§§ 1221; 1222; 1223.
Section 1221 defines a capital asset. The definition is a negative one. That is, the definition shares what is not a capital asset. Thus, anything else not listed under that list would ultimately be a capital asset. Thus, this article addresses cases to determine whether income derived from an asset is capital or ordinary.
The distinction between capital and ordinary income matters because long-term capital gains are taxed at a beneficial rate and capital losses are limited in what can be excluded. So, taxpayers want property gains to be listed as capital while losses listed as ordinary. Obviously, this creates a conflict between how a taxpayer wants the assets want the property to be classified.
This can be categorized in two ways: (1) Assets designed to produce ordinary income are not capital assets (such as inventory); (2) Assets where the gain comes from the taxpayers efforts to create an ordinary income is
Byram v. United States
705 F.2d 1418 (5th Cir. 1983).
Facts
Byram owned property and sold the property within a short period of time (22 sales over the course of 3 years). Ultimately, the sales totaled over $9 million with a net profit of $3.4 million. Byram did not advertise the property, was not in the business of real estate, and each sale arose because purchasers initiated the conversation.
Byram argued the property was capital assets rather than ordinary. In other words, he argued he was not a dealer in real estate, but instead was an investor.
Analysis
The appelate court uses the clearly erroneous standard. That is, the trial court’s ruling would need to be clearly erroneous to be overturned. To determine whether Byram was a dealer or investor, the court asks what the purpose of holding the property is. There are several factors to make this determination: (1) purpose of acquisition and duration of ownership, (2) efforts to sell, (3) number of sales, (4) subdividing to increase sales, (5) using a business office to sell, (6) supervision over the sale, and (7) time and effort devoted to the sales. Looking at the factors, the district court was not clearly erroneous in saying this was held for investment.
Corn Products Refining Co. v. Commissioner
350 U.S. 46 (1955).
Facts
Corn Products Refining had an issue with purchasing corn to manufacture products. To secure the price of corn, the company purchased corn Future Contracts to fix the price of corn at a future price. During one year, this resulted in a gain and a loss in different years. The question then becomes whether these gains and losses were capital or ordinary.
Analysis
These gains and losses were ordinary because the events arose out of the ordinary course of business.
Arkansas Best Corporation v. Commissioner
485 U.S. 212 (1988).
Facts
Arkansas Best purchased stock in bank. Unfortunately, the bank began to fail and Arkansas Best sold the stock at a loss. Arkansas Best then sought to claim the loss was ordinary rather than capital (capital loss has limitations of how much you can claim).
Analysis
During arguments, Arkansas Best relied on Corn Products to say this was an ordinary loss, arising out of the course of business. However, the court said this was a capital loss. The court said Corn Products was not applicable because Corn Products purchased the future contract to replace its inventory. § 1221 says inventory is ordinary. Here, this was not inventory and Corn Products does not apply. Additionally, the motivation in purchasing the asset is irrelevant; otherwise, Arkansas Best could simply game the system (choosing capital for gains or ordinary for losses). Because the statute does not discuss motive, motive does not matter.
Additional Notes
To obtain tax preferencial status, obtaining the asset must occur through a sale or exchange and be held for longer than a year.
