cost basis for the stock warrants. The stock warrants cost neither the trustees nor the beneficiaries of the trust anything when distributed to them. Of course the claim of the trustees for accumulated and unpaid interest on the debentures was a valuable right, but since this unpaid interest was never taken into income by the trustees, it had no cost basis to them. Petitioners do not contend that the past due and unpaid interest on the debentures had any cost basis to them. What they are contending is that the $1,452,000 stipulated cost of the debentures should be allocated between the preferred stock and the stock purchase warrants. But for reasons we have already stated we reject this contention. Therefore, in 1941, when petitioners, beneficiaries of the trust, sold the warrants here involved, they had no cost basis under section 113 of the code and all that they received, less expense of selling, represented gain to them. That gain the Commissioner has determined shall be taken into account at capital gain rates, and in this determination we sustain him. So far as we can see, there is nothing in this holding which is in conflict with Morainville v. Commissioner, supra; Skenandoa Rayon Corporation v. Commissioner, 122 Fed. (2d) 268, affirming 42 B. T. A. 1287; South Atlantic Steamship Line, 42 B. T. A. 705, and other cases along the same line cited by petitioners in their brief. So far as the question we have here to decide is concerned, we do not think they are in point. Decision will be entered for the respondent. FRIEDA E. J. FARLEY, PETITIONER, V. COMMISSIONER OF INTERNAL ELMER A. FARLEY, PETITIONER, V. COMMISSIONER OF INTERNAL Docket Nos. 8961, 8962. Promulgated June 20, 1946. Petitioners, husband and wife, acquired in 1923 and 1925 real estate in New Orleans as community property. The property was acquired and used in connection with petitioners' nursery business. The property had been platted some years before purchase by petitioners. In 1937 the city of New Orleans built streets through the property at its own expense in accordance with the original plats. This was not desired or requested by petitioners, whose property was thus increased in value for residential purposes but decreased in value for use as a nursery. During the taxable year petitioners sold 251⁄2 lots to various purchasers, realizing a profit thereon of $14.816.37. Petitioners made no active efforts to sell, but accepted such satisfactory offers as were made. Petitioners did not advertise the property for sale, hired no agents, erected no signs, did not list the property, or construct any improvements to facilitate its sale for residential purposes. Held, the property was not held by petitioners primarily for sale to customers in the ordinary course of their trade or business within the meaning of section 117 (a) (1) of the Internal Revenue Code; held, further, that the profit derived from the sales in question is taxable as long term capital gain and not as ordinary income. John F. Hartmann, C. P. A., and Louis H. Yarrut, Esq., for the petitioners. Frank B. Schlosser, Esq., for the respondent. Respondent determined deficiencies in petitioners' income tax liabilities for the fiscal year ended July 31, 1941, of $845.56 in Docket No. 8961 and $845.56 in Docket No. 8962. The question is whether the profit from the sale of certain real estate, owned by the petitioners as community property, is taxable as ordinary income or as capital gain. The two cases have been consolidated. The record consists of oral testimony and exhibits. Petitioners filed separate returns with the collector for the district of Louisiana. FINDINGS OF FACT. Petitioners are husband and wife residing in the city of New Orleans, Louisiana. Since Elmer A. Farley, the husband, is the active head of the business and manages the community property here involved, he will be referred to hereinafter as the petitioner for the sake of convenience. Since 1908 petitioner has been in the nursery, florist, and landscaping business, using for this purpose various tracts of land in and adjacent to a section of New Orleans known as Gentilly Terrace. Titles to the various tracts of land so used were acquired by petitioner at various times, as follows: These tracts constitute together one irregularly shaped but contiguous area and were acquired for use in petitioner's nursery business. Squares 1 to 4, inclusive, are within and part of the Gentilly Terrace section and hereinafter will be referred to sometimes as the Gentilly Squares. The Gentilly Squares had been platted and each had been divided into numbered lots by the city engineer of New Orleans in 1909. The platted squares were bordered by platted streets which had been similarly designated by the city engineer. The Gentilly Squares, as platted, and their bordering streets had been officially delineated on a map which was of record in the city engineer's office in New Orleans. When the Gentilly Squares were acquired by petitioner and until 1937, however, these streets existed only on paper. Until 1937 these streets had no physical existence on the ground, but were merely in the nature of proposed development plans. The Gentilly Squares when acquired by petitioner constituted unimproved pastureland. It is not unusual in New Orleans for a suburban area to be platted although many years may intervene between the original platting and the physical execution of the plans. Petitioner used the entire area described above in connection with his nursery business. Petitioner built permanent structures, such as hothouses and sheds, on squares 3080 and 3081. The Gentilly Squares were used for growing nursery stock. Due to restrictions on the use of the Gentilly Squares contained in the conveyances, no permanent business structures or fences could be built on these squares. Petitioner's nursery business was on a large scale and he devoted his full time and attention to its management. His wife and four of his five children assisted him in the business. In 1937 the city of New Orleans caused the platted streets to be built through Gentilly Squares. The construction of these streets was not requested or desired by petitioner, but was done at the behest of various individuals who were interested in real estate in the vicinity. New Orleans employed