United States Court of Appeals for the Fifth Circuit
SUBURBAN REALTY COMPANY,
Plaintiff-Appellant,
v.
UNITED STATES of America,
Defendant-Appellee.

Docket No. 77-3094
Date of Decision: April 7, 1980
Judge:  GOLDBERG

Tax Analysts Citation: 1995 TNT 147-31
Principal Code Reference: Section 1221

Summary
Provided by Tax Analysts.  Copyright 2000 Tax Analysts.  All rights reserved.
REAL ESTATE COMPANY'S SALE OF UNDEVELOPED LAND RESULTED IN ORDINARY INCOME.
Suburban Realty Company was formed in 1937 to acquire an
undivided one-fourth interest in a large tract of land in Texas. Suburban's
corporate charter stated that the company was formed to erect and repair
buildings, to purchase, sell, and subdivide real property, and to
accumulate and lend money for those purposes. Between 1937 and 1971,
Suburban made at least 244 sales of real estate from the property. Proceeds
from sales accounted for 83 percent of the company's revenue.
     Many of these sales were made by Houston Gardens, a separate
corporation formed in 1938 by Suburban and the other property owners to
plat and sell a parcel of the large tract. Between 200 and 250 lots were
sold in bulk to builders, before Houston liquidated in 1961.
     Suburban divided the center of the large tract into four
sections, designated as Homestead Addition Sections One, Two, Three, and
Four. Suburban's development efforts focused on Homestead Addition Section
Two, to which Suburban acquired full ownership in 1948. The land was
platted, and streets and sewers were installed, and, in the early 1950s,
eleven houses were built on Homestead Two. Between 1948 and 1966, Suburban
sold 252 subdivided lots in Homestead Two, approximately half in bulk to
builders. Although Suburban platted Homestead Additions Sections Three and
Four for residential use in 1951, the plats were withdrawn and canceled ten
years later, eliminating restrictions on commercial use.
     By 1961, Rice University became a Suburban stockholder. Rice
preferred income-producing assets to raw land, and the possibility of
liquidating Suburban's real estate holdings became a common topic of
discussion. Beginning in 1966, Suburban made substantial investments in
stocks and bonds and began receiving substantial income from this activity.
     Suburban also sold six pieces of unimproved land between 1968
and 1971, and reported the gain from the sales as ordinary. At the time of
the sale, the tracts were subject to a grass lease and had never been put
to any other substantial use. Suburban eventually filed a claim for refund
asserting that these six tracts (and three similar ones that were sold
later) were capital assets, and that the profits made on their sales were
entitled to capital gains treatment. The IRS denied the refund request, and
Suburban proceeded to district court, which held for the government.
Suburban appealed.
     The Fifth Circuit affirmed the district court's decision,
concluding that the six parcels of land were not entitled to capital gains
treatment, because Suburban held them in the ordinary for sale to customers
in the ordinary course of its business. Circuit Judge Goldberg found that
Suburban was in the real estate business, based on its continuous and
substantial sales and the fact that it described itself as in the real
estate business on its tax returns.
     The court was not persuaded by Suburban's contention that it had
withdrawn from the real estate business by 1968, and had shifted to the
investment business. Noting that the crucial point of reference for
determining the company's "ordinary course of business" was time when
Suburban acquired the six parcels that it sold beginning in 1968, Judge
Goldberg pointed out that Suburban was clearly in the real estate business
when it procured the property. Further, the court determined that Suburban
had never truly stopped selling real estate.

 US-CT-APP-5, [80-1 USTC ¶9351], Suburban Realty Company, Plaintiff-Appellant v. United States of America, Defendant-Appellee  , Claim for refund: Capital gains v. ordinary income: Profits from sale of real estate: Ordinary course of trade or business: Purpose of sale.--, (Apr. 07, 1980)
[80-1 USTC ¶9351]Suburban Realty Company, Plaintiff-Appellant v. United States of America, Defendant-Appellee  

(CA-5), U. S. Court of Appeals, 5th Circuit., No. 77-3094, 615 F2d 171, 4-7-80, Affirming District Court, 77-2 ustc ¶9547

[Code Sec. 1221]

Claim for refund: Capital gains v. ordinary income: Profits from sale of real estate: Ordinary course of trade or business: Purpose of sale.--The district court’s decision, which dismissed the taxpayer’s complaint seeking a refund for amounts claimed as ordinary income derived from the sale of real estate, was affirmed by the Court of Appeals.  This was so, despite the taxpayer’s argument that the properties sold were capital assets and thus, profits realized from the sales were capital gains.  The court held that because:  (1) the taxpayer was engaged in the business of selling real estate; (2) that it had held the property for the purpose of selling it; and (3) that the profits realized from the sale were contemplated in the ordinary operation of the taxpayer’s business, the profits were ordinary income and not capital gains.  BACK REFERENCES: 80FED ¶4729.517, 80FED ¶4729.54 and 80FED ¶4729.676.

