MALAT v. RIDDELL
Legal provision: Internal Revenue Code
Argument of George T. Altman
Chief Justice Earl Warren: Number 487, William Malat et ux. -- et al., versus Robert A. Riddell, District Director of Internal Revenue.
Mr. Altman --
Mr. George T. Altman: Yes.
Chief Justice Earl Warren: -- you may proceed with your argument.
Mr. George T. Altman: If the Court please.
This is a federal income tax case involving a sale of two pieces of unimproved real estate with the very familiar question of capital gain versus ordinary income.
It involves a -- an acquisition by a group of persons as a joint venture and acquisition of some 45 acres in the Los Angeles area with the purpose of developing it and holding it for rental.
There was testimony indicating that financing -- that there were financing and zoning problems and that incase -- incase these problems were not solve -- couldn't be solved that they would sell the property off in bulk so they wouldn't get hurt.
The District Court made that distinct finding that they would sell it off in bulk so they wouldn't get hurt.
The -- they also made a finding and in the same very -- very same paragraph that they were holding it for sale or development for rental whichever was more profitable.
During the course of the escrow -- there was a six months escrow and during the force of that escrow, there was considerable investigation of financing many efforts to get first on a total project, a thousand apartments for the whole thing.
Then when they couldn't that, they broke it down into getting smaller units financed.
For that purpose, it was necessary to subdivide the property in order to cut it down to small units.
But even there and I'm reciting the history chiefly as the Court Appeals relates it.
And the Court of Appeals obtain, I believe, it has a very good opening statement of the factual history of the case.
They had to break it down into a number of units in order to be able to finance it on a unit basis instead on a single basis that even at that point they were still hoping to withhold what they the frontages, two strips, one on one street, one on the other for commercial development and rental.
But they weren't able to finance the -- even this and this was -- all took place during the six months period of escrow.
And so as the Court of Appeals points out, they were then faced with interest, charges, and payments, and taxes, and so they sold the subdivided portion.
They sold it out.
They reported the ordinary income on that.
Apparently on the theory that since it was subdivided, they have to report it as ordinary.
I don't think that question is before this Court ago as to whether that was right or whether it was wrong or whether it had any bearing on their estimate.
Anyway on the question of the purpose, I think the record is very clear that at no time and there is no suggestion anywhere in the record that there was ever a purpose of selling in order to make a profit.
Respondent's briefs attempts page after page, after page to develop some words, somewhere in the record that shows that but it's a total failure and I covered that in our replied brief.
No record and the record is there anything to support the idea that there was ever a plan to sell the property in order to make a profit.
And the finding of the District Court itself says, “That if their plans for development for income purposes would not carry out, were not successful, they would sell it off in bulk so they wouldn't get hurt.”
And insofar -- as far as I can see, that in itself indicates no idea of making profit on the thing like that.
In fact, it's the very reverse, it's what any normal businessman would do, if went into an investment program.
At some point, he would try to protect himself so he wouldn't get hurt.
That was all it was there.
Now, there is a similar conflict you might say in the opinion of the Court of Appeals which I will come to.
But, on that question, on the question of purpose and I might say hereto that after our open brief was filed, the Government brought up as part of the record as an addition to the record, the exhibits in the case.
And there was one exhibit there, the opening agreement of the partnership which shows its purpose, a very detailed agreement and nowhere, not in that document not anywhere else is there the least suggestion.
And the efforts of respondent to find a suggestion of a profit purpose has let it in it's brief -- in his brief into the some of the strangest conceptions of logic that I have ever seen.
But we have covered that in our reply brief and I don't want to take the time to repeat that now.
On the second question which perhaps is the question why this Court granted certiorari, the question as to whether assuming that situation that there could be such a thing under the tax law, under the word primarily held for sale to customer such a thing as a dual purpose in a situation of this kind.
I mean note in passing in that a respondent now concedes in his brief that there was a conflict between the Ninth and Eighth Circuits on that point.
But here we have the question of the meaning that Congress had in mind in the word ‘primarily'.
In the statute primarily help to sale to customers in the ordinary course of trade or business.
And it's my contention that the words ‘primarily' means, what the dictionary says it means.
There is not a single dictionary, and I went through 15 of them, they're all set forth in the opening brief.
Not one which defines it as meaning substantial.
Now, under that circumstance, there would have to be something in the statute that there was in the Agnew case which is referred to in both briefs.
Something in the statute were one provision said principally and the other one said primarily to indicate that Congress possibly had in mind, some kind of a difference.
But in this statute there is nothing that time.
There is simply the word ‘primarily' and I think it is the law that has been recognized for all these for -- for all the way back.
That when a Congress uses a term unless there is something in the statute or otherwise to require a special meaning that it means what it means in everyday usage so that the average person, the average taxpayer, I might say in this case, can know what it is that the law says.
And I think and I submit that the people are entitled to know what the law says.
Now, I don't doubt and the respondent has mentioned numerous cases.
There are many situations where there is a rent or sale situation like in Rollingwood.
The Rollingwood case in the Ninth Circuit, I think is a one of the good cases on that where property was rented with an option to the buyer to -- to purchase the property, any number of cases involving equipment sales, where it's a lease or option with an option to buy.
It's one of this lease or purchase agreements.
There are many of those.
Now, in a situation like that, it's entirely deferent and there I believe that the Government is entitled to view the sale as being made in the ordinary course of business.
In fact, the rental itself is a sort of a variant of a sale.
It's -- a very much like the installment character, its part and parcel with the whole -- of the whole transaction.
And the sale there is indissolubly a part of the transaction.
