Decisions will be entered under Rule 50.
1. Held, lots sold by petitioner during 1950 and 1951 were held by him primarily for sale to customers in the ordinary course of his trade or business and the gains derived from such sales are taxable as ordinary income.
2. Held, discounts recovered on Michigan land contracts purchased by petitioner for less than their face amount and held to maturity are taxable as ordinary income.
25 T.C. 468">*469 The respondent determined deficiencies in the income tax of the petitioners and an addition to tax under section 294 (d) of the Internal Revenue Code of 1939 as follows:
| Petitioner | Docket No. | Year | Deficiency | Addition to |
| tax | ||||
| Arthur E. Wood | 51985 | 1950 | $ 24,887.91 | |
| Arthur E. Wood and Mary L. Wood | 51986 | 1951 | 28,823.04 | $ 2,448.27 |
The issues common to all proceedings are the correctness of the respondent's action (1) in determining that gains realized by petitioner from real estate transactions during 1950 and 1951 are taxable as ordinary income and (2) in determining that the recovery of discounts on land contracts purchased by petitioner are taxable as ordinary income. An 1955 U.S. Tax Ct. LEXIS 25">*26 additional issue presented in the proceeding of Arthur E. Wood and Mary L. Wood, Docket No. 51986, has been disposed of by stipulation.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found accordingly.
Petitioners, Arthur E. Wood and Mary L. Wood, are husband and wife. Arthur E. Wood filed his individual income tax return for 1950 with the collector of internal revenue at Detroit, Michigan. Petitioners filed a joint income tax return for 1951 with the collector of internal revenue at Detroit, Michigan.
Arthur E. Wood, hereinafter referred to as petitioner, and his first wife, Grace Wood, successfully operated a millinery business for a period of 25 years. Petitioner closed out his millinery business in 1928, and has thereafter considered himself to be in retirement. However, from 1917 until 1949, petitioner served as a member of the Michigan Legislature, with the exception of one term, and received a salary for his services.
Issue 1.
In 1934, petitioner commenced the purchase of vacant land both from the State of Michigan at auction sales and from private owners, continuing such purchases at least until 1950. Approximately 800 lots were purchased by petitioner during 1955 U.S. Tax Ct. LEXIS 25">*27 this period, most of which were located within a half-mile radius of the Oak Park Subdivision in Oakland County, Michigan. Petitioner testified that his purpose in purchasing these lots was to hold them as an investment with the expectation that eventually they would become salable. The lots varied in size, but the majority of them were 1-acre tracts. All the lots acquired by petitioner had been platted. Petitioner did not cut through 25 T.C. 468">*470 alleys or streets or install sidewalks. Petitioner frequently subdivided his 1-acre tracts into smaller lots of from 50 to 100 feet in width at the request of prospective purchasers who desired less than an acre of land on which to build.
In the early 1940's, petitioner built 6 houses both for income purposes and to improve the value of other property which he held in the surrounding area. These houses subsequently were sold.
Petitioner was never licensed to sell real estate. He was not listed as a broker and did not advertise as such. No signs were posted outside petitioner's home nor on any property in which he had an interest. Petitioner did not take prospective buyers out to look over property, and he did not request anyone else to take them 1955 U.S. Tax Ct. LEXIS 25">*28 out.
Although petitioner sold many lots during the period from 1940 to 1953 (as is demonstrated by the tabulation below), he refused to employ a sales agent or to advertise or in any way to promote the sale of his lots. The demand for property in Oakland County, Michigan, especially in the general area in which most of petitioner's lots were located, began during World War II, and increased sharply after the close of the war. Numerous builders, brokers, and prospective individual purchasers sought out petitioner for the purpose of buying lots. Many prospective purchasers were referred to petitioner by the officials at the Oak Park Village Office in Oakland County, where the records of most of petitioner's land holdings were on file.
