Rice v. Comm'r
97 T.C.M. 1807, 2009 T.C. Memo. 142, 2009 Tax Ct. Memo LEXIS 136 (2009)
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Rule of Law:
Property is considered a capital asset, eligible for capital gains treatment, unless it is held primarily for sale to customers in the ordinary course of the taxpayer's trade or business, in which case proceeds are ordinary income. The determination of whether property is held "primarily for sale" is a factual inquiry involving multiple factors related to the taxpayer's intent and activities.
Facts:
- Bruce and Donna Rice operated a successful business designing 401(k) plans and managing investments in Texas, reporting income in excess of a million dollars annually.
- Petitioners sought to purchase a lot in Austin to build their dream home and, after considering other properties, purchased a 14.4-acre undeveloped parcel for $300,000 with no financing, as it was only available as a single unit.
- Initially, petitioners intended to keep the entire property for their dream home, but Mrs. Rice later changed her mind, not wanting to live on such a large, isolated property.
- Petitioners decided to subdivide the property, hiring consultants for zoning, access, utilities, and environmental issues, ultimately dividing it into ten lots (eight for homes, two for environmental purposes) and naming the subdivision Sette Terra.
- Petitioners established a homeowner's association with covenants, conditions, and restrictions for the subdivision to create a desired aesthetic and attract specific types of neighbors.
- Petitioners spent two years constructing their 8,000-square-foot, Italian-style dream home, devoting significant personal time to the project.
- Petitioners made their first lot sale to friends in 2000, then in 2002, placed a single wooden sign at the subdivision entrance; subsequent sales were primarily by word of mouth to friends, acquaintances, and relatives.
- In 2004, petitioners sold Lot 1 to friends for a gain and Lots 9 and 10 (excess environmental lots) to Mrs. Rice's sister and her husband at a loss.
Procedural Posture:
- Respondent (Commissioner of Internal Revenue) issued a deficiency notice challenging petitioners' characterization of the 2004 sales of Lots 1, 9, and 10 as capital gains/losses and disallowed the loss claimed for the related party sale.
- Petitioners timely filed a petition for redetermination with the United States Tax Court.
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Issue:
1. Does a taxpayer's sale of subdivided lots, originally part of a larger parcel purchased for a personal residence, constitute the sale of property held primarily for sale to customers in the ordinary course of business, thereby generating ordinary income, or the sale of capital assets, generating capital gains or losses? 2. Are petitioners liable for an accuracy-related penalty under section 6662?
Opinions:
Majority - KROUPA, Judge
Yes, the proceeds from the sale of Lot 1 are entitled to capital gains treatment, and petitioners are not liable for the accuracy-related penalty. The court held that the excess lots were held for investment purposes, not primarily for sale to customers in the ordinary course of business. The Tax Court applied a multi-factor test to determine the taxpayer's primary intent at the time of disposal, emphasizing that "primarily" means "principally" or "of first importance" (citing Malat v. Riddell). The court found that the Rices initially purchased the 14.4-acre property as an investment to build their dream home, not to sell lots. The decision to subdivide was driven by Mrs. Rice's desire for neighbors and to protect their home's value and aesthetic, rather than to engage in a real estate business. Key factors supporting investment intent included: the small number and infrequency of sales (one lot in 2000, three in 2004, one in 2005, one in 2007, one in 2008), which contrasted sharply with cases like Winthrop (456 lots) and Biedenharn Realty Co. (158 lots); minimal advertising efforts (a single sign, relying on word of mouth); and the Rices' full-time jobs, which left little time for real estate sales, with lot sales constituting a small percentage of their total income. While significant improvements were made, many were necessary for their own residence or to establish the desired aesthetic, protecting their investment rather than solely facilitating sales. The court cited Ayling v. Commissioner, where sales of 13 lots over four years were granted capital gains treatment. Regarding the related-party loss from the sale of Lots 9 and 10, the court treated petitioners as having abandoned the issue as they did not address it on brief, thus holding for the Commissioner on that point. On the accuracy-related penalty, the court found petitioners were not liable under section 6662. Petitioners properly claimed capital gains treatment for Lot 1, maintained adequate records, cooperated with the audit, and Mr. Rice, a CPA, provided records to their accountant for tax preparation.
Analysis:
This case reinforces the factual nature of determining whether property is held "primarily for sale" under IRC Section 1221(a)(1), particularly for individuals who subdivide property initially acquired for personal use. It highlights that even significant development efforts might not trigger ordinary income treatment if the taxpayer's primary intent remains investment or personal use, rather than a sustained business of selling real estate. The court's emphasis on the frequency and substantiality of sales, advertising, and the taxpayer's primary occupation provides a useful framework for distinguishing between an investor liquidating an asset and a real estate dealer. The case offers a favorable outcome for taxpayers who can demonstrate a lack of dealer-like intent despite subdivision.