Gerald W. Hadock, Charles W. Hall, Fulbright & Jaworski, 8th Floor, Bank of the Southwest Bldg., Houston, Texas 77002, for plaintiff-appellant.  J. A. Canales, United States Attorney, Houston, Texas 77208, M. Carr Ferguson, Assistant Attorney General, Gilbert E. Andrews, Richard Farber, Marilyn E. Brookens, Department of Justice, Washington, D. C. 20530, for defendant-appellee.

Before Goldberg, Fay and Anderson, Circuit Judges.

Goldberg, Circuit Judge:

We must today answer the riddle at once adumbrated and apparently foreclosed by the false dichotomy created by the United States Supreme Court in Malat v. Riddell [66-1 ustc ¶9317], 383 U. S. 569, 572, 86 S. Ct. 1030, 1032, 16 L. Ed. 2d 102 (1966) (per curiam):  when profits have “aris[en] from the [ordinary] operation of a business” on the one hand and are also “the realization of appreciation in value over a substantial period of time” on the other, are these profits treated as ordinary income or capital gain?  Lacking any clear guidance but the language of the capital asset statute 1 itself, we turn to that language for the answer.  Before we can arrive at this interesting and important question, however, we must once again tramp along (but not trample on) that time- and precedent-worn path which separates capital gains from ordinary income.  By the time we emerge into the light at the far edge of the forest, we will find that the Riddell riddle has seemingly answered itself, and all that will remain will be a brief reassessment of our answer.  In our peregrinations, we of necessity wander into virgin territory.  We hope that we shed new light onto this murky terrain; at the least, we think we have neither riddled the cases nor muddled the issues.

I.  Suburban Realty Company was formed in November, 1937 to acquire an undivided one-fourth interest in 1,742.6 acres of land located in Harris County, Texas (“the property”).  Suburban received its interest 2 in the property to exchange for all of its stock from four individuals 3 who had themselves acquired the property in a foreclosure proceeding brought against the property as a result of a default in the payment of certain bonds, the payment of which was secured by the property.  Suburban’s corporate charter states that it was formed to erect or repair any building or improvement, and to accumulate and lend money for such purposes, and to purchase, sell, and subdivide real property, and to accumulate and lend money for that purpose.

The five transactions whose characterization is in dispute here concern six tracts of unimproved real estate sold from the property by Suburban between 1968 and 1971. 4  On its tax returns, Suburban originally reported profits from these sales, as well as all of its other real estate sales, as ordinary income.  Later, Suburban filed a claim for refund asserting that these six tracts, as well as three similar tracts sold later, were capital assets, and that profits from these sales were entitled to capital gain treatment.  The Internal Revenue Service denied Suburban’s claim as to the sales here in issue. 5  Suburban then instituted this action for a refund of $102,754.50.  The district court, in a non-jury trial, rendered a decision against Suburban and entered a judgment dismissing Suburban’s complaint.  Suburban appealed.

The parties’ legal contentions are closely bound to the facts.  It is undisputed that, at the time of sale, the tracts at issue here were subject to a grass lease which apparently covered much of the property.  Except for this grass lease, the six tracts, as well as much of the rest of the property, were never put to any substantial use.  However, certain other portions of the property were the subject of greater activity.  The parties disagree to some degree concerning the extent of, and appropriate characterization of, the activities conducted relating to these other portions of the property, and they fundamentally dispute the weight such activities carry in properly characterizing the sales at issue here.  We will first discuss Suburban’s overall activities with respect to the entire property, and then turn to those portions of the property singled out by the parties as being the subject of greater activity.

A.  Overall activities.

1.  Total Sales Activity From the Property.  Between 1939 and 1971, Suburban made at least 244 individual sales of real estate out of the property.  Of these, approximately 95 sales were unplatted and unimproved property legally suitable for commercial or any other purpose, 6 and at least 149 sales were from platted property restricted to residential development. 7  In each of these 33 years, Suburban concluded at least one sale; in most years, there were four or more sales.  Suburban’s total proceeds from real estate sales over this period were $2,353,935.  Proceeds from all other sources of income amounted to $474,845. 8  Thus, eighty-three percent of Suburban’s proceeds emanated from real estate sales; only seventeen percent flowed from all other sources.

2.  North Loop Freeway.  In 1957, the Texas Highway Department proposed that the limited access superhighway now known as the North Loop would be located from east to west across the property.  In 1959 and 1960, Suburban sold at least two parcels out of the property to the Texas Highway Department for the purpose of constructing this highway.  The location of the highway had a dramatic effect on the price of land in the area.  Land which had been selling for between three and five thousand dollars per acre prior to announcement of the highway rose in value to between seven and twelve thousand dollars per acre.

3.  Corporate Discussions and Investments.  Starting not later than 1959, Suburban’s officers, directors and stockholders began discussing liquidation of the corporation.  Many of these discussions occurred after 1961, when Rice University became a stockholder of Suburban and the Treasurer of Rice University became a member of the board of directors.  Because Rice University desired investments in income-producing assets rather than raw land, discussions concerning liquidation 9 of Suburban’s real estate holdings and the possibility of a partition of its holding among its stockholders 10 were common.  Starting in 1966, Suburban made substantial investments in stocks and bonds and began receiving substantial income from these investments.

