*215 Decision will be entered under Rule 50.
Held, on the basis of the facts of record, cattle raised by petitioner and sold when they were between the ages of 6 and 24 months were "held * * * for * * * breeding, or dairy purposes" within the meaning of
*1092 The Commissioner has determined the following deficiencies in petitioner's income tax:
| Year | Deficiency |
| 1944 | $ 59,927.24 |
| 1945 | 45,908.37 |
For each of the years involved the Commissioner determined that "all cattle sold by you [petitioner] which were less than twenty-four months of age at the date of sale were held for sale in *216 the ordinary course of business" and, consequently, that the income from those sales was ordinary income, not capital gain as reported by petitioner. Petitioner contests those determinations.
Other adjustments made by the Commissioner in petitioner's reported net income for each year have not been contested and will be reflected in the Rule 50 computation.
FINDINGS OF FACT.
Part of the facts have been stipulated and are incorporated herein by this reference.
James M. McDonald, hereinafter referred to as petitioner, is an individual who at all times here material resided in Cortland, New York. He filed individual income tax returns for the calendar years 1944 and 1945, on the cash basis, with the collector of internal revenue for the twenty-first district of New York.
Petitioner is a wealthy man, enjoying extensive dividend income. Since 1933, he has been the owner of a farm on which he has been developing a dairy and breeding herd of purebred Guernsey cattle. On January 1, 1938, the farm consisted of 500 acres and there were about 179 cattle in the herd. Both the farm acreage and size of the herd steadily increased and, on the dates here pertinent, were as follows:
| January 1 | Number of cattle | Acreage |
| 1944 | 487 | 1,500 |
| 1945 | 484 | 1,500 |
| 1946 | 523 | 1,500 |
*217 Petitioner set no predetermined limit on the size of his herd; rather he wished to increase its size with either raised or purchased cattle which would improve the herd's quality. He never sold any cattle *1093 for the purpose of reducing the size of the herd. It was his practice, moreover, to purchase in advance enough acreage so that he would always be able to retain all the raised cattle which met his standard of quality. The farm's 1,500 acres in 1944 and 1945 could accommodate about 600 head of cattle.
During the years in issue petitioner's herd ranked in the top 20 per cent (as regards quality) of Guernsey herds in the United States. Moreover, the most recent rating, prior to the hearing in this case, given petitioner's herd by the American Guernsey Cattle Club (under a program begun by the Club in 1947) classified it as having more "Excellent" cows than any other Guernsey herd in the country.
To continually improve the quality of his herd petitioner engaged in what is termed selective breeding. Petitioner's practice in this respect may be described as follows:
Each mating of bull and cow (or heifer) is planned in order to select parents who will produce an animal *218 superior to both, e. g., if a cow is generally satisfactory except for one characteristic she will be mated with a bull in whose progeny that characteristic customarily appears in satisfactory form. 1 More bulls are needed to carry out this practice than would be the case were selective breeding not engaged in. The calves born as a result of the matings are closely inspected and those which are born with abnormal or defective characteristics are sold, about 1 week after birth, to butchers. The income therefrom is reported as ordinary income and is not here in controversy.
Breeding is planned so that calves are born throughout the entire year; thus some cows are always "freshening" and the herd's milk production*219 is thereby maintained at a stable level. In each of the tax years involved about 190 to 200 calves were born; those calf crops were composed of approximately 51 per cent bull calves and 49 per cent heifer calves; and about 30 per cent of the bull calves and 10 per cent of the heifer calves (an over-all total of 20 per cent of the calf crops) were sold to butchers immediately after birth either because, as aforementioned, they were abnormal, defective, or the offspring of cows which were bred solely for milk-producing purposes. The standards applied in eliminating bulls are more stringent than those applicable to heifers because an unsatisfactory bull would have a more adverse effect on the herd than an unsatisfactory cow since a bull's progeny is more numerous than that of a cow.
The calves which are not sold at birth are given a name and number which, along with identifying marks and pedigree for three generations, *1094 are entered in the herd book. The number given to each female calf is tatooed on its ear and also placed on a tag which is hung around its neck. Each retained calf is also registered with the American Guernsey Cattle Club.