Petitioner at present has on hand only two lots, both of which he received from the estate of his wife. The number of lots acquired, the number of lots sold, the number of transactions, the cost of the lots sold, the gross selling price, and the gross profits realized on the sales which took place from 1940 to 1953, inclusive, as shown by petitioner's books and records, are summarized as follows:
| Year | Lots | Lots sold | Transactions | Cost of | Gross | Profit |
| acquired | lots sold | selling price | ||||
| 1940 | 95 | 1 | 1 | $ 30.00 | $ 106.00 | $ 76.00 |
| 1941 | 132 | 4 | 4 | 257.50 | 667.50 | 410.00 |
| 1942 | 21 | 7 | 6 | 296.43 | 1,015.00 | 718.57 |
| 1943 | 1 | 10 | 9 | 4,906.32 | 6,190.00 | 11955 U.S. Tax Ct. LEXIS 25">*29 1,383.68 |
| 1944 | 60 | 16 | 11 | 2,367.30 | 3,375.00 | 1,007.70 |
| 1945 | 6 | 8 | 7 | 6,589.08 | 7,000.00 | 410.92 |
| 1946 | 68 | 133 | 17 | 14,335.15 | 71,553.97 | 2 57,218.82 |
| 1947 | 17 | 60 | 11 | 15,258.64 | 41,716.71 | 26,458.07 |
| 1948 | 19 | 9 | 8 | 3,981.85 | 13,430.00 | 9,448.15 |
| 1949 | 11 | 37 | 16 | 7,313.47 | 34,065.11 | 26,751.64 |
| 1950 | 23 | 212 | 19 | 60,261.25 | 240,589.25 | 180,328.00 |
| 1951 | Unknown | 89 | 15 | 18,365.99 | 80,657.05 | 62,291.06 |
| 1952 | Unknown | 8 | 2 | 4,699.45 | 29,899.82 | 25,200.37 |
| 1953 | Unknown | 2 | 1 | 346.00 | 1,000.00 | 654.00 |
25 T.C. 468">*471 Further, during the period 1940-1946, petitioner sold 26 pieces of rental property, title to which he had acquired through foreclosure of land contracts previously purchased.
All sales transactions during the years in issue were conducted by petitioner from an office in his home. A supply of Federal excise stamps was maintained at the office for the convenience of purchasers.
During 1950 and 1951, petitioner employed his nephew, Walter S. Wood, to keep the books and records relating 1955 U.S. Tax Ct. LEXIS 25">*30 to the purchase and sale of lots and land contracts, prepare deeds for purchasers of lots, receive and record payments on land contracts, prepare income tax returns, take telephone calls, and to receive and refer prospective buyers of lots to petitioner. Walter S. Wood is presently employed by petitioner in this capacity. He obtained a real estate broker's license in 1954 after working for petitioner in the above-described capacity for approximately 10 years.
In addition, petitioner in 1951 employed his niece on a part-time basis to take telephone calls and receive payments on land contracts.
Miscellaneous itemized deductions were listed by petitioner on his income tax return for 1950 in the amount of $ 10,682.78, of which $ 8,285.24 represented amounts expended for items connected with the purchase and sale of lots and the purchase of land contracts, including the cost of office supplies and other expenses incurred in maintaining the office in petitioner's home, salary paid to Walter S. Wood for his services in managing the office and social security taxes paid on his behalf, the cost of automobile expense and depreciation, telephone service, and document stamps. Miscellaneous expenses, 1955 U.S. Tax Ct. LEXIS 25">*31 totaling $ 12,968.24, were deducted by petitioner on his return for 1951, $ 10,538.97 of which represented expenses connected with the purchase and sale of lots and the purchase of land contracts, including items identical with those listed above.
Petitioner invested the proceeds from the sale of his lots in land contracts, bank stock, Government bonds and, during the late 1940's, in a few additional lots.
The gains realized from the disposition of lots during 1950 and 1951 were reported by petitioner as long-term capital gains on his individual income tax return for 1950 and were so reported by petitioner and his wife on their joint return for 1951.
Issue 2.
Petitioner and Grace Wood, his first wife, had purchased numerous land contracts at a discount, beginning in the 1920's.
As a result of the economic depression beginning in 1929, petitioner lost approximately 1 1/2 million dollars which he had invested in land contracts, so that by 1933 he retained only 10 to 15 contracts, all of them 25 T.C. 468">*472 on improved property. Eventually he foreclosed on these contracts, obtaining title to the property. He continued to purchase land contracts during and after the depression years.
Petitioner held the 1955 U.S. Tax Ct. LEXIS 25">*32 land contracts until maturity or foreclosure, in every instance but one. At present, he holds about 70 such contracts.