B.  Specific portions.

1.  Houston Gardens.  In 1938, Suburban and the other owners of the property formed a separate corporation, Houston Gardens Annex, Inc. (“Houston Gardens”), to plat and sell a parcel in the northeast quadrant of the property.  The stock ownership in Houston Gardens was in the same proportion as ownership interests in the property--i. e., Suburban and Mrs. Talbot each owned one-quarter of the stock of Houston Gardens; Mr. Hamman owned one-half of the stock.  Houston Gardens owned approximately 200 or 250 lots, which were generally sold in bulk to builders.  These sales covered as many as 20, 30, or even 50 lots at a time.  By 1961, Houston Gardens had sold all but two of its lots, and it was then liquidated.  Houston Gardens never engaged in advertising, used brokers or real estate agents, or employed a sales organization at any time during its existence.

2.  Homestead Addition.  Certain portions of the property, located near its center, were designated as Homestead Addition Sections One, Two, Three, and Four.  Little was done with Homestead Addition Section One except for platting it and running a few utility lines up to it.

Homestead Addition Section Two, however, was the primary subject of Suburban’s activities.  In July, 1948, Suburban acquired 100 percent ownership of Homestead Addition Section Two by exchanging cash and other land for the other owners’ interests.  Immediately thereafter, Suburban commenced development of Homestead Addition Section Two.  The area was platted, streets and sewers were put in, and a sewage disposal plant was built nearby. 11  Suburban also built a lumberyard in Section Two. 12  At the instance of one of the individuals whom Suburban hired to collect water bills and notes on houses and to manage the lumber-yard, Suburban also built eleven houses in Section Two in the early 1950’s.  The last was built by 1955, and none was sold later than 1958. 13  Between 1948 and 1966, Suburban sold 252 subdivided lots out of Section Two.  About half of these lots were sold in bulk to builders--10, 15, or 20 lots at a time. 14

Homestead Addition Sections Three and Four were platted for residential use by Suburban in 1951.  This area was never developed by Suburban, however.  In 1961 the plats were withdrawn and cancelled.  This had the effect of eliminating restrictions which prevented commercial use of the land.  Subsequently, the real estate within Sections Three and Four was sold to commercial and industrial users.

3.  Other Parcels.  The remainder of the property appears to have been treated as one undifferentiated bulk by Suburban.  It is from this undifferentiated, undeveloped remainder that the sales at issue here were made.  There are no specific findings by the trial court, and there appears to be no evidence of record from which we could ourselves make findings, concerning the number and frequency of sales of real estate from other parts of the property.  Rather, the evidence concerning annual sales groups all sales made by Suburban, including sales from the Homestead Addition Sections, together. 15  However, it is clear that throughout the period 1939-1971, sales were being made from the remainder of the property.

 II.  Our analysis of this case must begin with Biedenharn Realty Co., Inc. v. United States [76-1 ustc ¶9194], 526 F. 2d 409 (5th Cir.) (en banc), cert. denied, 429 U. S. 819, 97 S. Ct. 64, 50 L. Ed. 2d 79 (1976).  Biedenharn is this Court’s latest (and only) en banc pronouncement concerning the characterization of profits of a real estate business as ordinary income or capital gain.  The decision answers the characterization question by evaluating certain “factors” often present in cases of this ilk. 16  Biedenharn attempts to guide the analysis in this area by assigning different levels of importance to various of the “factors.”  Substantiality and frequency of sales is called the most important factor.  Biedenharn, 526 F. 2d at 416.  Improvements to the land, solicitation and advertising efforts, and brokerage activities also play an important part in the Biedenharn analysis.

The question before us today, put into the Biedenharn framework, can be stated as follows:  when a taxpayer engages in frequent and substantial sales over a period of years, but undertakes no development activity with respect to parts of a parcel of land, and engages in no solicitation or advertising efforts or brokerage activities, under what circumstances is income derived from sales of undeveloped part of the parcel ordinary income?

The Biedenharn framework allows us to ask the question, but gives us little guidance in answering it.  In the principal recent cases, there has always been a conjunction of frequent and substantial sales with development activity relating to the properties in dispute.  See, e.g., Houston Endowment, Inc. v. United States [79-2 ustc ¶9690], 606 F. 2d 77, 82 (5th Cir. 1979), Biedenharn, 526 F. 2d at 417; United States v. Winthrop [69-2 ustc ¶9686], 417 F. 2d 905, 911 (5th Cir. 1969).  The conjunction of these two factors “will usually conclude the capital gains issue against [the] taxpayer.”  Biedenharn, 526 F. 2d at 418.  Judge Wisdom has recently written that “ordinary income tax rates usually apply when dispositions of subdivided property over a period of time are continuous and substantial rather than few and isolated.”  Houston Endowment, 606 F. 2d at 81.  Also, it has been explicitly stated that the factor which will receive greatest emphasis is frequency and substantiality of sales over an extended time period.  See Biedenharn, 526 F. 2d at 417.  However, substantial and frequent sales activity, standing alone, has never been held to be automatically sufficient to trigger ordinary income treatment.  In fact, we have continual reminders of the fact that “specific factors, or combinations of them are not necessarily controlling,” Biedenharn, 526 F. 2d at 415, quoting Thompson v. Commissioner [63-2 ustc ¶9676], 322 F. 2d 122, 127 (5th Cir. 1963), quoting Wood v. Commissioner [60-1 ustc ¶9390], 276 F. 2d 586, 590 (5th Cir. 1960).