It cannot be determined that the*220 retained calves will definitely measure up to the standards set for the herd (a) until, in the case of retained heifer calves, they are 24 months old by which time they will have been bred, produced a calf, and begun milk production, and (b) until, in the case of bulls, they are 60 months old by which time they will have been bred, produced a calf, and their calf will have produced offspring and had a year of milk production. However, it is possible to determine if retained calves will not meet the herd's standards after they reach 6 months of age, by which time their physical characteristics begin to take definite form. For example, judgment that calves are undesirable can and is made at any time after the calves are 6 months old on the basis of such factors as beefiness and straightness of back, condition of legs and feet, shape of shoulders, size of muzzle, width of nostrils, shape of jaw, depth of chest and spring of ribs and, in the case of heifers, shape of rump evidencing capaciousness of the udder and the firmness of the udder's attachment to the body.
Petitioner's selectivity process continues throughout the entire life of a herd animal. No matter what an animal's*221 age, it will be culled if it at any time becomes diseased, injured, too aged or infirm to properly breed or produce milk, or develops any other undesirable physical traits. Thus it is never a certainty that any particular animal will remain in the herd until it dies.
Petitioner also purchases animals for the herd, on occasion, when he judges that such animals will improve the quality of the herd. In 1944, petitioner purchased 13 head of cattle at a total cost of $ 17,950 and, in 1945, he purchased 12 head at a total cost of $ 19,075.
As a result of petitioner's breeding practices the quality of his herd has improved substantially over the years. The herd's cows produce 45 per cent more milk than that which the cows produced in 1935, with practically no increase in feeding costs over that earlier year, and the average productive life of the cows has increased from 6 years in 1935 to 12 years.
In 1944 and 1945, petitioner had about 200 to 225 milking cows on the farm and about 200 heifers under milking age. He had approximately 52 to 67 bulls, of which 10 to 12 were in use as herd sires, 30 to 40 were under breeding age, and 12 to 15 were reserve bulls which were held as replacements*222 for the herd sires and leased to other breeders in the interim.
*1095 A stipulation filed by the parties shows that petitioner's sales, in the tax years involved, of cattle held by him over 6 months were as follows:
| A. Cattle 24 mos. | 1944 | 1945 | ||||
| old and older | ||||||
| at time of sale | ||||||
| Raised: | No. | Gain | No. | Gain | ||
| Bulls | 12 | $ 2,000.56 | 8 | $ 6,805.87 | ||
| Cows | 38 | 37,478.98 | 26 | 25,016.10 | ||
| $ 39,479.54 | $ 31,821.97 | |||||
| Purchased: | ||||||
| Bulls | 1 | 49.94 | ||||
| Cows | 25 | 4,456.41 | 4,456.41 | 24 | 2,900.87 | 2,950.81 |
| $ 43,935.95 | $ 34,772.78 | |||||
| B. Cattle between | ||||||
| 6 and 24 mos. | ||||||
| old at time | ||||||
| of sale | ||||||
| Raised: | ||||||
| Bulls | 46 | $ 45,283.91 | 59 | $ 50,744.35 | ||
| Cows | 37 | 30,196.04 | 19 | 14,793.01 | ||
| $ 75,479.95 | $ 65,537.36 | |||||
| Purchased: | ||||||
| Cows | 2 | 524.04 | 524.04 | |||
| $ 75,479.95 | $ 66,061.40 | |||||
| Total gain | $ 119,415.90 | $ 100,834.18 |
Each one of the sales of cattle reflected in the above tabulation was made by petitioner because he did not believe the animal sold measured up to the standards of his herd. This belief was based either on the animal's development of undesirable physical characteristics*223 or traits, as heretofore detailed, or because the animal was diseased, injured, or too aged or infirm to properly breed or produce milk. Experience had proved that those factors resulted in an animal's failure to conform to the standards of petitioner's herd. Furthermore, the aforementioned sales were spread fairly regularly and consistently throughout the years involved; they did not occur in any particular season. This was a consequence of the fact that calves were born throughout the entire year, thereby attaining at different times the age at which their physical characteristics became sufficiently developed for petitioner to determine if they met herd standards, plus the fact that petitioner continually inspected all his animals for defects and disposed of them when such defects were found.
