Glazer v. Commissioner
44 T.C. 541, 1965 U.S. Tax Ct. LEXIS 58 (1965)
Rule of Law:
Gain from the purported sale of a partnership interest will be treated as ordinary income, not capital gain, if the transaction's substance reveals it to be an anticipatory arrangement for collecting ordinary partnership income or if the proceeds are attributable to the partnership's 'unrealized receivables' under Internal Revenue Code Section 751.
Facts:
- In 1957, Herman Glazer and the Fleishers (Forrest and his father David) formed Lowell Hills, a partnership, to construct and sell 94 single-family dwellings on a 30-acre tract in Upper Merion Township, Pennsylvania.
- Herman Glazer was entitled to 75% of Lowell Hills' profits, and the partnership Fleisher and Fleisher (two-thirds Forrest, one-third David) received the balance.
- By July 21, 1959, Lowell Hills had already sold 70 of the 94 homes; the remaining 24 homes were all under agreements of sale, and construction was approximately 80% completed.
- On July 21, 1959, Herman Glazer and Forrest Fleisher (acting for himself and David) entered an agreement with Marvin J. Levin, Lowell Hills' attorney, to sell their partnership interests for $172,000.
- Marvin J. Levin had no experience or training in building construction, and simultaneously with the sale agreement, Herman Glazer and Forrest Fleisher contracted with Levin to complete the construction of the unfinished homes and necessary street and sewer installations for $65,000.
- Legal title to the real estate owned by Lowell Hills was not transferred to Levin; instead, the sellers executed a declaration of trust, and proceeds from the house sales were to be deposited into an account in the sellers' names.
- Notice of the purported sale of partnership interests was not given to salesmen, subcontractors, or customers, who continued to deal with Herman Glazer and Forrest Fleisher as if they were the business principals.
- The parties stipulated that if the 24 remaining lots and homes had not been under agreements of sale, the sales price of the partnership interests would have been $6,000 less.
Procedural Posture:
- The Commissioner of Internal Revenue determined deficiencies in income tax for the year 1959 against Herman and Mollie Glazer, Forrest B. Fleisher, and the Estate of David Fleisher.
- Petitioners (Herman and Mollie Glazer, Forrest B. Fleisher, and the Estate of David Fleisher and Frances E. Fleisher) filed a petition with the Tax Court challenging the Commissioner's determination.
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Issue:
Is the gain realized by Herman Glazer, Forrest B. Fleisher, and David Fleisher from the purported sale of their partnership interests in Lowell Hills taxable as ordinary income or as capital gain when the partnership's primary remaining assets were agreements of sale for nearly completed homes that would have generated ordinary income?
Opinions:
Majority - Raum, Judge
No, the gain to the petitioners from the purported sale of their partnership interests in Lowell Hills is to be treated as ordinary income. The court determined, applying the long-established 'substance over form' doctrine, that the transaction was not a true sale of partnership interests but rather an anticipatory arrangement designed for the partners to receive their distributive shares of ordinary partnership income. This conclusion was supported by several factors: the buyer (Levin) was the partnership's attorney with no construction experience, the selling partners simultaneously agreed to complete the remaining construction, only a minimal downpayment was made by Levin, legal title to the property was not transferred, and all proceeds from house sales were to be deposited in the sellers' names. Furthermore, no notice of the 'sale' was given to third parties who continued to deal with the original partners. Alternatively, even if the transaction were considered a true sale of partnership interests under Section 741 of the Internal Revenue Code, the gain would still be treated as ordinary income because the proceeds were attributable to 'unrealized receivables' as defined by Section 751. Section 751 explicitly excludes amounts attributable to unrealized receivables from capital gains treatment, aiming to prevent the conversion of potential ordinary income into capital gain. The agreements for the sale of the 24 remaining homes, which would have generated ordinary income upon completion and collection by the partnership, constitute 'unrealized receivables.' The court rejected the petitioners' argument that only the $6,000 incremental value added by the existing agreements was attributable to these receivables, holding that the full portion of the sales price received in exchange for these rights (beyond the cost of completing construction) must be allocated to them, consistent with the statute's purpose.
Analysis:
This case reinforces the fundamental tax principle of 'substance over form,' demonstrating that courts will scrutinize transactions to determine their true economic nature, regardless of how parties label them. It highlights the anti-abuse provisions of IRC Section 751, specifically targeting attempts to convert ordinary income into capital gains through the sale of partnership interests when those interests include rights to income that would otherwise be ordinary. The decision provides a clear interpretation of 'unrealized receivables' in the context of a service-oriented business (like construction and sales), emphasizing that existing contracts for ordinary income-generating goods or services fall under this definition. This ruling serves as a crucial reminder for tax planners and partners to carefully evaluate the character of partnership assets before structuring a sale of partnership interests, as the presence of such receivables can significantly alter the tax treatment of the proceeds.