Each of the parties invites us to look back to a case from long ago for guidance.  Suburban points to Alabama Mineral Land Co. v. Commissioner [58-1 ustc ¶9162], 250 F. 2d 870 (5th Cir. 1957).  The Government points to Thompson, supra.  Each claims that the case it cites is substantially identical on its facts to the one before us.  Each is essentially correct. 17  However, we again decline, as have the earlier cases, to attempt a case-by-case distinction.  See Houston Endowment, 606 F. 2d at 82, Biedenharn, 526 F. 2d at 421; Thompson, 322 F. 2d at 127.  We merely note that the Alabama Mineral decision contains no analysis of whether “the antiquated purpose” (liquidation of property holdings) was “overborne by later, but substantial and frequent selling activity.”  Biedenharn, 526 F. 2d at 421.  Rather, the court simply characterized taxpayer’s purpose for acquiring the property as “liquidation,” and concluded that sales made in liquidation result in capital gain rather than ordinary income.  Alabama Mineral, 250 F. 2d at 872.  Biedenharn tells us, however, that “investment purpose has no built-in perpetuity nor a guarantee of capital gains forever more [sic].”  526 F. 2d at 421.  Thus, the method of analysis used in Alabama Mineral has not survived Biedenharn. 18

Today, we must go into territory as yet unmapped in this Circuit.  Suburban’s case is at once more favorable to the taxpayer than Biedenharn’s and less so.  It is more favorable because, with respect to the particular parcels of land here at issue, it is undisputed that Suburban undertook no development or subdivision activity.  It is less favorable because Biedenharn was continually engaged in business activities other than real estate sales, whereas Suburban was for many years doing little else.  Following the Biedenharn framework alone, we would be left with yet another essentially ad hoc decision to be made.  We could justify a decision for either party, yet remain confident that we were being fully consistent with the analysis in Biedenharn.  However, although there will always remain a certain irreducible ad hoc-ishness in this area, we are now firmly convinced that the uncertainty can be substantially reduced by turning to the divining rod of capital gains versus ordinary income--the statute itself.

III.  The jurisprudence of the “real estate capital gains-ordinary income issue” in this Circuit has at times been cast somewhat loose of its statutory mooring.  The ultimate inquiry in cases of this nature is whether the property at issue was “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.”  26 U. S. C. A. §1221(1) (West 1967).  In our focus on the “tests” developed to resolve this question, we have on occasion almost lost sight entirely of the statutory framework.  The “tests” or “factors,” whether they be counted to number, seven, see Winthrop, 417 F. 2d at 910, or to number four, see Houston Endowment, 606 F. 2d at 81, have seemingly acquired an independent meaning of thier own, only loosely tied to their statutory pier.  Some years ago, Judge Brown cautioned us against this tendency:

Essential as they are in the adjudication of cases, we must take guard lest we be so carried away by the proliferation of tests that we forget that the statute excludes from capital assets “property held by the taxpayer primarily to customers in the ordinary course of his trade or business.”

Thompson, 322 F. 2d at 127.  See Biedenharn, 526 F. 2d at 424 (Roney, J, specially concurring).

The tendency to overemphasize the independent meaning of the “factors” has been accompanied by, perhaps even caused by, a tendency to view the statutory language as posing only one question:  whether the property was held by the taxpayer “primarily for sale to customers in the ordinary course of this trade or business.”  This determination was correctly seen as equivalent to the question whether the gain was to be treated as ordinary or capital.  However, probably because the question “is the gain ordinary” is a single question which demands an answer of yes or no, the courts have on occasion lost sight of the fact that the statutory language requires the court to make not one determination, but several separate determinations.  In statutory construction cases, our most important task is to ask the proper questions.  In the context of cases like the one before us, the principal inquiries demanded by the statute are:

(1)  was taxpayer engaged in a trade or business, and, if so, what business?

(2)  was taxpayer holding the property primarily for sale in that business?

