Opinion
Docket Nos. 94686-94688.
Filed October 10, 1963.
Partnership, engaged in the real estate subdivision business, had surplus funds as a result of adverse zoning in respect of part of its property, and determined to use such funds in securities speculation. It bought and sold securities and made short sales of securities, for its own account, through a licensed broker. Held, the net loss of $114,115.59 which it sustained from all such trading in the year ending March 31, 1959, was a capital loss and not an ordinary loss.
K. G. Seitz, for the petitioners.
W. Dean Short, for the respondent.
Respondent determined the following deficiencies in income tax:
1956 1957 1958 1959 Harry M. Adnee and Margaret P. Adnee ..... $30,358.00 ____ ___ $60.20 Carolyn Jo Adnee Trust ................... 1,930.45 $653 $82 ______ Christine Lou Adnee Trust ................ 1,930.45 653 82 ______ Petitioners were partners in the Triton Co., and the sole question for decision is whether the 1959 net loss incurred by the partnership from the buying and selling of listed securities was an ordinary loss or a capital loss; years prior to 1959 are also involved by reason of carry-backs.FINDINGS OF FACT
Some of the facts have been stipulated, and, as stipulated, are incorporated herein by reference.
Petitioners Harry M. and Margaret P. Adnee are husband and wife, residing in Cincinnati, Ohio. The husband, sometimes referred to as petitioner, was engaged in business as a real estate developer. In 1946 he formed a partnership with his wife to carry on that business. In 1952 the partnership, called the Triton Co., was reorganized so as to admit two trusts as additional partners. These trusts, also petitioners herein, were for the benefit of each of the two dependent children of Harry M. and Margaret P. Adnee. Petitioner Harry M. Adnee is the trustee of each trust. He was the "managing partner" in the Triton Co., hereinafter referred to as "Triton"; his wife was an "inactive partner." The trusts each had a one-eighth interest and petitioner and his wife each had a three-eighths interest in the partnership.
The real estate development business which petitioner carried on in behalf of the partnership consisted in the acquisition of raw land, putting in streets, subdividing the land into lots, building houses on the lots, and then selling the individual houses and lots. This type of activity has been referred to as "speculative building."
In 1957 a subdivision owned by Triton had approximately 300 lots. About one-third of the lots were zoned so as to permit the building of the inexpensive type of house that petitioner promoted in behalf of Triton. The zoning in respect of the other two-thirds required the building of more expensive houses than the type that petitioner wanted to build. Accordingly, after unsuccessful attempts to obtain a change in zoning, petitioner began to sell such unfavorably zoned lots to other builders, but continued to build and sell houses in Triton's behalf on the other lots. The partnership return for the fiscal year ending March 31, 1959, discloses gross receipts or gross sales in the amount of $284,378, all attributable either to sales of lots or to sales of speculative houses.
In 1957, when the amount of speculative building on Triton's subdivision began to slow down by reason of the zoning situation, the partnership had available funds which petitioner determined to use for its benefit in speculating in securities with a view to obtaining "as much of a profit within as short a time as possible."
Accordingly, petitioner began to buy and sell securities in Triton's name, using Triton's funds. Purchases and sales were made through a stockbrokerage firm with a membership on the New York Stock Exchange. All the securities thus bought or sold were listed on a stock exchange and all trades were at market prices. Triton did not maintain an office in which it dealt with customers for securities, and did not deal with anyone other than the stockbroker when it bought and sold securities. It purchased and sold securities for its own account for investment or speculative purposes.
Petitioner devoted time and attention to these speculative activities. He kept in touch with the market by subscribing to services reporting on market conditions, attending "board" rooms in the broker's offices, and receiving daily reports from the broker concerning securities in which he was interested.
