Burr Oaks Corp. v. Commissioner

In 1957, Aaron Elkind, Harold Watkins, and Maurice Ritz (the taxpayers) (plaintiffs) formed Burr Oaks Corporation (Burr Oaks) (plaintiff) in relation to a land-development venture. Burr Oaks had an initial paid-in capital of $4,500. The taxpayers purchased land for $100,000 and transferred the land to Burr Oaks, and each taxpayer received a promissory note for $110,000 in exchange. Burr Oaks recorded the total liability on its books as $360,000, which included the notes plus $30,000 still due on the original land purchase. Burr Oaks subsequently made a few payments to each taxpayer, writing a new promissory note each time for the remaining difference. In 1959, Burr Oaks purportedly paid off the notes, but the taxpayers immediately loaned Burr Oaks the same amount as what remained on the notes in return for new notes. Although the taxpayers considered the 1957 transfer of property as a sale, they did not report a gain on their 1957 returns. In 1959—the year that Burr Oaks purportedly paid off the promissory notes—the taxpayers reported long-term capital gains, but the Commissioner of Internal Revenue (the Commissioner) (defendant) determined that the taxpayers’ transfer of property constituted an equity contribution to Burr Oaks rather than a sale, and therefore, any gains to the taxpayers were dividends and thus taxable as ordinary income. The Commissioner also determined that the $360,000 basis for the transferred property was higher than its fair market value of $165,000 and therefore increased Burr Oak’s taxable income in the amount of the difference for the relevant years. The tax court ruled in the Commissioner’s favor, finding that the promissory notes were, in substance, preferred stock. Burr Oaks and the taxpayers appealed.