(3)  were the sales contemplated by taxpayer “ordinary” in the course of that business? 19

We by no means intend to suggest that we disagree with anything decided by the recent Fifth Circuit decisions.  Biedenharn guides our decision-making process.  But after the relevant three independent statutory inquiries are pried apart, it becomes apparent that the central dispute in Biedenharn was a narrow one:  was Biedenharn Realty Company holding the land in dispute “primarily for sale?”  The majority, applying the Winthrop factors, decided this question in the affirmative.  The dissent, emphasizing the continuing farming activities being conducted by Biedenharn, see Biedenharn, 526 F. 2d at 425 & n. 5, 426 (dissenting opinion), disagreed as to this conclusion. 20

In fact, once the inquiry is redirected towards the statutory inquiries, the ultimate relevance of the Biedenharn factors becomes apparent.  It will remain true that the frequency and substantiality of sales will be the most important factor.  But the reason for the importance of this factor is now clear:  the presence of frequent and substantial sales is highly relevant to each of the principal statutory inquiries listed above. 21  A taxpayer who engages in frequent and substantial sales is almost inevitably engaged in the real estate business.  The frequency and substantiality of sales are highly probative on the issue of holding purpose because the presence of frequent sales ordinarily belies the contention that property is being held “for investment” rather than “for sale.”  And the frequency of sales may often be a key factor in determining the “ordinariness” question.

The extent of development activity and improvements is highly relevant to the question of whether taxpayer is a real estate developer.  Development activity and improvements may also be relevant to the taxpayer’s holding purpose, but, standing alone, some degree of development activity is not inconsistent with holding property for purposes other than sale. 22  The extent of development activity also seems to be only peripherally relevant to the “ordinariness” question. 23  Thus, under the statutory framework, as under Biedenharn, the extent of development activity and improvements, although an important factor, is less conclusive than the substantiality and frequency of sales.

Solicitation and advertising efforts are quite relevant both to the existence of a trade or business and to taxpayer’s holding purpose.  Thus, their presence can strengthen the case for ordinary income treatment.  See Biedenharn, 526 F. 2d at 418.  However, in cases like Biedenharn, their absence is not conclusive on either of these statutory questions for, as we noted there, “even one inarguably in the real estate business need not engage in promotional exertions in the face of a favorable market.”  Id.

We need not comment individually on each of the other Biedenharn-Winthrop factors.  It should be apparent that each factor is relevant, to a greater or lesser extent, to one or more of the questions posed by the statute along the path to the ultimate conclusion. 24

 IV.  Having laid the framework for the requisite analysis, we must now apply that framework to the facts here.  We must decide whether Suburban was engaged in a trade or business, and, if so, what business; whether Suburban was holding the properties at issue here primarily for sale; and whether Suburban’s contemplated sales were “ordinary” in the course of Suburban’s business.

Before we commence this analysis, we must ascertain the appropriate standard of appellate review.  Unfortunately, the hidden supposition that the statutory language poses only one question, see Slip op. p. 4497, p. -- supra, has caused great confusion 25 concerning whether the appropriate standard is “clearly erroneous” or “plenary review.”  This Circuit has often faced the question whether the characterization of property as “primarily held for sale to customers in the ordinary course of [taxpayer’s] trade or business” is a question of law or a question of fact.  This characterization is of course crucial to the outcome of many cases--if the characterization is a question of fact, the factfinder’s answer must be accepted unless clearly erroneous, but, if a question of law is presented, plenary review on appeal is appropriate.  Unfortunately, there are two independent lines of authority in this Circuit on this issue.  One line has its genesis in Galena Oaks Corporation v. Scofield [55-1 ustc ¶9127], 218 F. 2d 217 (5th Cir. 1954), and holds that the characterization “is inherently a question of law.”  United States v. Winthrop [69-2 ustc ¶9686], 417 F. 2d 905, 910 (5th Cir. 1969). 26  The other line traces its roots to Thompson v. Commissioner [63-2 ustc ¶9676], 322 F. 2d 122, 127 (5th Cir. 1963), and can be followed through United States v. Temple [66-1 ustc ¶9165], 355 F. 2d 67, 68 (5th Cir. 1966) to United States v. Burket [68-2 ustc ¶9632], 402 F. 2d 426, 429 (5th Cir. 1968) and Huxford v. United States [71-1 ustc ¶9379], 441 F. 2d 1371, 1375 (5th Cir. 1971).  This line holds that “the question of whether certain properties were held by a taxpayer ‘primarily for sale to customers in the ordinary course of [his] trade or business’ is essentially a question of fact.”  Burket [68-2 ustc ¶9632], 402 F. 2d at 429.  See Commissioner v. Tri-S Corp. [68-2 ustc ¶9541], 400 F. 2d 862, 864 (10th Cir. 1968) (question is “essentially a question of fact”); Maddux Construction Co. [Dec. 30,174], 54 T. C. 1278, 1284 (1970) (“question is purely a factual question”).

