Gladden v. Commissioner

William and Nicole Gladden (plaintiffs) together were 50 percent partners in a partnership that purchased land in Arizona in 1976 for $675,000, paying a premium for the land because it was eligible for water rights. The land had no actual water rights when purchased. The partnership was able to acquire water rights to the land sometime later at no additional cost. In 1993 the partnership sold its water rights for a total of $1,088,132. The Gladdens’ 50 percent share of the sales price was $543,566; the Gladdens reported a capital gain on the sale of only $130,762 after allocating a basis to the water rights equal to a portion of the purchase price of the land itself. The commissioner of Internal Revenue (defendant) issued a notice of deficiency on the ground that the Gladdens had no basis in the water rights because the land was purchased without water rights and the partnership paid nothing for the water rights at the time they were acquired, making the entire sales price of the water rights a gain subject to tax. The Gladdens appealed the assessment to the United States Tax Court. The tax court granted summary judgment to the commissioner, agreeing that the Gladdens could not apply any of their basis in the land to the water rights, because water rights were acquired only after the land purchase, at no additional cost. The Gladdens appealed the tax court ruling to the United States Court of Appeals for the Ninth Circuit Court.