Land contracts of the type here involved are widely used in real estate transactions in Michigan. Upon the purchase of the vendor's interest in a land contract, the buyer acquires all of the rights of the vendor, and the vendee makes payment directly to the purchaser of the contract under the same conditions and terms as were agreed upon by the original parties. Where property is sold under such contracts, the vendor is protected by a right to recover the property in the event of default. Michigan Stat. Ann. (1938 ed.), sec. 27.1986. Under Michigan law, the vendor's interest in such contracts becomes personal property at the time of sale by virtue of the doctrine of equitable conversion.
Land contracts are freely assigned in Michigan, and the purchase of such contracts at a discount is a common practice.
The total number of land contracts purchased at a discount, the face value, the cost, and the amount of discount of the land contracts for the years 1943 to 1953, inclusive, as shown by the petitioner's books and records, are summarized as follows:
| Total | Face | Cost | Discount | |
| Year | number | value | ||
| purchased | ||||
| 1943 | 1 | $ 2,850.00 | $ 2,450.00 | $ 400.00 |
| 1944 | 2 | 15,700.00 | 13,585.00 | 2,115.00 |
| 1945 | 3 | 14,436.82 | 11,749.46 | 2,687.36 |
| 1946 | 5 | 33,726.32 | 28,203.07 | 5,525.25 |
| 1947 | 4 | 22,451.66 | 18,226.58 | 4,225.08 |
| 1948 | 12 | 74,305.28 | 61,184.83 | 13,204.60 |
| 1949 | 8 | 58,672.28 | 47,092.25 | 11,580.03 |
| 1950 | 4 | 23,714.83 | 18,646.87 | 5,067.96 |
| 1951 | 10 | 81,530.79 | 63,278.93 | 18,251.86 |
| 1952 | 24 | 223,536.64 | 169,148.37 | 54,388.27 |
| 1953 | 11 | 97,737.82 | 65,030.62 | 32,707.20 |
The 1955 U.S. Tax Ct. LEXIS 25">*33 profits (equal to the "discount" or excess of the amounts collected from the purchasers of real estate over the price paid for the contracts) realized on land contracts during 1950 and 1951 were reported as long-term capital gains by petitioner on his individual income tax return for 1950 and by petitioner and his wife on their joint income tax return for 1951.
OPINION.
Issue 1.
Respondent determined that gains realized by petitioner from real estate transactions during 1950 and 1951 are taxable as ordinary 25 T.C. 468">*473 income on the ground that the property sold during those years was held by him primarily for sale to customers in the ordinary course of his trade or business. Petitioner contends that such income is properly taxable as long-term capital gains. The question presented is whether at the time of sale petitioner held each parcel of real estate "primarily for sale to customers in the ordinary course of his trade or business" within the meaning of section 117 (a) (1) and (j) (1) of the Internal Revenue Code of 1939. 11955 U.S. Tax Ct. LEXIS 25">*35 Petitioner's principal argument is that, since he refused to advertise or to employ a sales agent and since each sale made by him was unsolicited, he was simply a passive 1955 U.S. Tax Ct. LEXIS 25">*34 investor liquidating investment property to his best advantage, and at no time was engaged in the real estate business.
While resolution of the issue here presented involves essentially a factual determination, the courts, in considering this question, have pointed out the most important factors to be utilized in determining whether property at the time of sale was held primarily for sale to customers in the ordinary course of business. The considerations to be given the most weight in such cases include the original purpose of the taxpayer in acquiring the property, the purpose for which it is held at the time of sale, the frequency, continuity and substantiality of sales, and the extent of sales activity on the part of the seller or his agents by improving the property, advertising and soliciting purchasers. Dunlap v. Oldham Lumber Co., 178 F.2d 781; W. T. Thrift, Sr., 15 T.C. 366.
Beginning in the mid-1930's and continuing through 1949, petitioner purchased a great many parcels of real estate which he thereafter held until a demand for 1955 U.S. Tax Ct. LEXIS 25">*36 real estate created a favorable market and made disposition profitable. Petitioner was engaged in selling these lots from 1940 through 1951. Petitioner stated that his purpose in purchasing the lots acquired, beginning in 1934, was to hold them as an investment with the hope that eventually they would become salable. 25 T.C. 468">*474 We recognize that the purpose for which property initially is acquired and held is not the determinative factor, since that purpose may change prior to the time of disposition. Differential Steel Car Co., 16 T.C. 413; Carl Marks & Co., 12 T.C. 1196.