We need not here psychoanalyze the nightmares of characterization that have fascinated professors of civil procedure:  the distinctions between historical, evidentiary, subsidiary, and ultimate facts are too fine for useful discussion.  Once it is perceived that the ultimate legal conclusion of capital gain or ordinary income involves several independent determinations, it can be easily seen that some of the determinations are predominantly legal conclusions or are “mixed questions of fact and law”, whereas others are essentially 27 questions of fact.  Thus, the question of taxpayer’s purpose or purposes for holding the property is primarily factual, as is the question of which purpose predominates.  Similarly, the “ordinariness” of the contemplated sales is mainly a fact question.  The question of whether taxpayer was engaged in a trade or business involves the application of legal standards concerning what constitutes a trade or business to the facts concerning taxpayer’s activities, and therefore is best characterized as a “mixed question of fact and law.”  The ultimate legal conclusion, based on these factual and legal conclusions, of whether the property was “held primarily for sale to customers in the ordinary course of his trade or business” cannot be appropriately characterized in this scheme at all because, as noted above, there are several subsidiary questions which, separately answered, lead to the ultimate conclusion. 28

A.  Was Suburban in the real estate business?

This is a relatively simple issue.  The question is whether taxpayer has engaged in a sufficient quantum of focused activity to be considered to be engaged in a trade or business.  The precise quantum necessary will be difficult to establish, and cases close to the line on this issue will arise.

Happily, we need not here define that line.  It is clear to us that Suburban engaged in a sufficient quantity of activity to be in the business of selling real estate.  Suburban’s sales were continuous and substantial.  It completed at least 244 sales transactions over the 33-year period 1939-1971.  This averages to over 7 transactions per year.  Proceeds from these sales exceeded 2.3 million dollars.

Suburban does not claim to have been engaged in any business other than real estate; rather, it claims that during the periods at issue it simply “did not carry on a trade or business.”  Br. for Appellee at 20. Were additional support necessary for our conclusion, we would point to Suburban’s own statements on its tax returns over the years that its principal business activity was “development and sales of real estate.”  These statements are by no means conclusive of the issue.  See Thomas v. Commissioner [58-1 ustc ¶9443], 254 F. 2d 233, 236-37 (5th Cir. 1958).  However, we believe they show at least that if Suburban is engaged in a trade or business, that business is real estate. 29 And Suburban’s activities over the years were sufficient to convince us that it cannot sustain its contention that it was never engaged in any “trade or business” at all.

Suburban relies heavily on the insignificance of its subdivision and development activity and the total absence of any advertising or sales solicitation activity on its part.  However, the first two absences do not concern us at all.  We need not decide whether its subdivision and development activities were sufficient to compel the conclusion that Suburban was in the real estate deveiopment business. 20  We rely solely on Suburban’s real estate sales business.

The presence of any sales soliciation or advertising activity would certainly be relevant to the issue of whether Suburban was in the business of selling real estate.  Strenuous, but largely unsuccessful, attempts to sell might compel the conclusion that a taxpayer with very few sales transactions was nonetheless in the business of selling.  But the absence of such activity does not compel the opposite conclusion.  See Slip op. p. 4498, p. --, supra; Thompson, 322 F. 2d at 126.

Suburban also seeks solace from the fact that it never purchased any additional real estate to replenish acreage it sold.  As is the case with the presence of sales activity, the presence of such purchases tends to demonstrate that a taxpayer is engaged in a real estate business, but their absence is not conclusive:

The fact that [taxpayer] bought no additional lands during this period does not prevent his activity being a business.  [Taxpayer] merely had enough land to do a large business without buying any more.

Biedenharn, 526 F. 2d at 417, quoting Snell v. Commissioner,, 92 F. 2d 891 (5th Cir. 1938).

Additionally, Suburgan points to its commencement of an investment program in securities in 1966.  By itself, this cannot affect our conclusion that Suburban was in the real estate business.  It merely demonstrates that, commencing in 1966, Suburban was also engaged in investing in securities. 31  As stated earlier, the presence of other types of activities does not prevent taxpayer’s real estate activities from being considered a business. 32

Suburban also contends that, if it was ever in the real estate business, it had exited that business long before 1968, the time of the first transaction here at issue.  Even if this is true, it cannot affect our ultimate conclusion.  The statutory language does not demand that property actually be sold while a taxpayer is still actively engaged in its trade or business for ordinary income treatment to be required.  Rather, it demands that the property have been held primarily for sale in that business. 33  To that inquiry we now turn.

B.  What was Suburban’s primary purpose for holding the properties whose characterization is here in dispute?

Put into the framework being used here, Suburban’s contention concerning holding purpose is two-fold.  Principally, it argues that, at the time of the sales in dispute, the properties were not being held for sale.  Alternatively, it contends that it “originally acquired its property as an investment . . ., and it continued to hold it for investment purposes.”  Br. for Appellant at 7.

We reject Suburban’s statement of the legal principle upon which its first argument is premised.  It simply cannot be true that “the decisive question is the purpose for which [the property] ‘primarily’ was held when sold.”  Br. for Appellant at 15 (emphasis omitted). 34  At the very moment of sale, the property is certainly being held “for sale.”  The appropriate question certainly must be the taxpayer’s primary holding purpose at some point before he decided to make the sale in dispute.

There is language in the cases that supports the proposition we are here rejecting.  For example, the Tax Court has stated explicitly that “the determining factor is the purpose for which the property is held at the time of sale.”  Eline Realty Co. [Dec. 24,388], 35 T. C. 1, 5 (1960).  See Maddux Construction Co. [Dec. 30,174], 54 T. C. 1278, 1286 (1970).