Petitioner knew that, as a result of his selective breeding program, there would be some animals each year which would not meet the standards of his herd and would be sold. Therefore, petitioner advertised approximately once a month during 1944 and 1945 in the Guernsey Breeder's Journal. The advertisements were of a general nature merely mentioning that "occasionally" petitioner would*224 have some pureblood Guernsey cattle for sale; no specific cattle were ever advertised for sale. Petitioner's advertising expenditures were *1096 $ 1,682.43 in 1944 and $ 3,184.37 in 1945. The increased expenditure in 1945 was attributable to the printing of a booklet of the herd's history which was distributed to those persons who visited petitioner's farm in order to purchase cattle. The booklet was conceived in order to relieve the farm's key personnel from spending time in personally relating the herd's history to prospective purchasers.
Petitioner reported in his returns for the years in issue the following income, expenses, and operating losses from his farm operations:
| Income: | 1944 | 1945 |
| 2 Milk sales | $ 71,047.30 | $ 72,947.27 |
| Bull service | 1,515.00 | 780.00 |
| Calf and cow sales (butchered or | ||
| held less than 6 months) | 5,586.73 | 1,323.27 |
| Miscellaneous | 761.28 | 544.30 |
| Total income | $ 78,910.31 | $ 75,594.84 |
| Expenses: | ||
| Total expenses (itemized) | 220,457.33 | 223,879.43 |
| Net operating loss | $ 141,547.02 | $ 148,284.59 |
He also reported the following as long-term capital gain:
| 1944 | 1945 | |
| Animals raised -- held more than 6 months | $ 114,294.01 | $ 97,961.80 |
| Animals purchased -- held more than 6 months | 4,456.41 | 3,424.91 |
| Total | $ 118,750.42 | $ 101,386.71 |
*225 Respondent disallowed long-term capital gain treatment on $ 76,645.64 of the $ 118,750.42 claimed for 1944, and $ 74,741.80 of the $ 101,386.71 claimed for 1945. The disallowances were based on the ground that those profits were from sales of cattle under 24 months of age, which cattle were held by petitioner primarily for sale.
Petitioner's selective breeding program has been so costly that he has never, in all his years of operation, realized a profit in farm operations from sales of milk and of calves to the butcher immediately after their birth. By constant improvement of his purebred herd, however, he hopes in the future to realize profit from those sales. Petitioner's farm losses have been considerably reduced over the years, though not eliminated, by the gains realized from cattle held over 6 months and sold because of failure to conform to the standards established for*226 the herd.
OPINION.
Respondent, in his brief, concedes that the sales during 1944 and 1945 of all cattle purchased by petitioner and held *1097 by him for more than 6 months are entitled to capital gains treatment under the provisions of
*227 Whether or not the cattle in question were, under
In the course of our Opinion in the earlier case, we stated:
While there was always the possibility that any individual bull calf might ultimately become a part of petitioner's breeding herd, it is obvious that most of the bull calves born would be sold whether they were good enough for petitioner's herd or not. * * *
*1098 It is true that the standards for petitioner's herd were*228 high. But we think the evidence establishes that those standards were set for the bona fide purpose of improving petitioner's herd and that if a particular animal met those standards it would be retained. We are drawn to that conclusion by our findings (a) that petitioner's Guernsey herd was in fact one of the best in the country; (b) that there was no predetermined limit on the size of the herd and there was sufficient acreage for the herd to increase; (c) that during the years in issue the size of the herd increased from 487 to 523 head; and (d) that, as evidenced by petitioner's continual losses from his farm operations, he was willing to incur considerable expense to develop a herd of the highest quality.
On July 7, 1954, our decision in the prior case was reversed by the Court of Appeals for the Second Circuit,
it was always*229 clear and predictable that each year substantial numbers of them [cattle] would eventually be culled and sold. It was this predictability which led the Tax Court to the view that the young animals were held for sale up to the point where their breeding qualities had been tested by examination of their offspring. This period of time it fixed at 24 months; and so it held the proceeds of cattle sold earlier to be only income.
