Malat v. Riddell
383 U.S. 569, 16 L. Ed. 2d 102, 1966 U.S. LEXIS 2016 (1966)
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Rule of Law:
The word "primarily" in § 1221(1) of the Internal Revenue Code, which denies capital gains treatment for property held "primarily for sale to customers," means "of first importance" or "principally," not merely "substantially."
Facts:
- Petitioner Malat was part of a joint venture that acquired a 45-acre parcel of land.
- The venturers intended either to develop the property by constructing an apartment project or to sell the land, depending on which course proved more profitable.
- The joint venture encountered difficulties in obtaining the necessary financing for development.
- Due to these financial hurdles, the interior lots of the tract were subdivided and sold off.
- The venture then encountered zoning restrictions that further frustrated the commercial development of the remaining exterior parcels.
- Convinced of the desirability of terminating the venture due to these ongoing difficulties, Malat and another partner sold their interests in the remaining property.
- Malat reported the profit from this final sale as a capital gain, but the IRS (respondent) classified it as ordinary income.
Procedural Posture:
- Petitioner Malat sought a refund for taxes paid, which the Internal Revenue Service denied, leading him to file suit against the District Director of Internal Revenue, Riddell, in U.S. District Court.
- The District Court, as the court of first instance, ruled in favor of the respondent, finding that the property was held primarily for sale to customers.
- Malat (appellant) appealed the decision to the U.S. Court of Appeals for the Ninth Circuit.
- The Court of Appeals affirmed the District Court's judgment.
- The U.S. Supreme Court granted the petitioner's writ of certiorari to resolve a conflict among the circuit courts on the meaning of "primarily."
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Issue:
Does the term "primarily" as used in § 1221(1) of the Internal Revenue Code mean "of first importance" or "principally," as opposed to merely "substantial?"
Opinions:
Majority - Per Curiam
Yes. The term "primarily" as used in § 1221(1) means "of first importance" or "principally." The Court reasoned that statutory language, particularly in revenue acts, should be interpreted according to its ordinary, everyday meaning. The legislative purpose of § 1221 is to differentiate between profits from the "everyday operation of a business" (ordinary income) and gains from "the realization of appreciation in value accrued over a substantial period of time" (capital gains). Defining "primarily" as "principally" aligns with this purpose. The respondent's proposed definition of "primarily" as "substantially" is incorrect. Because the lower courts applied this incorrect legal standard, their judgments are vacated and the case is remanded for new fact-finding under the proper definition.
Analysis:
This decision resolved a significant circuit split, providing a clear and uniform definition for the term "primarily" in a key section of the Internal Revenue Code. By rejecting the government's broader "substantial purpose" interpretation, the Court made it easier for taxpayers with dual intentions for holding property (e.g., investment and potential sale) to qualify for more favorable capital gains treatment. This ruling forces lower courts to conduct a more nuanced factual inquiry into the taxpayer's foremost purpose for holding an asset, rather than denying capital gains treatment if a sales motive was merely a significant factor. It thus narrows the scope of what constitutes property held for sale in the ordinary course of business.
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