A careful review of the evidence discloses nothing which would indicate a change in petitioner's original purpose eventually to dispose of the lots acquired. Inasmuch as only 6 of the total number of nearly 800 lots held by petitioner were capable of producing current income, petitioner does not contend that those lots ever were held for the purpose of realizing investment income. Petitioner held the lots he had purchased until their market value had increased sufficiently to yield a substantial profit upon disposition. Thus, petitioner's later activities appear to be thoroughly consistent with his stated purpose. 1955 U.S. Tax Ct. LEXIS 25">*37 Accordingly, we are satisfied from the record that, during 1950 and 1951, at the time the lots in question were sold, petitioner's definite intention was to hold them for sale to customers, rather than merely to liquidate an investment.
During the 10-year period commencing in 1940 and continuing through 1949, petitioner sold a total of 285 vacant lots in 90 separate transactions. In 1950 petitioner acquired 23 lots and sold 212 involving 19 separate sales transactions. While the record does not show the number of lots, if any, that were purchased in 1951, petitioner in that year sold 89 lots in 15 sales transactions. At present, petitioner has only 2 lots on hand, both of which he received from the estate of his wife.
Petitioner's ability to sell so large a number of lots without solicitation was due primarily to the demand for real estate in the general area in which most of petitioner's lots were located. The demand for property in Oakland County, Michigan, began during World War II and increased sharply thereafter. In situations such as this, where the market is favorable to the seller, it is not essential that active sales promotion be demonstrated in order to prove that he 1955 U.S. Tax Ct. LEXIS 25">*38 is engaged in the business of selling real estate. Mauldin v. Commissioner, 195 F.2d 714, affirming 16 T.C. 698.
In addition to the sales of vacant lots described above, during the period 1940-1946 petitioner sold 26 pieces of rental property, title to which he had acquired through foreclosure of land contracts previously purchased.
The fact that petitioner's real estate activities were so extensive as to necessitate the maintenance of an office in his home to facilitate the record keeping and document preparation involved in purchasing and selling lots lends further support to the position taken by the respondent that the sales activities of petitioner had in fact acquired the character of a business. A supply of Federal excise stamps was maintained 25 T.C. 468">*475 at the office for the convenience of purchasers. Moreover, during the 2 years in issue petitioner employed his nephew, Walter S. Wood, on a full-time basis to keep the books and records relating to the purchase and sale of lots and land contracts, prepare deeds for purchasers, accept payments, take telephone calls, and to refer prospective buyers of lots to petitioner. Wood, after having worked for petitioner in the above-described 1955 U.S. Tax Ct. LEXIS 25">*39 capacity for nearly 10 years, obtained a real estate broker's license in 1954. He is presently employed by petitioner in the capacity outlined above.
Petitioner's stated intention ultimately to dispose of his property, together with his continuous activities in the purchase and sale of lots over a period of several years, the maintenance of an office in his home to facilitate the handling of real estate transactions and the employment of a full-time office assistant to supervise and expedite such matters compel us to conclude that during the years in issue he had established himself in the business of selling real estate and that the parcels of realty sold during those years were, at the time of sale, held primarily for sale to customers in the ordinary course of that business. The applicable principle has been aptly stated in Curtis Co., 23 T.C. 740, at page 755:
However, the essential fact seems to be that these properties were acquired for the purpose of resale whenever a satisfactory profit could be made. Petitioner may not have aggressively promoted the sale of these properties; but, nevertheless, the frequency and volume of its sales of undeveloped real estate and its substantial 1955 U.S. Tax Ct. LEXIS 25">*40 holdings of such properties convince us that these properties were held, not only for sale at some time in the future, but primarily for sale to its customers in the ordinary course of its business during each of the years here in issue. Petitioner was a dealer in undeveloped land, and gains derived from the sale of such property are taxable as ordinary income.