* * * *
We think, however, that this view penalizes breeders with skill sufficient to detect and cull inferior animals even before they have been bred. True, an affirmative judgment that an animal is superlative cannot be made without examination of its offspring. But the evidence is compelling that a negative judgment can often be made on the basis of such factors as brightness of eyes, width of nostrils, size of muzzle, length of neck, sharpness of shoulders, depth of chest and spring of ribs, straightness of back, width and level of rump, and, in the case of a cow, size of udder and its firm attachment to the body. Thus younger animals can be accurately culled, and the animals which the taxpayer sold were selected in this manner. Before an animal had been*230 thus weeded out it was part of the regular herd, held for dairy and breeding purposes until it should prove unfit. See O'Neill v.United States, D. C. S. D. Cal., Vol. 5 CCH, 1952 Fed. Tax Rep. para. 9462, affirmed
Of course it was in the taxpayer's contemplation that many or most of the animals would be found wanting and be sold. The operation might perhaps even have proved unfeasible without the income thus derived. And in a very real sense the taxpayer could have said at any moment that most of his calves were held for possible sale. But this was not the motive behind their retention *1099 and legislative history of the new law 4 shows that motive is to be controlling. And it is this new law which is and must be decisive.
*231 Although the Court of Appeals' decision is binding upon us in the prior case, it having established the law of that case, we are not compelled to follow it in the case now before us if we think it is wrong, however much we may respect the views of the Second Circuit. The reasons why our Court must endeavor to have a uniform treatment equally applicable as nearly as possible to all 48 States of the Union and equally applicable in all the United States Courts of Appeals is stated at some length in
We are persuaded that all the raised calves here in controversy were held for breeding or dairy purposes within the meaning of
*233 Neither is it fatal to petitioner's case that the greater part of the income from the farm operations was derived from sales of the cattle in question. Though that circumstance does weigh against petitioner we think it is counterbalanced by other factors present. The animals in question were sold at all ages rather than at the earlier ages only, indicating that their disposal was motivated not by a desire for profit *1100 from such sales but, rather, because of their unfitness for the breeding and dairy purposes held. See
Respondent's use of the so-called age test to determine which cattle were and were not held for breeding or dairy purposes (setting 24 months of age as the dividing line) was derived from the Fox case, supra. In
We adopted the age test in the Fox case because we had to make an approximation of which animals involved were part of the breeding herd. In that case, the taxpayers had relied exclusively on the fact that the registration of their purebred animals was enough to classify them as members of the breeding herd. We felt that more evidence of the purpose for which the animals were held was necessary. However, we were convinced that some of the animals involved were part of the breeding herd but, because of the state of the record in that case, we were unable to determine with respect to particular animals whether or not they were used for breeding. Therefore, we adopted the age test as a kind of rule of evidence to decide the case. On review, the Fourth Circuit held that our test was reasonable and fair in the circumstances of that case.
We then went on to say in the Smith case that respondent's proposed age test was erroneous in that it made immaturity conclusive, whereas the Fourth Circuit in the Fox case noted that, under the amended
The evidence in the instant case distinguishes it from Fox and makes it unnecessary to resort to the age test. Petitioner here does not solely rely on registration of his cattle to prove the purpose for which they were held. Rather, he has given us a picture of his complete method of operation, emphasizing the selective breeding practices followed. We are convinced, as was the Second Circuit in the previous McDonald case, that although an affirmative judgment cannot be made that an animal is of the quality desired prior to examination of its offspring, it is possible prior to that time to make a negative judgment (on the basis of objective physical characteristics) that an animal is unsatisfactory. It has been established to our satisfaction that the animals sold by petitioner were disposed of solely on the basis of such judgments as not being fit for breeding or milk producing, and that they were held for those purposes before disposal. Moreover, we note that in Fox the ages at which the animals were sold depended on the preferences and desires of purchasers, whereas here the age of*236 sale was that age at which it became evident that the particular animal did not meet the established standards for breeding or milk producing.
*1101 We are aware that on facts somewhat similar to those in the instant case it was held, in
Admittedly the question here is a difficult factual one to decide. The Sixth Circuit in
*239 Decision will be entered under Rule 50.