So in that case, I think it quite proper to hold.
In fact that I believe that follows the corn future case, the Corn Products case rather where the sales -- there's a course of sale which is part and parcel of the everyday operation.
Now, that's an entirely different thing because there -- the sales -- the property is held primarily for sale.
The sale is embedded in all the transactions and is the outcome of the transactions and the rental there is only a preliminary factor in those cases.
That's an entirely different story.
But here in this situation, where there was only a prospect, the possibility that eventually they might have to sell it to save themselves.
That's not a holding primarily for sale.
That's exact -- that District Court itself said.
That was held that they would sell it off in bulks so they wouldn't get hurt.
In fact, I would say that here since the whole plan was one for development as an income property and I might point out that the partnership agreement was a 30-year agreement.
That in that case, the sale eventually was actually in derogation of the primary purpose and not in preference of it.
Now, so that in this case on the question whether or not the property was primarily held the sale to the (Voice Overlap) this rent or sale cases have no bearing at all.
Now as a final position, the Court of Appeal said that when they've got to point where the partners had a dispute and they decided to sell the property, in effect really, it was sale to two of the partners.
When they got to that point, the Court of Appeals said, that the resolve to make that sale was the evidence of a purpose to hold for sale to customers in the ordinary course of trade or business.
Now, on the first place, that was obviously not the ordinary course of trade or business.
It was situation in which all but two partners liquidated themselves out.
And in the second place, it was -- well, if there's the same it's a different view of the same thing that was really a sale to other partners.
That could hardly be said to in the ordinary course of trade or business or the customers.
Justice John M. Harlan: (Inaudible)
Mr. George T. Altman: Well, there indications that the dispute develop over period of three or four months.
There was a ranking among the partners because of the difficulty in developing their original plan.
Now, I will come to what happen during that period which could be significant.
Now, let me -- I said that I was going to refer to a similar conflict in the Court of Appeals' opinion and let me show that.
I fail to pick this up in either of my briefs.
In the record, on page 33, where the Court of Appeals comes to the question of the eventual sale and they said that to put the question another way, was it the exercise of a purpose not to hold rather than of a purpose to hold for sale.
In other words, they were saying that if it was for the exercise of a purpose not to hold and that would simply be -- that would conflict with a capital gain position.
Whereas if it was for the exercise of a purpose to hold for sale, then it would to that court indicate a holding for sale of the customers.
Now, on the first place I don't believe that second position is sound either because, if you say that on the basis of this actual sale using that solely as evidence of a holding, you're begging question because there'd be no taxes if there were no sale.
There'd be no problem at all if there were no sales.
We would not be here before this Court.
They would be no gain.
There had to a sale in order to bring the issue up.
Now, if you going to rely on that very sale for proof a holding.
You're definitely begging the question.
Justice Potter Stewart: The taxpayer could never win that?
Mr. George T. Altman: He could never win, never win.
Justice Potter Stewart: I think this --
Mr. George T. Altman: But I want to go further now and show the conflict in the Court of Appeals have been when they say was it a holding -- was it a -- the exercise of a purpose and not to hold rather that of a purpose to hold for sale.
Let's go back to page 30 where the Court of Appeals in summarizing the fact says, “So we took the next route”, quoting now from testimony and proceeded to sell the lots, that was after they were faced with the interest charges and other costs, and the -- and then court goes on to say, the frontage parcels were retained still in a hope that commercial zoning could be secured as to them.
The prospect of rezoning remained discouraging and the rift developed among the venturers.
That's where they show -- when that prospect of rezoning became very dim.
That's when the rift developed among the -- of the venturers.
Then it says Lesser and two individuals wanted to get out and be done with it.
The other two wished to hold on.
Eventually, those who wished to get out including the Lesser sold out their interest which is in effect what they did because one of the sales was to the other, two partners had stayed in, and the other sale was to a business associate, one of them.
So, I'm comparing now these two positions.
Here, they say, “Lesser and two individuals wanted to get and be done with it.”
And over here the Court says, “What is the purpose not to hold.”
Now, that was a purpose then not to hold.
There wasn't a purpose to hold for sale.
That was a purpose simply not to hold and the court itself in its own statement on the facts brings out that purpose.
So that when it comes over to the final statement here, the Court of Appeals was in conflict with its own history of the case when they said that they try to see in there a purpose to hold for sale.
Of course, entirely out of this one transaction, they derive that purpose.
But the purpose to hold for sale rather than a purpose not to hold --
Justice Abe Fortas: (Voice Overlap)
Mr. George T. Altman: In their own history of the case shows it was a purpose strictly not to hold.
Justice Abe Fortas: I note that there was a merely uncontested return with respect to the -- some of these lots --
Mr. George T. Altman: Yes.
The inner portion --
Justice Abe Fortas: -- at the same account?
Mr. George T. Altman: When they found that they were faced with interest charges and this is as the Court of Appeals summarized it in taxes and other costs.
These inner parcels, this had been subdivided not for the purpose of sale but subdivided for the purpose of smaller units --
Justice Abe Fortas: Oh, whatever --
Mr. George T. Altman: -- of development.
Justice Abe Fortas: Whatever the purpose was, what is the --
Mr. George T. Altman: They reported that as ordinary income.
Justice Abe Fortas: That's right.
Mr. George T. Altman: Yes, sir.
Justice Abe Fortas: And I (Voice Overlap) --
Mr. George T. Altman: And that has never been challenge --
Justice Abe Fortas: What is -- what difference is there in term -- in legal terms?
