Burr Oaks Corp. v. Commissioner of Internal Revenue

Aaron and Rosella Elkind, Harold and Fannie Watkins, and Maurice and Esther Ritz (plaintiffs) entered into transactions in which the individuals transferred real estate and cash to a newly formed corporation, Burr Oaks Corporation (plaintiff). In October 1957, Rosella Elkind and Fannie Watkins (shareholders) each purchased 150 shares; Maurice Ritz’s brothers (shareholders) each purchased 75 shares. None of the shareholders were active in the corporation; Aaron Elkind, Harold Watkins, and Maurice Ritz (directors) were officers and controlled the business. In November 1957, the directors transferred a jointly owned real estate parcel to Burr Oaks, and each received in exchange a promissory note of $110,000 with 6 percent interest payable in two years. Burr Oaks assumed the remaining mortgage on the property. The fair market value of the property was approximately $165,000 at the time of transfer. In late 1959, in a series of transactions, the directors surrendered the promissory notes and received cash payments. Burr Oaks claimed to have paid the remaining loan amounts totaling $237,000 in full, but its bank balance was $5,498.88. After the notes were repaid, the directors loaned the company $79,000 each, evidenced by new promissory notes. The directors treated the transfer of the real estate to Burr Oaks as a sale but did not report gain on the sale until 1959, when the repayment of the promissory notes was reported as long-term capital gain. The commissioner of the Internal Revenue Service (defendant) issued notices of deficiency to the directors, treating the gain on the sale of the property as ordinary income rather than capital gain. The notices were appealed to the United States Tax Court.