Pellar v. Commissioner - 25 T.C. 299 (1955)

Rule:

The purchase of property for less than its value does not, of itself, give rise to the realization of taxable income. Realization of income normally arises, and is taxed, upon sale or other disposition. 

Facts:

Petitioners entered into an agreement with a construction company for the erection of a dwelling on land previously purchased by petitioners. The actual cost of construction was substantially in excess of the price fixed in the agreement, the excess being in part due to "extras" requested by petitioners, and in part to increased labor costs and errors in construction work on the part of contractor. The fair market value of the dwelling (exclusive of the value of the land) at the time of completion was materially in excess of the price fixed in the agreement, but was materially less than the actual cost of construction. The contractor had never expected to make a profit on the construction work and was satisfied to take a small loss. This was because Sam Briskin, father of Rosalie Pellar, one of the petitioners, had an interest in several corporations which had employed contractor for construction work in amounts totaling in excess of a million dollars, and Briskin had likewise, at various times, recommended the contractor to others. The contractor agreed to do the work for petitioners at the arranged price to keep Briskin's goodwill in the hope of future business from the Briskin interests and from others to whom the contractor might be recommended by Briskin. The commissioner argued that the taxpayers received income taxable to them measured by the difference between the price that they paid for the house and its final cost. 

Issue:

Did petitioners receive income by virtue of the construction of a residence for them where the cost of construction and the fair market value of the residence materially exceeded the agreed price paid to the contractor for such construction?

Answer:

No.

Conclusion:

The court found that neither the taxpayers nor the individual that recommended the builder had any obligation to favor the builder in the future. The court held that the taxpayers did not realize any taxable income on the transaction. The court concluded that the taxpayers would only report gain if they sold the house.