What differences there in legal terms between the status of the profit on the first transactions with respect to small lots and (Voice Overlap) --
Mr. George T. Altman: Well, I think the proceeded on the theory -- Your Honor, they proceeded on the theory that the property had been subdivided.
In other words, I -- I think you will find quite a few cases on that that where the property is subdivided.
Although, there are cases to the contrary that even subdivisions, if there was a purpose to sell as they sold these inner lots because there were faced with charges and they had no money that that would not derogate against a position that it was capital gain.
There are cases that indicate that but there are cases that simply say that if there was -- if there was subdivided that's that in its ordinary income.
Justice Abe Fortas: And your --
Mr. George T. Altman: It was strictly on that basis and none other.
Justice Abe Fortas: Well, what is the difference in theory?
We have -- this Court does not so held, does it?
Mr. George T. Altman: I don't think so.
I don't think this Court --
Justice Abe Fortas: What is -- what is --
Mr. George T. Altman: -- has so held.
Justice Abe Fortas: What is the difference in legal theory, a statutory construction between the first group of transactions and the one that you're presenting to us today?
Mr. George T. Altman: Well, the factual difference Your Honor, if may speak of the factual difference first --
Justice Abe Fortas: I know it --
Mr. George T. Altman: -- is very great.
The first group had been subdivided, broken up.
The second were two pieces of the property that it had not been touch.
There was no improvement of any kind on it.
Justice Abe Fortas: Well, are you saying that it is just a matter of size and from that you deduce.
Mr. George T. Altman: No.
Justice Abe Fortas: -- intent or -- (Voice Overlap)
Mr. George T. Altman: No.
The only difference that I can see and as I say, the fact is, I might point out a very recent case.
I don't want to drag this in before the Court but the Fifth Circuit just decided in a case involving subdivision.
That it was capital gain not ordinary income and it's a split case, who just came through in the reports, the Temple case.
And so, this Court may eventually be faced with that problem.
But I think the only reason why they reported it as ordinary income was the fact that it had been subdivided and nothing else.
Justice Abe Fortas: So what is the difference in theory between the (Voice Overlap) --
Mr. George T. Altman: Well the theory, there is a difference.
There is --
Justice Abe Fortas: -- that you're submitting to us?
Mr. George T. Altman: Yes.
There is substantial difference in theory, I might say.
I think there is a sound basis for treating a sale of subdivided lots as ordinary income.
And that is that there was a gain and value simply from the -- from the Act of Subdivision.
Justice Abe Fortas: Well, I understand that but all of these tracts, the tracts that were involve in the first group of transaction --
Mr. George T. Altman: Yes.
Justice Abe Fortas: -- was in the tract that is before us now --
Mr. George T. Altman: Yes.
Justice Abe Fortas: -- were part of the same deal, weren't they?
Mr. George T. Altman: They were part of the original purchase.
Justice Abe Fortas: That's right.
Mr. George T. Altman: And these two --
Justice Abe Fortas: And now as I understand it, you're -- we are here confronted with the situation in which some of the lots were sold off and there is no contest, I take it, that the profit to subject ordinary --
Mr. George T. Altman: There is no contest.
We have not raised that.
I might say that I myself I have some slight doubt about it, based upon other cases as to whether they should have reported the subdivided lots as ordinary income.
I have some reservations on that but this issue is not brought up and they reported it as ordinary income.
Justice Abe Fortas: Well, perhaps I can simplify it by saying that, am I correct in understanding that you are not submitting to us any circumstances with respect to ownership or intent of the tidiness that affected the first group of transactions and did not affect to transaction that is before us in this case.
Mr. George T. Altman: You mean as to originally intent?
Justice Abe Fortas: Take it you way.
Mr. George T. Altman: I think you're correct.
I think so.
Now, for that reason I'd like to bring now then now.
What happened between the close of escrow and the sale of these two unimproved parcels?
The recitation of the history of the case in the Court of Appeals shows, that the inner group of lots were sold because they needed money for the taxes interest charges and a so forth.
Now, the evidence is very clear that after that took place, they didn't need any money.
They could hold and were planning to hold the two frontages, they were just holding them and that's when the rift started and the sale was entirely because of the rift.
I think this is brought up in my opening brief and in fact, I have something in my reply brief too on the same -- on the same points showing that -- oh, yes!
On pages 7 and 8 of my opening brief and this was testimony brought out by the respondent.
Evidence brought out by the respondent which says and then the Court said, there what I -- he said, “I think, he said that was a reason that they sold that, isn't that right?”
And then the Court says, “That was the only reason, they had a dispute.”
The witness, “We could well still be sitting with that property waiting to develop it if they have been a rapport among the partners.
We weren't press for cash.
At that point, they were not press for cash, it was the difference.
When they sold inner group, they were pressed for money.
They had to meet as the Court of Appeals brings out all of these charges.
But after was done, they no longer were pressed for cash.
They were able to hold and they were planning to hold.
And then the court -- the District Court said, “I try to question Mr. Malat there.
The Court interrupted me.”
And he said, “He says, Mr. Altman and it's very clear, he said more than once.
The reason they sold it was because of the accruement and the dispute and the ill feeling between the partners."
And then I said yet -- “Yes.”
And then the court said, “That is a reason they sold it.”
They have this plan and they would have held it and made all three if they couldn't get the commercial zoning.
It's very clear, in fact in my reply brief, I'm watching clock because I'd like to have a couple minutes left if I can for a rebuttal if necessary.
But in my reply brief, I bring out some other testimony and this was a deposition right into the record by respondent, not by the taxpayer.
