Hale v. Commissioner

The tax commissioner assessed deficiencies on tax returns filed by Herman Hale and other partners in The Hale Company (Hale Co.) jointly with their spouses (collectively, taxpayers) (plaintiffs). Hale Co. had purchased a tract of land and formed a partnership called The Walnut Company, Ltd. (Walnut) with a construction company and another individual to subdivide the tract into lots and build and sell homes. The partnership agreement provided that Walnut would dissolve after all the homes were sold. In exchange for agreeing to provide future services to Walnut, Hale Co. received a right to participate as a partner in Walnut’s future profits. When Walnut had built 111 houses and had deposits or purchase agreements from 39 buyers but had yet to make any profits, Hale Co. sold 90 percent of its partnership interest in Walnut to D-K Investment Corporation (D-K) for $125,000. That meant D-K acquired 90 percent of Hale Co.’s partnership interest in Walnut’s future profits. At that point, the parties could reasonably estimate the profits that would be made on each house, but not how many would sell or when. The taxpayers treated the proceeds from the sale as capital gains on their joint tax returns, claiming that a right to share in income is a partnership interest, which is generally treated as a capital asset. After the commissioner assessed deficiencies, the taxpayers petitioned the tax court for review. The tax court consolidated their cases to decide together.