However, neither party has cited any Supreme Court or Fifth Circuit precedent which states the proposition that the relevant holding purpose is that existing at the moment of sale.  Suburban relies on Malat v. Riddell [66-1 ustc ¶9317], 389 U. S. 569, 86 S. Ct. 1030, 16 L. Ed. 2d 102 (1966) and Fahs v. Crawford [47-1 ustc ¶9233], 161 F. 2d 315 (5th Cir. 1947).  Malat does not address this issue at all, but concerns the meaning of the word “primarily” in 26 U. S. C. §1221(1).  See 389 U. S. at 571-572, 86 S. Ct. at 1032.  Fahs merely acknowledges the possibility that a taxpayer’s holding purpose for an asset may change, see 161 F. 2d at 317, a concept we whole-heartedly approve.  The Government points to Ridgewood Land Co., Inc. v. Commissioner [73-1 ustc ¶9308], 477 F. 2d 135 (5th Cir. 1973) (per curiam).  There, as in Fahs, we see no more than a holding that a taxpayer’s purpose for holding an asset may change, so that his intentions at the time of acquisition of the asset do not control the characterization of the proceeds of its sale.  See 477 F. 2d at 136. 35

Actually, although we are exceedingly hesitant to tell other courts that they do not mean precisely what they have said, the Tax Court cases cited above are not inconsistent with our approach.  In Eline Realty, supra, the court found that taxpayer’s holding purpose for the particular parcel at issue changed “from one of sale to one of investment” long before the parcel was sold.  Id., 35 T. C. at 6.  Similarly, Maddux Construction, supra, stands for the proposition that a taxpayer can abandon prior to sale his initial purpose for acquiring the property.  Id., 54 T. C. at 1286.

The “holding purpose” inquiry may appropriately be conducted by attempting to trace the taxpayer’s primary holding purpose over the entire course of his ownership of the property.  See Malat v. Riddel [66-1 ustc ¶9317], 383 U. S. 569, 86 S. Ct. 1030, 16 L. Ed. 2d 102 (1966); Devine v. Commissioner [77-2 ustc ¶9623], 558 F. 2d 807 (5th Cir. 1977). 36  Thus, the inquiry should start at the time the property is acquired.  We seek to divine the taxpayer’s primary purpose for acquiring the property.  In this case, we are willing to assume, as Suburban argues, that the property was acquired principally as an investment. 37  We then seek evidence of a change in taxpayer’s primary holding purpose.  Here, such evidence is plentiful and convincing.

The property was acquired in December, 1937.  Houston Gardens Annex, Inc. was formed in 1938 to plat and sell a portion of the property.  Sales commenced by 1939, and sales were transacted in each year thereafter.  From 1946 through 1956, approximately 17 sales per year occurred.  Proceeds from sales exceeded $8,500 each year, and were as high as $69,000 (in 1952).  Also during this period, the development activity pertaining to Homestead Addition Two was occurring.  See Slip op. p. 4494, pp. --, supra.  This development activity clearly contemplated, and was accompanied by, sales.

 All of these factors convince us that, by the mid-1940’s at the latest, and probably much earlier, Suburban’s primary holding purpose was “for sale.”  We need not decide the precise moment.  Were it necessary to our decision, we quite likely would be unwilling to accept Suburban’s contention that the property was initially acquired for investment.  See n. 37, supra.

With its primary holding purpose through the 1940’s and 1950’s fixed at “for sale,” Suburgan is then entitled to show that its primary purpose changed to, or back to, “for investment.”  Suburban claims that this shift occurred either in 1959, when its officers and directors discussed liquidation; in 1961, when Rice University became a stockholder of Suburban, further liquidation discussions were held, and the plats were withdrawn; or, at the latest, in 1966, when further liquidation discussions were held and Suburgan began investing in securities.

We view this determination to be a closer call than any of the others in this case.  The frequency of sales did drop off after the late 1950’s.  Suburban had discontinued its development activities. 38  Also, 1961 was the year the plats for Homestead Additions Three and Four were withdrawn.

This withdrawal of plats could be quite significant.  Unlike liquidation discussions, 39 which were apparently a dime a dozen for Suburban, withdrawal of the plats was an action taken by Suburgan which may evince a different relationship to its land.  The critical question is whether this withdrawal indicated that henceforth the land was being held principally as an investment or simply showed that Suburban was attempting to maximize sales profits by selling to commercial users.