In which speaking of time of the sale, the -- the witness stated, oh, simply that they were not offering it.
They were not holding it for sale.
They were not offering at the time that the sale took place.
They were not making offers of that property for sale.
It's a -- somewhere in this --
Justice William J. Brennan: Page 11.
Mr. George T. Altman: -- page 11.
Incidentally even at that time and this is right into the record by the respondent.
We were not offering those properties.
That is the two frontage pieces for sale, the Crenshaw and Century properties.
They were not listed with brokers.
They were not advertised for sale.
They were not being offered for sale.
And then I think are also have quote from one of the respondent's witnesses where -- oh, yes!
On page 6 were he says, “Well, I think it goes much further than that.
We were not happy with the other people specially lessor.
And we made the partnership an author of those substantial prices for the land and said, either the land should be sold to somebody else or sold to us.”
That's what happened, and so the land was sold to them and the respondent in his brief attempts to bring out that the -- the purpose of the buying partners, the statements of the buying partners that -- that the reason why they bought it was to make a profit on the sales.
Now, naturally that would mean only a resale by them, they could not say that they bought the property in order to make a profit for the sellers.
That -- I couldn't understand that at all and the testimony bears out simply the fact it was -- that was a reason why they bought it, that's all.
And there is nothing, nothing whatever and I've gone through it page by page and line by line, not just the record but the respondent's brief.
And there is nothing to support the idea that there was a purpose of profit on the sale anywhere in this record.
And the record is clear, that between the time that the inner portion was sold, that after the inner portion was sold they no longer had any need from money.
They were there in the position to hold and intended to hold for development, for income purposes.
So that when this time came for the sale, there was nothing but that sale.
There is nothing else upon which the respondent can rely to show that there was any purpose of holding for sale at that point.
And I think to that's fundamental because under the law the question of holding for sale to customers must be attributed to the period in which the sale took place or the immediately prior period.
It couldn't go way back to the beginning either.
And there -- the Court of Appeals itself says that many changes took place during that period and I want to point this out and -- I don't know if the Court is familiar with Los Angeles statistics.
But land goes up and value there from one day to the next.
It doesn't get this matter of 15 months from the beginning of escrow to the sale.
It's a long time in Los Angeles.
Sales of many pieces of land have doubled and tripled and quadrupled in value in less time than that.
I will leave it at this Your Honor and I hope that if have to have couple minutes left if I need a --
Chief Justice Earl Warren: You only have three minutes left.
Mr. George T. Altman: Thank you.
Chief Justice Earl Warren: Yes.
Argument of Jack S. Levin
Mr. Jack S. Levin: Mr. Chief Justice, may it please the Court.
I would like at the outset to put the factual question which petitioner has argued in its proper legal context.
The statute which we are here concerned with is Section 1221 of the Internal Revenue Code of 1954 which is printed at page 2 of our brief.
Now, the statute in general strokes sets up assistant whereby a taxpayer is entitled to report as capital gain, sales of property where that property fits within certain categories and one of the excluded categories from capital gain, is property held by the taxpayer primarily for sale to customers in the ordinary course of business.
And as this Court has recognized in a number of previous decisions including the Corn Products case, the general intent of Congress was to tax as ordinary income the everyday profits of a business, but to give capital gain on passive long term accretions in value and it has a -- of course no little problem in distinguishing between the two types of profits.
Those from a business on the one hand and those from passive or long term accretions in value on the other, many cases for somewhere in the middle.
The traditional touchstone is been one of asking whether the taxpayer was in business, whether the taxpayer was in business has frequently been -- almost always been left to the trier of fact as a factual question with proper instructions from the judge.
The courts have enunciated a number of factors bearing upon whether a person is in business.
These factors have been included the number of transactions into which he enters, the continuity of the transactions, the size and extent of the transactions.
The -- activities in which he engage.
Where a taxpayer was engaged in enough activity then he was in business and if he brought a piece of real estate and he was an attorney who were never engaged in real estate transactions before and held this one piece real estate and sold it 20 years later, he got capital gain on that sale.
If, however, his activities in the real estate business were sufficiently substantial, so that the trier of fact could, under proper legal standards, find that he was in the trade of business then he got ordinary income.
And the question of whether you are in a business and whether the particular property on which the gain was realized was held for sale in the course of that business are typically factual type questions.
Justice Potter Stewart: The -- of course the statute doesn't quite describe the definition that you as said.
Mr. Jack S. Levin: No.
Justice Potter Stewart: -- the properties held primarily --
Mr. Jack S. Levin: No.
Justice Potter Stewart: -- for the sale to customers.
Mr. Jack S. Levin: That's right.
That there is -- there are here two questions.
One is the factual question.
That is, “Were there people in a business, did they hold this property for sale in the business?
And what were their intentions?”
Those are things in which we have the findings of two lower courts and we have a great amount testimony.
I will be happy to detail that testimony.
I think it supports our position.
The second question and the one I -- I assume this Court granted certiorari to, to resolve if possible, is the legal question as to what the phrase ‘property held by the taxpayer primarily for sale to customers in the ordinary course of this trade of business' means.
Justice Potter Stewart: And it narrowed down really, doesn't it or am I mistaken to the meaning of the word ‘primarily' in the statute?
Mr. Jack S. Levin: That's -- that's right.
This -- this Court has frequently recognized that the capital gain statute is perhaps not the most articulately worded statute and it has -- it has recognized that in many instances its got to interpret it with the intension of Congress in mind.
Now, here the dispute in a number of case coming to the Courts of Appeals, and we have approximately six Courts of Appeals, five Courts of Appeals I think in Court of Claims ruling on this question.
