed to purchase his El Paso residence for its fair market value upon termination of his employment.
- Azar, advised by other executives that this demand was common for high-level hires, ultimately agreed to purchase Frankovic’s residence and incorporated this agreement into his employment contract.
- After two years, Azar fired Frankovic and, as per the contract, purchased his house for $285,000.
- Azar immediately listed the house for sale but did not sell it for almost two years.
- Azar eventually sold the house for approximately $185,000, incurring a loss of $111,366.
Procedural Posture:
- Azar Nut Company deducted the $111,366 loss as an ordinary and necessary business expense on its 1984 tax return.
- The Commissioner of Internal Revenue disallowed Azar's deduction, recharacterizing the loss as a capital loss, and assessed a deficiency.
- Azar petitioned the United States Tax Court for a redetermination of the deficiency.
- The Tax Court held that Azar had incurred a capital loss, thus limiting Azar's deduction to the extent of its capital gains (of which Azar had none in 1984).
- Azar (appellant) appealed the Tax Court's decision to the United States Court of Appeals for the Fifth Circuit.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Does a house acquired by Azar Nut Company from a terminated employee, pursuant to an employment contract made for a business purpose, qualify as property 'used in' the company's trade or business under I.R.C. § 1221(2) to allow for an ordinary loss deduction upon sale, or as an ordinary and necessary business expense under I.R.C. § 162(a)?
Opinions:
Majority - W. Eugene Davis, Circuit Judge
No, the house acquired by Azar Nut Company from its terminated employee does not qualify as property 'used in' its trade or business under I.R.C. § 1221(2) to allow an ordinary loss deduction, nor is the loss deductible as an ordinary and necessary business expense under I.R.C. § 162(a). The court affirmed the Tax Court's decision, holding that the loss was a capital loss. The court emphasized that the plain language of § 1221(2), which excepts property 'used in' the taxpayer's trade or business from capital asset treatment, requires considering the asset's post-acquisition role in the business. The taxpayer's purpose for acquiring the asset and the method of acquisition are irrelevant to this inquiry, especially after the Supreme Court's ruling in Arkansas Best Corp. v. Commissioner, which largely renounced the broad 'business purpose' test previously derived from the Corn Products Doctrine. The court reasoned that the words 'used in' demand that the asset play an actual role in business operations after acquisition, and Azar's house played no such role in its nut processing, packaging, and marketing business. Allowing a business purpose to define 'used in' would effectively revive the Corn Products doctrine, which the Supreme Court rejected due to its potential for tax manipulation. Regarding I.R.C. § 162(a), the court held that the loss was not deductible as an 'expense' because the money spent to acquire the house was a capital expenditure, citing Commissioner v. Lincoln Savings & Loan Assoc. Capital expenditures are not deductible as ordinary expenses.
Analysis:
This case is significant for reinforcing the narrow interpretation of the 'used in' exception under I.R.C. § 1221(2) following Arkansas Best. It clarifies that an asset's acquisition for a business purpose alone is insufficient to transform it into an ordinary asset; rather, its actual post-acquisition role in the taxpayer's primary business operations is determinative. The decision limits avenues for taxpayers to claim ordinary losses on property acquired incidentally to business but not directly integrated into daily operations, pushing back against a broader 'business purpose' test that Corn Products had seemed to allow. This strengthens the distinction between capital assets and ordinary assets, ensuring that losses from investment-like property are treated as capital losses, regardless of the initial motivation for acquisition.