During the year ended March 31, 1959, petitioner in behalf of Triton completed 37 transactions involving short sales of securities and 75 transactions involving regular sales of securities. It sustained a net loss of $115,156.11 on the former and realized a net gain of $1,040.52 on the latter, and thus sustained a net loss from all its security trading transactions in the amount of $114,115.59 during that fiscal year. This loss, together with a loss of $1,755.74 representing the excess of dividends paid (in respect of the short sales) over dividends received, was reported on the partnership return for the year ended March 31, 1959, as an ordinary loss, in the total amount of $115,871.
Petitioners Harry M. and Margaret P. Adnee claimed their shares of the reported partnership loss on their joint individual income tax return for 1959, and a loss carryback to the year 1956, for which a tentative refund was allowed by the respondent.
The two trusts each claimed its share of the reported partnership loss on its return for the year 1959 and loss carrybacks to the years 1956, 1957, and 1958, for which tentative refunds were allowed by the respondent.
Respondent determined that the loss from security trading sustained by the Triton Co. was a loss from the sale or exchange of capital assets, and not an ordinary loss.
OPINION
Petitioners argue that Triton's losses from trading in securities, particularly its losses on short sales, must be treated as ordinary losses rather than capital losses. We disagree.
The proper classification of the net loss in question does not depend upon the number of transactions or the degree of trading activity or the fact that the principal component of the net loss was attributable to the short sales. Rather, it depends upon whether the securities sold in connection with the regular sales and the securities used to close the short sales constituted "capital assets" within the meaning of section 1221 of the 1954 Code. The term "capital asset" is defined therein, subject to certain exceptions, to mean "property held by the taxpayer (whether or not connected with his trade or business)." Accordingly, the question before us is whether any of those exceptions are applicable. And the only exception of any possible pertinence is contained in subsection (1) of section 1221 which provides that the term "capital asset" does not include —
(1) 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;
The securities involved herein do not qualify for exclusion under the foregoing provisions. Certainly, they were not "stock in trade * * * or other property of a kind which would properly be included in the inventory of the taxpayer." Triton was not a dealer or merchant regularly engaged in the sale of securities to customers in the ordinary course of its trade or business. It did not use inventories in determining income and indeed was not entitled to do so under regulations of the Commissioner which permit their use by dealers in securities and expressly provide that taxpayers "who buy and sell or hold securities for investment or speculation, irrespective of whether such buying or selling constitutes the carrying on of a trade or business, * * * are not dealers in securities within the meaning of this section." Regulations section 1.471-5 issued under the Internal Revenue Code of 1954. Triton was merely engaged in stock market speculation, buying and selling through a licensed broker for its own account. It was not a dealer; it had no customers and consequently did not hold securities "primarily for sale to customers."
Our conclusions, set forth above, are amply supported by decisions of long standing in this field. E.g., O. L. Burnett, 40 B.T.A. 605, affirmed on this issue 118 F.2d 659 (C.A. 5); Schafer v. Helvering, 83 F.2d 317 (C.A.D.C.), affirmed 299 U.S. 171; Francis Shelton Farr, 44 B.T.A. 683; George R. Kemon, 16 T.C. 1026.
Nor is there any basis to reach a different result in respect of the short sales. Section 1233 of the 1954 Code explicitly provides:
SEC. 1233. GAINS AND LOSSES FROM SHORT SALES.
(a) CAPITAL ASSETS. — For purposes of this subtitle, gain or loss from the short sale of property shall be considered as gain or loss from the sale or exchange of a capital asset to the extent that the property, including a commodity future, used to close the short sale constitutes a capital asset in the hands of the taxpayer.
Thus, if a dealer uses stock in trade to close a short sale in the ordinary course of his business, the transaction may result in ordinary gain or loss, but if the sale is not made by a dealer or if the stock used to close the short sale cannot otherwise qualify for exclusion from classification as a capital asset, the resulting gain or loss is governed by the statutory provisions relating to capital gains or losses. See Income Tax Regs., sec. 1.1233-1(a)(2).
Decisions will be entered for the respondent.