That the legal question which we put forth in our brief, is whether a taxpayer, who is in the regular business of both selling and renting the same type of assets, whether that that be real estate that he said -- he buys it and then either sells or rent it, whether it be computers that they manufacture or buy and then and sell or rent or water coolers or recording equipment.
The cases are concern items of this nature.
When the taxpayer acquires an asset which he intends either to rent or to sell and one can say that majority of his income is derived from rental.
And only the minority from the sale, say, he sells 70%, he rents 70% of the -- of the computers or real estate and he only sales 30% of it in the normal course of his business.
The Court has found this to be -- assuming the Court has found this to be a business that he's on a business both selling and renting, can you say that taxpayer has held the property primarily for sale to customers in the ordinary course of this business?
The taxpayers have contended that ‘primarily' means ‘chief' or ‘first' or ‘primary' and that you've got to look the chief motive which they had and if they acquired it with a -- with the motive in mind to rent if possible or with the thought in mind that they acquire 70% of their income from the rental, then they say their chief motive was rental.
And their motive of selling in the ordinary course of business was a subsidiary or secondary motive.
It is our position that the word ‘primary' here is broader than that.
It doesn't mean solely the chief motive.
This Court had a case before it Board of Governors versus Agnew a few years back in which the exact same word was involved, the word ‘primarily'.
There the question is whether someone was primarily engaged in the underwriting business when that was only 30% of their income and they get 70% of their income from acting as broker and dealer, etcetera.
And there the Court said that where the legislative history demonstrates that the context in which Congress used the word ‘primarily', they're primarily engaged in underwriting was such that it would be more logical in order to accomplish the end sought, the evils to be remedied, etcetera.
The word ‘primarily' could be interpreted as meaning ‘essential' or ‘substantial'.
It is our position here that the legislative of history and the clear intent of the capital gains statute were to catch up as ordinary income whether it be with this phrase or some order phrase, we think this is been being the most apt phrase in the exceptions to capital gain.
All the everyday profits of the business enterprise, so that if you're in the business of acquiring land, computers, water coolers or what have you for either rental or sale, that your sales in the normal course of business must produce ordinary income and if necessary this Court will interpret the word ‘primarily' as having the broader scope that it had in the Agnew case.
Justice William J. Brennan: The issue is little different in the Agnew case.
Here for example, you could find these petitioners or just take some imaginary businessman who are surely in the business of -- of a fine and selling real estate to customers 80% of their business was that and the 20% of their business was a buying real estate and renting, apartment houses and renting them.
Well, don't you have to look -- alright, he's primarily in the business of selling real estate to customers in the ordinary course of business by my definition.
His 80% of his business is that?
Mr. Jack S. Levin: Yes.
Justice William J. Brennan: But you don't have to look the particular piece of property over the statute?
Mr. Jack S. Levin: Absolutely.
No question about it.
If the man acquired this particular piece of property and he said, “All I'm going to do is rent this out.
I have no intention to sell it,” and the court find that that in truth was his intent, well then, his entitle to capital gain.
And the same thing is through here, these taxpayers did not vigorously contend, not too vigorous contend that they weren't really in the business of selling, their major contention was this piece of property was not acquired for the purpose of selling in the ordinary course of business.
It is our position which I -- I will now attempt to demonstrate from the record that the lower court found and the records supports the findings that this taxpayer, these taxpayers, the joint ventured by taxpayers acquired this 45-acre piece of property with the intention either to build on it and then rent it out or to sell it in the ordinary course of business either by individual lots or in larger chunks or in some combination of it whichever was more profitable.
Justice Abe Fortas: Mr. Levin, do you take the -- on the attempt of the taxpayer as of the time of the sale or do you take the original intent even though in last sentence, he used the word ‘your burden the intent at the time of acquisition is settled to me'.
Mr. Jack S. Levin: Well, Your Honor as we point out in our brief, this is -- this is not an easy question.
The statute says, “The purpose for which it was held by the taxpayer.”
Justice Abe Fortas: Yes.
Mr. Jack S. Levin: We do not think that the purpose for which was acquired is determinative nor do we think that the purpose for which was sold is solely determinative.
We do not go so far, nor did the Court of Appeals go so far as petitioner pointed out.
We do not contend that the mere fact that a person sold the piece property indicates that he held that for the purpose of sale in the ordinary course of business to customers.
We don't go nearly that far.
If -- if a taxpayer acquires a piece of property with the intention solely to rent it out and then at some point his intent changes and he has a great deal of activity.
Let say, he acquires a hundred-acre piece of property with the intent just to rent it out.
But then he realizes that it would be much better to break it up into 500 lots and he puts in streets and sewers and so forth he goes -- he goes to a lot of activity.
He hires a hundred salesmen, sends them out, and goes full scale in a business.
His intent has changed.
His purpose for holding the property has changed.
He gets ordinary income.
You can change your purpose.
However, the purpose for which you acquire piece of property is relevant whether there is no evidence of change.
Here, we contend that the taxpayer's original purpose of acquisition and his purpose during the entire nine-month period that he held the property was to explore all the ways in which he could profit from it.
Including building shopping centers, building apartment buildings, subdividing a part of it, selling part of it in 10-acre lots.
Doing whatever he could to profit from it.
We think that the first instance which tends to show that and which I'd like to point out in order to put this in its context is that of the five venturers who formed this joint venture and acquired the 45-acre parcel, three were engaged in the real estate business full time.
Petitioner, who was a member of the joint venture only and that he represented Louis Lesser Enterprises a partnership.