W. P. A. labor in the construction of these streets, which was not financed in any way by petitioner. Petitioner did furnish the materials required in constructing curbings and sidewalks at a cost to him of $1,773.01. The furnishing of curbing and sidewalk material to the city by owners whose property flanked public streets was customary in New Orleans. The construction of streets through the Gentilly Squares increased the value of such land for residential purposes, but substantially decreased its usefulness for nursery purposes. Due to the restrictions on the use of the Gentilly Squares, petitioner could not construct fences to protect his nursery stock on such land. The construction of the streets and the encroaching residential development in the area exposed petitioner's nursery stock to increasing dangers. In addition to the changing character of the area, petitioner was having difficulty in obtaining sufficient labor in 1940. During the taxable year ended July 31, 1941, petitioner sold a total of 252 lots to private purchasers out of the Gentilly Squares. Petitioner realized a gain of $14,816.37 on these sales. Petitioner did not advertise these lots for sale in any way, nor did he hire a real estate agent or list the property with any agents. On one occasion petitioner permitted an agent to erect a "Sold by" sign on the property. Except for furnishing sidewalk and curbing material, petitioner did not improve these lots in any way for purposes of sale. The initial purchasers of these lots were friends of petitioner. They went to him, unsolicited, and requested him to sell lots to them. These initial purchasers persuaded and attracted their friends and relatives to make similar purchases on adjacent and nearby lots. In this fashion, word going from friend to friend, were the sales made. Houses were built on all but four of these 251⁄2 lots by the purchasers or their successors. At the time these lots were sold during the taxable year they were covered with nursery stock. Petitioner consequently required time to remove such stock before the purchasers could take possession. Due to labor shortages, petitioner gave such stock to local Army installations and state parkways, which in turn furnished the labor required to move it. Under the customary real estate practice prevailing in New Orleans, petitioner was required to pay commissions to agents representing purchasers. Similarly petitioner was required to have prepared the necessary documents for accomplishing the formal transfer of title. The 252 lots sold during the taxable year were the community property of petitioners, who filed separate returns. Each reported as income his or her community interest in the profit realized from the sales as long term capital gain. Respondent, in the explanation accompanying the notice of deficiency to Elmer, which is identical in this respect to the explanation given to Mrs. Farley, stated: It is held that the lots which you sold during the fiscal year ended July 31, 1941, were held primarily for sale to customers in the ordinary course of a trade or business, and that they were accordingly not capital assets as defined in section 117 (a) of the Internal Revenue Code. It follows that the profit from the sales constitutes ordinary gain to the marital community, and not long-term capital gain as contended by you. The taxable gain from the sale of these lots is computed as follows: HILL, Judge: The question presented is whether the profit realized on the sales of the Gentilly lots is taxable as capital or ordinary gain. 737695-47- -14 Respondent argues that the property involved is excepted from the general definition of capital assets because "held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business," within the meaning of section 117 (a) (1) of the Internal Revenue Code.1 Petitioner argues that the property was not so held, because he was not engaged in the trade or business of selling real estate. Respondent contends primarily that the sales involved were so frequent and continuous as to constitute such activity a trade or business. It is unquestionably true that the frequency and continuity with which a particular activity is carried on is a primary consideration in determining whether such activity constitutes a trade or business. It is significant to note, however, that the cases which have applied this test to real estate transactions involved elements of development and substantial sales activity which are essentially lacking in the instant case. See Richards v. Commissioner, 81 Fed. (2d) 369; Snell v. Commissioner, 97 Fed. (2d) 891; Welch v. Solomon, 99 Fed. (2d) 41; Ehrman v. Commissioner, 120 Fed. (2d) 607; Oliver v. Commissioner, 138 Fed. (2d) 910; Gruver v. Commissioner, 142 Fed. (2d) 363; Brown v. Commissioner, 143 Fed. (2d) 468; James Lewis Caldwell McFadden, 2 T. C. 395. In none of these cases did the taxpayer maintain the passive posture held by petitioner in the instant case. Not only are there absent here the elements of development and sales activities which distinguish the instant case from those cited above, but there are also other circumstances which, in our opinion, explain the frequency and continuity of sales here involved in terms other than those connotating business activity. In the first place, it should be borne in mind that the Gentilly Squares were subdivided and platted prior to the time petitioner acquired them. In the second place, the method of selling the property in lots, we think, was determined by the purchasers rather than by petitioner. Although taking no active steps to sell the property, petitioner was approached by individual purchasers seeking small residential lots. These unsolicited approaches were what lent the element of frequency and continuity to the sales. Petitioner might have eliminated the frequency and continuity of the sales by selling the entire tract in one piece. It is not improbable, however, that to interest an individual or group of individuals in a 1 SEC. 117, CAPITAL GAINS AND LOSSES. (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 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, or property, used in the trade or business, of a character which is subject to the allowance for depreciation provided in section 23 (1) [Emphasis supplied.] |