Brnilovich v. Commissioner

In 1984, attorney David Brnilovich (plaintiff) represented James and Donna Harlacher in an action to quiet title to property that the Harlachers held as adverse possessors. That same year, the Harlachers transferred one-third of the disputed land to Brnilovich by quitclaim deed. The Harlachers subsequently settled the quiet-title action for $200,000 and then sold the property to a third party. The Harlachers deducted the $200,000 settlement amount from the sale proceeds and gave Brnilovich one-third of the remaining proceeds, totaling $62,771. Brnilovich deducted $1,500 for expenses from that amount, and Brnilovich and his wife reported $61,271 as capital gain (i.e., gain from the sale of a long-term capital asset) on their 1985 tax return. The Commissioner of Internal Revenue (the commissioner) (defendant) determined that the $62,771 was ordinary income to the Brniloviches and assessed a deficiency. The Brniloviches challenged the commissioner’s deficiency determination in tax court, asserting that they had a valid property interest in the property as of 1984, when the Harlachers gave Brnilovich the quitclaim deed. The Brniloviches further asserted that they had held the property as an investment for more than six months, which meant that they could treat the gain from disposing of the property as a long-term capital gain. The commissioner claimed that the receipt of the deed to the property in 1984 did not vest the Brniloviches with a recognizable interest in property and thus that the Brniloviches had not held the property as an investment and could not treat the income from the disposition of the property as a capital gain. Under Arizona law, which governed the relevant property rights, (1) an adverse possessor of property did not have marketable title to that property until a judicial determination had been made as to the title, and (2) a quitclaim deed conveyed no greater rights in the property than the rights held by the transferor.