Louis Lesser Enterprises, it was one-fifth owner of this venture and petitioner was a general partner in Louis Lesser Enterprises.
Louis Lesser Enterprises which had been formed five years before had during its five-year existence, engaged in the construction and rental of approximately 300 duplex apartment buildings and homes.
It had engaged in building and managing of two shopping center projects and the rental of an office building.
It had engaged in seven venturers, at least seven venturers the record shows, where land was acquired and subdivided for sale and all of those profits reported as ordinary income apparently that they were in a business.
And it is engaged in at least five or perhaps eight sales of raw land in bulk and bigger than individual lot sizes, for a total consideration of at least a $1,300,000.
Justice Abe Fortas: That's a total consideration that all the transaction --
Mr. Jack S. Levin: That's right.
Justice Abe Fortas: -- including --
Mr. Jack S. Levin: If --
Justice Abe Fortas: -- including the --
Mr. Jack S. Levin: That's right.
Justice Abe Fortas: -- ones that are clearly of a capital gains nature.
Mr. Jack S. Levin: Well, --
Justice Abe Fortas: And the ones that are -- they rent only?
Mr. Jack S. Levin: We -- we do not concede that any of the transactions were clearly of a capital gains nature.
Justice Abe Fortas: I thought you said in the response to --
Mr. Jack S. Levin: Any of these particular transactions --
Justice Abe Fortas: No.
No, I'm talking about this particular are you describing business of Lesser Company in generally.
And I thought you responded in my -- response to the question by my brother Stewart that you take it and you would pay some attention.
They could separate the tax consequences on the basis of an individual bought the property?
Mr. Jack S. Levin: You could.
It depend on --
Justice Potter Stewart: You could and you must under the statute, mustn't you?
Mr. Jack S. Levin: Yes.
Justice Potter Stewart: Yes.
Mr. Jack S. Levin: We agree, you must.
I -- but -- I thought your question was more directed to whether some of these sales were entitled to capital gain treatment.
Justice Abe Fortas: Oh, what I'm really asking is whether -- is there any dispute in your mind as to the major or majority whatever you want to call it trust of the Lesser business.
Mr. Jack S. Levin: Well -- what I'm tempting to demonstrate here is that as regular part of their business they engaged in all facets of the real estate transactions.
Including purchasing land to build on, shopping centers, duplex-apartment buildings, shopping centers to subdivide, to sell by lots or to sell in large blocks, and I'm pointing out to all the transactions which they engage in which form the context in which the District Court reached its conclusion.
There was testimony on at least two of these eight sales of real estate, that the taxpayers said, “Oh, well this one was a sale for $621,000”.
The taxpayer said, “Oh well this was the hundred acres left over after we finish setting up the subdivision.”
And I think it -- it's not worthy to that piece of property held eight months, so in eight months the acquired piece of property apparently they could subdivide a part.
And eight months later sold the hundred acres for $621,000 yielding a profit a $25,000.
What I'm pointing out is course of conduct.
Justice Abe Fortas: In what -- in what category does that fall?
Mr. Jack S. Levin: Well, since this case did not concern that piece of property with an earlier year, apparently the statute of limitations run.
That's not here in question.
Justice Abe Fortas: I know that but do you know how it was treated by the taxpayer?
Mr. Jack S. Levin: Yes.
The taxpayer reported capital gain on a number these transactions including this one.
A deficiency notice was served upon the taxpayer and setting forth the proposition that all of these sales of the real estate including the one we are now talking about which is called the Buena Park real estate that the proper -- that $125,000 profit and all the other profits were ordinary income on the ground that they were engaged in the real estate business.
Taxpayer then paid the entire deficiency which included the deficiency now in question that is on the Century Crenshaw Land and all the other pieces of real estate.
He's filed for a refund only on this one piece of property, thus, he has paid in the ordinary income tax on the other pieces.
I don't know if by that -- I don't by that contend that he has conceded anything in discussions of that counsel.
He assumes, he doesn't concede that that was right but they did pay that deficiency, did not sue for refund of that portion.
So while they originally paid capital gains tax on it, they later made up the rest of the tax and have paid ordinary income tax and not sued for refund the statute now having run.
In addition to Lesser Enterprises which I believe this is clearly in all faces of the real estate business.
Two of the other venturers were man named Hicks.
Mr. Hicks was the record shows a real estate broker and Mr. Fenmore.
The record shows that Mr. Fenmore was engaged principally in the real estate business and that had -- he had been engaged in the real estate business for 20 years according to his own testimony.
The other two joint venturers were not full time in the real estate business so far as the record discloses, although, one was looking full time for a real estate deals whatever that means.
Now, I point this out as the context in which the District Court got this case.
Here what three people, that is petitioner in behalf of Lesser Enterprises, Hicks and Fenmore.
Three of the five joint venturers, who were in the real estate business, who were in the habit of handling property, acquiring it in logic, in common sense shows that they acquired property for whatever purpose they could make a profit on it.
If they could build on it, they did so.
If they couldn't get financing they subdivided it, if it look more probably sold in bulk.
Now turning to this piece of property, what were their intentions with regard to this piece of property?
The petitioner testified that it was located in a fast growing area.
And that the -- they had made a good buy as far as price was concerned.
He also testified that they hope to build an apartment development on the entire 45-acres but when they purchased the property, before they purchased the property, they knew that the mortgage market was rough because they were trying to get financing for other similar deals.
As it turned out they were unnable to get financing.
The mortgage market remained rough.