*1102 Murdock, J., concurring: The petitioner has sustained his burden of proof on the issues raised and the case should not be decided upon reasoning which was not the basis for the Commissioner's determination and was not timely injected into the case. However, the result might be different if the point had been made that the petitioner's business was essentially that of selling high-grade Guernseys for profit and his dairy business was subordinate. The fact that young animals were retained for substantial periods of time as a part of the herd might not be determinative of that issue. The largest returns were from sales. The dairy paid a much smaller part of the expenses, but it no doubt demonstrated the quality of the animals and made them more attractive to possible purchasers. It is obvious that the petitioner always intended to sell most of the animals retained, and it is conceivable that his purpose in retaining many of them was to sell them at prices based upon the distinction that they had been members of his outstanding herd.
Turner, J., dissenting: I concur in the views of Judge*240 Rice as to the meaning and intent of the statute. In addition, it is my view that the facts as found in this case not only show that the animals in question were never "used for breeding purposes," but that they were "never held for breeding purposes," even though the identification of the individual animals and their segregation from other young animals which were held and used for breeding purposes did not actually occur until at or shortly before their sale.
Tietjens, J., dissenting: I dissent, reluctantly, because I consider this question essentially to be a question of fact and I hesitate to disagree with the trier of the facts. On the underlying facts, however, I could come to no other ultimate conclusion than that the cattle in question were held primarily for sale to customers in the ordinary course of business and that the profit from such sales is properly taxable as ordinary income and not as capital gain.
Rice, J., dissenting: I dissent, among other reasons, 1 because the legislative history of section 324 of the Revenue Act of 1951, 2 which amended
*1103 The sole objective, which Congress sought by the amendment, was to insure that livestock used in a taxpayer's trade or business be accorded the same treatment as any other asset so used. The Senate Finance Committee Report on the 1951 Act 3 states:
The "considerable confusion and dispute" of which the committee spoke arose because several decisions of this Court and the Courts of Appeals were not being followed by the respondent. In
When Congress enacted the Revenue Act of 1950, 4*244 it was fully aware of the Albright and Fawn Lake cases. An amendment was offered on the Senate floor 5 designed to clarify
After the Bennett case was handed down by the Court of Appeals for the Fifth Circuit in 1951, following the rule of the Albright case, *1104 the Bureau of Internal Revenue issued a ruling, Mim. 6660, to the effect that capital gains treatment would be applied to sales of culls. Again quoting from the Report of the Senate Finance Committee, pages 41, 42:
However, this ruling contained a statement that this treatment might not be applied in the case of animals "not used for substantially their full period of usefulness." This exception appears to have resulted in new uncertainties, and it has been stated that Bureau agents are interpreting this ruling to mean that only animals which have completely outlived their usefulness can qualify for the capital gains treatment.
In view of the uncertainties resulting from the recent ruling (Mim. 6660), section 324 of your committee's bill restates the sentence contained in the House bill as follows:
Such term also includes livestock, regardless of age, held by the taxpayer for draft, breeding, or dairy purposes, *245 and held by him for 12 months or more from the date of acquisition.
ThusInsofar as the statute is made applicable to all livestock, "regardless of age" and "held by him for 12 months or more from the date of acquisition," Congress obviously intended nothing more than to incorporate the holding of the aforementioned cases into the law and thus require the Commissioner to follow them.
The amendment raised doubts on the part of some Senators that it would permit capital gains treatment on all or most livestock sales. Those doubters were assured that no such broad extension of capital gains treatment was intended. In the course of the debate, the Chairman of the Finance Committee, in arguing for the defeat of a proposed amendment which would have eliminated section 324, made the following statement: 6
Mr. George. Mr. President, the question, without this amendment, has been before the courts. Some courts have held one way on it, and the Treasury Department*246 has seen fit to disregard the holdings of the courts, and, sometimes in the same judicial circuit, has continued to administer the law according to its own interpretation.
Generally the view has been that livestock used for breeding purposes and held for a longer period than a year does become a capital asset, and may be treated as such. The Treasury has disregarded that opinion. The House inserted the provision purely for the purpose of clarifying the particular section of the code applicable to the subject. It would be a most dangerous thing indeed to say now that the whole section should be impaired by an amendment which would deny to one capital asset the treatment which has been accorded capital assets heretofore, since the passage of the act.
I sincerely hope that the amendment will not be adopted. The committee approved the committee amendment and the House included its provision solely because the Treasury has not followed the rulings of the circuit courts in this matter. [Emphasis added.]