The continuing sales activity is strong evidence that the latter interpretation is the correct one. 40  Moreover, the trial court found that the withdrawal evinced “an attempt to maximize profits from the sale of real estate and to capitalize on the new North Loop Freeway which would cross [Suburban’s] property.” 41  Thus, we conclude that Suburban’s primary purpose for holding the property remained “for sale” at the time of the transactions here disputed. 42

Suburban does not explicitly contend that its primary purpose for holding the specific parcels at issue here was different from its purpose for holding the property as a whole.  However, it does attempt to rely to some degree on the lack of development activity relating to the parcels here at issue.  Although in some circumstances a taxpayer in the real estate business may be able to establish that certain parcels were held primarily for investment, see n. 24, supra and cases cited, the burden is on the taxpayer to establish that the parcels held primarily for investment were segregated from other properties held primarily for sale.  The mere lack of development activity with respect to parts of a large property does not sufficiently separate those parts from the whole to meet the taxpayer’s burden.  Cf. Houston Endowment, 606 F. 2d at 81 (pattern of sales activity with respect to entire tract determines characterization of individual sales).  The lack of development activity with respect to the parts of the property here at issue is at least equally consistent with a primary motivation to maximize immediate sales profits as it is with a primary motivation to hold for investment.

C.  Were the sales contemplated by Suburban “ordinary” in the course of Suburban’s business?

We need say no more on this question than quote from the discussion of this issue in Winthrop, supra:

The concept of normalcy requires for its application a chronology and a history to determine if the sales of lots to customers were the usual or a departure from the norm.  History and chronology here combine to demonstrate that [taxpayer] did not sell his lots as an abnormal or unexpected event.  [Taxpayer] began selling shortly after he acquired the land; he never used the land for any other purpose; and he continued this course of conduct over a number of years.  Thus, the sales were . . . ordinary.

417 F. 2d at 912.

The same is true here.

V.  Having relied on the language of §1221 itself to determine that the assets here at issue were not capital assets, we must return for a moment to the query posed at the outset.  In this case, as we have demonstrated, sales of the type here in dispute were precisely what Suburban’s business was directed towards.  In other words, the profits garnered from these sales arose from the ordinary operation of Suburban’s business.

At the same time, however, these profits did not arise principally from the efforts of Suburban.  Rather, they arose from the same historical, demographic, and market forces that have caused the City of Houston to grow enormously during the years Suburgan held the land.  Shrewdly, Suburban held on to much of its land.  It only sold relatively small portions year by year.  Thus, by 1968, market forces and the location of the North Loop Freeway had driven up the value of Suburban’s land. 43  We must decide whether the policies motivating lower tax rates on capital gains and the controlling precedents expressing those policies require that we ignore the plain language of §1221 and hold for Suburgan.

The key cases we must explore here number three.  First is Malat v. Riddell [66-1 ustc ¶9317], 389 U. S. 569, 86 S. Ct. 1030, 16 L. Ed. 2d 102 (1966) (per curiam).  It lends us no aid.  As we have previously stated, 44 it suggests that profits cannot arise from both “the [ordinary] operation of a business” and “appreciation in value accrued over a substantial period of time.”  Yet here we have profits which fall squarely into both categories.

We thus turn to the two cases from which the Malat court quotations are taken, Commissioner v. Gillette Motor Transport Inc. [60-2 ustc ¶9556], 364 U. S. 130, 80 S. Ct. 1497, 4 L. Ed. 2d 1617 (1960), and Corn Products Refining Company v. Commissioner [55-2 ustc ¶9746], 350 U. S. 46, 76 S. Ct. 20, 100 L. Ed. 29 (1955).  In Gillette, Supreme Court said:

This Court has long held that the term “capital asset” is to be construed narrowly in accordance with the purpose of Congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time, and thus to ameliorate the hardship of taxation and the entire gain in one year.

364 U. S. at 134, 80 S. Ct. at 1500.

We note that the quoted language does not state that all gains emanating from appreciation in value over a substantial period of time are to be treated as capital gains.  Rather, it states the logical converse of that proposition; i. e., that capital gain treatment will be proper only if the gain emanates from appreciation in value.  Instances of gain emanating from appreciation being treated as ordinary income are not inconsistent with this proposition.

We also note the Supreme Court’s recognition of the attempt by Congress to avoid taxing income earned over a period of years in one year.  In Suburban’s case, although it is true that with respect to each individual parcel of land there is a “bunching” effect, taxation of the overall gains from the property as a whole has been spread over a long period of years.  Thus, the “bunching” effect has been minimized.  Last, we note the Supreme Court’s admonition to construe the term “capital asset” narrowly.  Id.

Further support for a narrow construction of the term “capital asset” and a broad interpretation of its exclusions comes from Corn Products, the third key case in this area.  See Corn Products, 76 S. Ct. at 24.  More importantly, the Supreme Court in Corn Products squarely stated:

Congress intended that profits and losses arising from the everyday operation of a business be considered as ordinary income or loss rather than capital gain or loss.

Id.  It is this type of profit that is before us today.

We thus conclude that §1221(1) should be construed in accord with its plain meaning, and that, if the other requirements of §1221(1) are met, when the ordinary business of a business is to make profits from appreciation in value caused by market forces, those profits are to be treated as ordinary income.  Such is the case here.

VI.  Our journey over, we have nothing more to add.  The decision of the district court dismissing Suburban’s complaint is AFFIRMED.