They also had hopes of getting commercial zoning on the two frontage parcels, the two 10-acred parcels which are here in question.They never did get commercial zoning on it.
In fact, what happened is they acquired the property, within two months being unable to get financing.
They began subdividing the interior 25-acres.
They subdivided it into 105 parcels and within nine months after acquisition it sold the entire 105 parcels reporting the income as the capital gain.
That is ordinary income.
Excuse me, that is ordinary income.
During this period, they had received the number of fillers, the word ‘fillers' is used in the record, with regard to the two, 10-acre frontages.
That is the frontage on the Century Boulevard and the frontage on Crenshaw Boulevard that they had not subdivided.
Within nine months after the acquisition of property, they in fact sold those two frontages making a profit on a two frontages of $127,000 which is the profit here in question.
Now, the testimony on their intention for holding the property other than it was fast are and that they made -- in a fast growing area and they've made a good buy as far as price was concerned was the following.
Counsel of the Government asked, “Did you con --” asked the petitioner -- “did you contemplate in acquiring the property, the possibility that rezoning or refinancing or whatever might not be possible?”
He replied, “This is always a possibility.
We felt that we have made a good buy in the property as far as price is concerned, so that if we couldn't do anything in the way zoning, we would sell the whole thing off in bulk.”
He then testified two pages later that, “The type of mortgage financing that we would like for apartment developing was not available.
That is financing that would permit us to build apartments for rent and get what we felt was a reasonable return on our equity investment.”
When they found that they could not get a reasonable return on their equity investment by building.
They then subdivided the interior 25 acres, sold the two 10-acre parcels.
Mr. Fenmore, one of the other joint venturers testified, “My own understanding of why we sold it, why in our case we bought it was there was a chance to make a very substantial profit on the sale or sales.
And we proceeded to do it.”
On the basis of this testimony, the District Court concluded that the subject real property was held for development or sale depending upon which course appeared to be most profitable.
And the plaintiffs have failed to establish by a preponderance of the evidence that the subject real property was not held by Plaza, primarily for sale the customers in the ordinary course of its trade or business.
He'd already said that primarily meant something broader than cheaper principle.
Now, one other factual point before I -- before I finish with the facts, petitioner has talked a great deal about the rift among the partners.
That they wouldn't give sold this property, these two frontage parcels which they were holding for long term investment.
They would have sold those within nine months after acquisition but for the fact that a rift developed.
Now, it is our position that the District Court heard conflicting testimony on whether the rift caused the sale or not and determined the facts.
I reach very briefly the relevant testimony.
Petitioner testified that the lack of report among the partners was one of the elements that entered into the decision it sell.
Mr. Fenmore in the other hand, one of the joint venturers testified, that there was no serious rift among the partners until after the sale of the two parcels here in question.
One more piece of testimony, the petitioner testified that the rift was between Misters Rogen and Millman on the one hand.
The two men were not at real estate business full time and Mr. Fenmore and the other.
Mr. Fenmore then testified that he remain partners with both Misters Rogen and Millman in another real estate deal for at least six years after the instant sale.
Now, on the basis of this testimony which -- which we believe is certainly a testimony, each way is to just how instrumental some disagreement was because Mr. Fenmore himself testified that there was nothing of any serious nature other than the usual partnership disagreements, we -- which contend that this testimony shows some conflict as to just what role a possible disagreement may have had in causing the sale.
On that basis, the District Court found that any rift among the partners may have expedited the sale but that it didn't change the essential nature of the -- of the parties' intent.
Justice Potter Stewart: Mr. Levin, we are not here really to weigh the evidence but --
Mr. Jack S. Levin: No.
Justice Potter Stewart: -- whether to decide whether or not the Court of Appeals and the District Court applied the correct test under the --
Mr. Jack S. Levin: That's right.
Justice Potter Stewart: -- statute and that --
Mr. Jack S. Levin: I -- I turn it only because petitioner he has argued it rather extensively.
Justice Potter Stewart: The Court of Appeals had the ‘primary' meant -- ‘primarily' meant to a ‘substantially' and the Court of Appeals for the Eighth Circuit is said that primary -- ‘primarily' means ‘predominantly' and so and then the Sixth Circuit and the Second Circuit of taking kind of a middle course.
Mr. Jack S. Levin: Well, I -- no I don't think they're taking the middle course.
I think that the Second Circuit, the Sixth Circuit, the Ninth Circuit, and the Court of Claims have all gone along with the position we are here advocating.
Justice Potter Stewart: The Eighth Circuit has said that --
Mr. Jack S. Levin: The Eighth Circuit which by (Voice Overlap) --
Justice Potter Stewart: -- primarily?
Mr. Jack S. Levin: The Eighth Circuit has said in the case somewhat similar to this.
You look at -- for the chief purpose for which it was acquired and if the chief purpose or the parties' major intent was to build on it and rent, the fact that they also had the intention to sell and eventually, did sell in the ordinary course of business has given capital gain.
It is -- it is our position that the factual context in which this case arises, well not the -- possibly not the clearest case of the rent or sale dual business is one aspect of the rent or sell business.
These people, we think, acquired the property for the purpose of either renting or selling whichever was more profitable.
We think it just exactly like the Court of Claims case Recordak, in the Recordak case or the -- there was recording machinery of some type, that the taxpayer manufactured and then either rent it or sold.
And they said, “Well, we get the best majority of our income from the rentals of the recording machines rather that from sales.
Therefore, our primary purpose in holding any given machine is for rental rather that for sale.”
The Court said that whatever the price -- precise scope of the troublesome term ‘primarily' in other context, it does not exclude from ordinary income the proceeds of sales by one who conducts a dual enterprise involving both rentals and sales.