*247 *1105 But, by our holding herein, we have extended capital gains treatment to the very sales which those Senators, who opposed section 324 and the similar amendment proposed in 1950, feared would be accorded such treatment, but which the managers of the bill on the floor assured them would not happen.
By the enactment of section 324 in the 1951 Act, I am convinced that Congress did not intend to provide any special kind of treatment for cattle as distinguished from all other assets to which
Footnotes
1. In certain cases cows which were good milk producers but which were not capable of producing quality calves were bred solely for the purpose of milk production. Their calves were sold to butchers immediately after birth, the income therefrom was reported as ordinary income, and that income is not here in issue.↩
2. Gross income from milk sales for the years 1940 through 1943 were $ 27,221.49; $ 32,214.66; $ 39,649.61; and $ 50,383.66, respectively.↩
3.
SEC. 117 . CAPITAL GAINS AND LOSSES.(j) Gains and Losses From Involuntary Conversion and From the Sale or Exchange of Certain Property Used in the Trade or Business. --
(1) Definition of property used in the trade or business. -- For the purposes of this subsection, the term "property used in the trade or business" means property used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (l), held for more than 6 months, and real property used in the trade or business, held for more than 6 months, which is not (A) property of a kind which would properly be includible in the inventory of the taxpayer if on hand at the close of the taxable year, or (B) property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business, * * * Such term also includes livestock, regardless of age, held by the taxpayer for draft, breeding, or dairy purposes, and held by him for 12 months or more from the date of acquisition. * * *
(2) General rule. -- If, during the taxable year, the recognized gains upon sales or exchanges of property used in the trade or business, plus the recognized gains from the compulsory or involuntary conversion * * * of property used in the trade or business and capital assets held for more than 6 months into other property or money, exceed the recognized losses from such sales, exchanges, and conversions, such gains and losses shall be considered as gains and losses from sales or exchanges of capital assets held for more than 6 months. * * *
[The sentence last quoted in
section 117 (j) (1)↩ above was added by section 324 of the Revenue Act of 1951 and made retroactive to taxable years beginning after December 31, 1941, with the exception that the extension of the holding period from 6 to 12 months was made applicable only to taxable years beginning after December 31, 1950.]4. Sec. 324. Revenue Act of 1951, amending
sec. 117 (j) (1)↩ of the 1939 Code. See footnote 3.5. In this connection the Court of Appeals said further:
we disapprove the view that an animal is held for breeding purposes only if there is an expectation and intention that it produce offspring. Life is replete with situations (advertising, war, reproduction) where many are employed in the hope that one will succeed. Yet the purpose subserved by the many is clear. This does not mean that every farmer can obtain the benefit of the capital gains provision for his entire calf crop merely by selecting one of the better looking animals every time he needs a replacement for his producing herd. This taxpayer, however, has made a thoroughly convincing record that his retention of calves was a necessary factor in building his champion herd. He is entitled to the benefit of
I. R. C. § 117 (j) (1)↩ in its new and revised form.6.
Gotfredson v. Commissioner, supra, at p. 677 :We recognize that the Court of Appeals for the Second Circuit in
McDonald v. Commissioner, 214 Fed. 2d 341 , has recently reached a different result from that reached inFox v. Commissioner, supra. If this matter was before us in a trial de novo↩ the reasons given for the ruling in that case would be persuasive. The two cases represent different conclusions from similar factual situations, both reasonably arrived at. But, eliminating the legal issues involved, hereinabove discussed, the basic question remaining is one of fact. * * * We are unable to say that the facts in this case do not support the Tax Court's finding that the heifers and bulls sold by the taxpayer before they were accepted into the herd were not held for dairy purposes, but instead were held for sale to customers, or that such finding is clearly erroneous. Unless clearly erroneous, the finding is binding upon us. * * *1. See
James M. McDonald, 17 T. C. 210↩ (1951) .2. 65 Stat. 452.↩
3. S. Rept. No. 781, 82d Cong., 1st Sess. (1951), p. 41.↩
4. 64 Stat. 906.↩
5. 96 Cong. Rec. 14082 (1950).↩
6. 97 Cong. Rec. 12337 (1951).↩