Having found that petitioner held the property in question for sale to customers in the ordinary course of his trade or business within the meaning of section 117 (a) and (j) of the 1939 Code, we hold that the profits realized from the sale of his property during 1950 and 1951 must be treated as ordinary income, taxable under section 22 (a) of the 1939 Code. 21955 U.S. Tax Ct. LEXIS 25">*41
Issue 2.
Real estate in the State of Michigan is commonly conveyed pursuant to executory contracts of sale which provide for a down payment with 25 T.C. 468">*476 the balance of the purchase price payable in installments. These contracts are referred to as land contracts. Land contracts are accepted in Michigan as evidence of indebtedness and are freely traded, assigned and pledged, the purchase of such contracts at a discount being a common practice in that State. Upon the purchase of the vendor's interest in a land contract, the buyer acquires all of the rights of the vendor, and the vendee makes payment directly to the purchaser of the contract under the same conditions and terms as were agreed upon by the original parties. Where property is sold under such contracts, the vendor is protected by a right to recover the property in the event of default. Michigan Stat. Ann. (1938 ed.), sec. 27.1986. Under Michigan law, the vendor's interest in such contracts becomes personal property at the time of sale by virtue of the doctrine of equitable conversion.
Petitioner has been purchasing 1955 U.S. Tax Ct. LEXIS 25">*42 land contracts since the 1920's. In more recent years, he has been able to make a great many such purchases at a favorable rate of discount. Petitioner presently holds about 70 land contracts. Apart from interest income (treated separately by petitioner on the two returns here in issue), the profits derived from the land contract purchases are equal to the excess of the amount realized over the cost of each contract purchased. Therefore, in each instance the profit is equal to the amount of the discount.
Respondent takes the position that the discounts recovered on such land contracts are taxable to petitioner as ordinary income. Petitioner insists that such profits derived from his land contract transactions are properly taxable as long-term capital gains.
Land contracts of the type here in question have been held by the United States Court of Appeals for the Sixth Circuit to be closely analogous in nature to bonds, notes and mortgages. Commissioner v. Hart, 76 F.2d 864.
The profits derived by petitioner from such contracts were realized simply by holding the contracts until maturity, meanwhile collecting the periodic payments from the purchaser of the property. Petitioner merely 1955 U.S. Tax Ct. LEXIS 25">*43 collected the proceeds of assigned claims. None of the profits here in issue resulted from the disposition of a contract. Consequently, there was no "sale or exchange" of a capital asset within the meaning of section 117 (a) (4) of the 1939 Code. 3 It is well settled that gain resulting from the collection of a claim or chose in action is taxable as ordinary income. Osenbach v. Commissioner, 198 F.2d 235, affirming 17 T.C. 797; Cooper v. Commissioner, 197 F.2d 951. 25 T.C. 468">*477 Petitioner appears to be in the same economic position as a bondholder who realizes gain from the recovery of discount on bonds purchased for less than their face amount.
We, therefore, hold that the profits realized by petitioner from the collection of the proceeds of land contracts during 1950 and 1951 are taxable as ordinary income under section 22 (a) of the 1939 Code.
Decisions will be entered under 1955 U.S. Tax Ct. LEXIS 25">*44 Rule 50.
Footnotes
1. The subdivided portion of lot 221 (described as S. 53' of N. 265') has been included in the exhibits as having been sold twice on the same date, without explanation. Therefore, the cost, selling price, profit, total number of lots sold and total transactions for 1943 have been correspondingly reduced in this summary to compensate for the aforementioned duplication.
2. Of the 133 lots sold in 1946, 22 were repossessed and resold in 1950. The cost, selling price, and profit figures for both years have been included in this summary and consequently require adjustment. However, the number of lots acquired, the number of lots sold and the number of transactions, as listed in this summary, are correct for both years.↩
1. SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this chapter --
(1) Capital assets. -- The term "capital assets" means property held by the taxpayer (whether or not connected with his trade or business), but does not include --
(A) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
* * * *
(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 (1), 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, * * *
2. SEC. 22. GROSS INCOME.
(a) General Definition. -- "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *
3. SEC. 117. CAPITAL GAINS AND LOSSES.
(a) Definitions. -- As used in this chapter --
* * * *
(4) Long-term capital gain. -- The term "long-term capital gain" means gain from the sale or exchange of a capital asset held for more than 6 months, if and to the extent such gain is taken into account in computing net income;↩