In that setting, primarily invokes the contrast not between selling and renting but between selling in the ordinary course of business and selling outside of that normal course of business.
And in reaching that conclusion, the Court reviewed the cases which this Court is decided such as Corn Products and the Gillette Motor case in which this Court has said that in order to effectuate Congress' intention to tax his ordinary income, the everyday business profits of an enterprise, it would read broadly the exceptions from capital gain and where necessary, it would construe “other than their ordinary sense.”
And that's quotation, “Other than their ordinary sense”, the language of the capital gain statute.
Justice Abe Fortas: Suppose there were incontestable finding that these people are required at all of these property or purposes of a development on the rental basis and that there came a point of time where for whatever reason, they subdivided some of it and sold it all and paid capital gains, have paid the tax on that at ordinary income rates.
But as to a portion of the land, the original intent carried through and they held that, and sold couple of large tracts of a raw land.
Where would we come out on the tax analysis of that?
Mr. Jack S. Levin: I -- I think you could very welcome out much differently.
Many of the questions would be primarily questions of fact.
In other words, if the case was a practicing lawyer, who had acquired a 200-acre piece real estate and held that for 20 years, never engaged in the real estate business before.
Held it for 20 years and then he wanted to get rid of it to put his children through college.So he --
Justice Abe Fortas: No, no.
But that you say (Voice Overlap) --
Mr. Jack S. Levin: -- subdivided in 50-acre.
Justice Abe Fortas: Yes.
But I -- you don't want to say -- press that to you because that would lead to the conclusion that people who are engaged in the general real estate business as you described, for example, the Lesser properties here could never get capital gain, is that --
Mr. Jack S. Levin: No, we don't take position.
Even if he was engaged in the real estate business, I -- I'll take another example, an individual's engaged in the real estate business.
His real estate business is that he generally buys and sells pieces of property both in bulk and by through subdividing and he generally turns them over within two years each.
That's reasonable, it's a reasonable elapsed time for turning properties over, improving them, putting in streets sewers, etcetera, doing whatever is necessary to make them more salable.
He engages in these activities, he has salesman, he has an office.
Engages in a regular course of activates, he generally turns it over for two years.
He acquires another piece of property.Generally, he deals let's say in farmland which he's turning into subdivision or for development.
Here he acquires a lot in the city or even another large tract somewhere else which he doesn't apply his normal business acumen to.
He doesn't subdivide it.
He doesn't turn it over.
He doesn't bring to bear his salesman and all of his activities.
But he puts it aside and lets it sit 20 years.
Then when he wants to get rid of it, he takes one portion of it and he subdivides it.
We do not contend that that necessarily would bring the other portion within the scope of his business.
It's a factual question in most difficult cases to be determined on proper standards of law.
Justice Abe Fortas: Well, that so, how do you arrive at your result in the present case?
How do you distinguish the present case from the last example that you put?
Mr. Jack S. Levin: We -- we think that the --
Justice Abe Fortas: What are the crucial factors?
Mr. Jack S. Levin: Well, the crucial factors, alright.
One fact is that we think the record shows that the regular course of these people's dealings where to acquire pieces of property of this type 45 acres, a hundred acres to hold it for a years, a year and half whatever period that that the record shows a number of such transactions to a -- meanwhile explore whether they could build the apartment buildings on it, what the mortgage market was like, what the zoning situations was like.
Within a few months they decide whether they would abandon their original -- one of the original dual intentions, that is to build on it and rent it out.
If they abandon, they would then subdivide parts of its, self parts of it in bulk.
There are at least two and possibly more transactions where they did exactly that.
In the Buena Park transaction, they held it eight months subdividing part selling a hundred acres in bulk.
In the Garden Canyon transaction, they did the same thing, although, holding period is not shown.
Developed part of it and sold the rest in bulk.
It is our position that the regular course of business for these people that the way and which they earn their living was through rentals, through sales of subdivision individual lots, through sales of larger pieces in bulk but this is what they employed their full time business activities on.
It is our position that the facts bear out the findings of the two lower courts and it is our position that when you have that's sort of a factual dual purpose business that they cannot avoid ordinary income under everyday business profits through the argument that they were not holding the piece of property -- property primarily for sale to customers in the ordinary course of business but that was merely their secondary intention.
Chief Justice Earl Warren: Mr. Altman.
Rebuttal of George T. Altman
Mr. George T. Altman: Yes.
Everything I think that counsel has said is quite thoroughly covered in my briefs, the opening and the closing briefs so I'll leave most of it to that.
There are just a couple of points, one is this.
Counsel said that the statute was not very clearly drawn.
Just what he meant by that I'm not sure but I believe it -- this question has never come up in this case before this point.
I believe it's again well understood and held by this Court over a long period that if there was a doubt in the statute it couldn't be held against the taxpayer.
So, that's -- on that point, there is just one other point and this is, I frankly say, a repetition by me.
The Court of Appeals itself set out and I'm reading again what I read a half an hour ago.
The prospects of resorting remained discouraging in a rift about among the venturers Lesser and two individuals wanted to get and get done with it, the other two wish to hold on, eventually, those who wished to get out including Lesser sold their interest.
I don't believe that on the basis of that statement, it is possible to derive the conclusion that the Court of Appeals derived.
Because by their own statement they say at the end of the question is whether their -- the purpose was not to hold or to hold for sale.
But that statement of the facts by the Court of Appeals itself shows that the purpose of the sale was not to hold as far as the sellers were concern.