Farley v. Commissioner
1946 U.S. Tax Ct. LEXIS 147, 7 T.C. 198 (1946)
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Rule of Law:
Profit realized from frequent and continuous sales of real property is treated as capital gain, not ordinary income, if the taxpayer plays a passive role and does not engage in development or active sales promotion, as such activity constitutes a liquidation of a capital asset rather than a trade or business.
Facts:
- The petitioner owned a tract of land, known as the Gentilly Squares, which he used for his nursery business.
- The land was already subdivided and platted into lots before the petitioner acquired it.
- As the city of New Orleans grew, the property became more valuable for residential purposes but less suitable for the petitioner's nursery business due to city growth and restrictive covenants.
- The city of New Orleans constructed streets on the property, an improvement the petitioner did not desire or initiate.
- The petitioner was approached by unsolicited, individual purchasers seeking to buy small residential lots.
- The petitioner sold lots frequently and continuously in response to these unsolicited offers.
- The petitioner did not advertise the property, hire real estate agents, list the property for sale, or erect any signs.
- The petitioner's only contribution to improvements was providing some materials for sidewalks and curbing, which was a customary and relatively insignificant expense in the area.
Procedural Posture:
- The Commissioner of Internal Revenue determined a tax deficiency against the petitioner, classifying profit from land sales as ordinary income.
- The petitioner challenged this determination by filing a petition in the United States Tax Court.
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Issue:
Does the sale of numerous subdivided lots of land, without any active development, advertising, or sales promotion by the owner, constitute property held 'primarily for sale to customers in the ordinary course of his trade or business' under section 117(a)(1) of the Internal Revenue Code, thereby making the profits taxable as ordinary income instead of capital gain?
Opinions:
Majority - Hill, Judge
No. The profits are taxable as capital gains because the property was not held for sale in the ordinary course of a trade or business. While the sales were frequent and continuous, this factor alone is not determinative when other elements of business activity are absent. The court distinguished this case from precedents where taxpayers engaged in development and substantial sales activity, noting the petitioner here maintained a passive posture. The frequency of sales resulted from unsolicited offers from buyers, not from any business activity by the petitioner. The court was impressed by the 'almost complete absence of any development or sales activity,' concluding that the petitioner 'merely accepted satisfactory offers from unsolicited purchasers.' These sales were essentially a 'gradual and passive liquidation' of a capital asset, the purpose of which falls squarely within the intent of the capital gains provisions of the tax code, which aim to relieve taxpayers from excessive tax burdens on gains from the conversion of capital investments.
Analysis:
This case is significant for establishing that the frequency and continuity of sales are not, by themselves, sufficient to classify a taxpayer as being in the trade or business of selling real estate. It creates a more nuanced, multi-factor analysis that heavily weighs the taxpayer's passivity and lack of developmental or promotional activities. The decision provides a crucial precedent for taxpayers who are liquidating a capital asset, clarifying that they can do so through numerous small sales without necessarily triggering the higher tax rates associated with ordinary business income, so long as their role remains passive.
