Stephen Looney on Fargo V. Commissioner

by Stephen Looney*

In Fargo v Commissioner [T.C. Memo 2015-96], the Tax Court held that a couple had ordinary income from a property sale by a partnership in which they were partners because the property was sold in the ordinary course of business. The taxpayer, husband and wife, were partners in Girard Development, L.P. (GDLP), an entity subject to the partnership procedures under IRC Section 6626. The primary issue for decision was whether the sale of certain property by GDLP generated capital gain or ordinary income for the taxpayer.

The taxpayer was engaged in the real estate business through a variety of business entities, including GDLP and Fargo Industries Corp ("FIC"). FIC acquired a leasehold from La Jolla Medical Building Corp., an unrelated entity, to lease a 2.2 acre parcel of real estate (the "La Jolla Property") including its building and site development plans...

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IRC Section 1221(a)(1) defines a capital asset as "property held by the taxpayer ... but does not include ... property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." Whether a taxpayer held specified property primarily for sale to customers in the ordinary course of business is a question of fact. Citing Malat v. Riddell, ² the Tax Court has held that the term "primarily" for purposes of IRC Section 1221(a)(1) means "of first importance" or "principally." The court then identified several factors for evaluating whether a taxpayer holds property primarily for sale to customers in the ordinary course of business...

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Although the court recognized that the La Jolla Property was used as rental property and GDLP and all related entities maintained their offices on the property, the court found that the rental of the La Jolla Property to third parties and the use of the La Jolla Property by GDLP's affiliates was not GDLP's primary purpose of holding it, but rather GDLP was simply making its best use of the La Jolla Property as office and rental space while never abandoning its primary intention of selling the La Jolla Property.

Observation

The holding of the court that GDLP was a "dealer" rather than an investor with respect to the La Jolla Property, thereby generating ordinary income versus capital gain, is interesting given the fact that GDLP made no physical improvements to the property itself and only made a single sale of property to one buyer (two of the factors to which many courts give the greatest emphasis). [See e.g., Biedenharn Realty Co. v. United States, 526 F.2d 409 (5th Cir. La. 1976)  In this case, the court placed primary emphasis on the intent of the taxpayer at the time of purchase and at the time of the sale of the property, and found GDLP to be a "dealer" despite the fact that no physical improvements were made to the property and that the taxpayer only made a single sale to one buyer.

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* Stephen R. Looney received his B.A., with honors, in Accounting and Business Administration from Drury College in 1981 and earned his J.D., cum laude, from the University of Missouri-Columbia in 1984, where he was also a member of the Order of the Coif and the Missouri Law Review. He received his Master's in Taxation from the University of Florida in 1985, where he graduated first in his class. He practices in the areas of tax, corporate, partnership, business and health care law, with an emphasis in entity formations, acquisitions, dispositions, redemptions, liquidations and reorganizations. His clients include closely held businesses, with an emphasis in medical and other professional practices. He is a Florida Board Certified Tax Lawyer, and is a member of The Florida Bar Association, the State Bar of Texas and the Missouri Bar Association. Additionally, he has his CPA Certificate, and is a member of the Missouri Society of CPAs. he is a past-chair of the S Corporations Committee of the American Bar Association Tax Section. Additionally, he is on the Board of Advisors and Department Heads for the Business Entities journal where he also serves as one of the editors for the Current Developments column. He is a Fellow of the American College of Tax Counsel and is listed in Best Lawyers in America in Taxation. He writes and speaks extensively on a nationwide basis on a variety of tax subjects. He is the co-author of Tax Planning for S Corporations (Matthew Bender). His articles have appeared in a number of professional publications, including the Journal of Taxation, The Tax Lawyer, the Business Entities Journal, the Journal of S Corporation Taxation, the Journal of Partnership Taxation, and the Journal of Corporate Taxation.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

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