Minhas 1
Akash Minhas
Tax Research
Dr. Schisler
Case 2-B
Minhas 2
FACTS
Web Baker was hired as a CEO for Berry Corporation three years ago. As stated in his
employment contract, if Web Baker were to be fired the corporation would buy back his home at
the fair market value. Last year Web Baker was fired, forcing Berry Corporation to purchase
Web Baker’s home for $350,000. Due to a decline in housing market conditions, Berry
Corporation was only able to sell the home for $270,000 which included $12,000 of selling
expenses. Berry corporation decided to deduct the $92,000 as an ordinary loss, but the IRS has
challenged this stating that it is a capital loss.
ISSUES
1. Can Berry corporation’s loss be deducted as an ordinary loss?
2. Was home considered a capital asset in the hands of Berry Corporation?
3. Is the home part of Berry Corporation’s ordinary course of business?
ANALYSIS AND EVALUATION OF AUTHORITY
IRC § 65 defines an ordinary loss as any loss from the sale or exchange of any asset which is
not a capital asset. IRC § 1231 (b)(1) defines property which is subject to capital losses and
gains as real property used in a trade or business that is held for than one year. Treasury
Regulation § 1.1231-1 states that section 1231 gains and losses apply to the sale, exchange or
involuntary conversion of property which was held for more than 1 year and used in the
taxpayer’s trade or business.
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In Chilton T. C. Au v. The United States [84-1 USTC ¶9256] Chilton had purchased property in
Hawaii. Chilton was unable to afford the payments for his note and was forced to sell the
property. Upon selling the property Chilton had failed to include the $90,000 selling expenses in
the sale price, therefore he had sold the property for $90,000 less than what he had paid for it.
On his tax return, he had initially filed an adjusted capital loss of $85,318 but had amended the
return and changed that loss to an ordinary loss. The IRS challenged this and stated the loss was
capital and disallowed the deduction. The Claims Court stated that if the property was initially
held with the intention of selling it in an ordinary course of business, then it would be
considered an ordinary loss. The Claims Court determined the only way to test for this is by
determining the purpose for which the land was acquired, the motive for selling, the extent of
improvements made, frequency of sales, and time and method employed in selling. The Claims
Court held that Chilton’s actions of acquiring and selling the property were not part of his
ordinary course of business. Therefore, the loss is considered capital and is subject to limited
deductibility under IRC § 1211.
CONCLUSION
Upon referencing IRC § 65, an ordinary loss is considered any loss from the sale or exchange of
any asset which is not a capital asset. This applies a clear limitation and standard which Berry
Corporation should adhere to in order to meet the requirements for deducting the loss as
ordinary. To build upon this, we have to determine if the home which Berry Corporation agreed
to purchase from Web Baker upon termination fits into the criteria of either an asset which is
used in their ordinary course of business, or a capital asset. In order to figure this out we need
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to determine if the home acquired by Berry Corporation was part of their ordinary course of
business. In this situation, Berry Corporation had only purchased the house from Web Baker
because of an obligation which required them to do so upon termination Web Baker. This
doesn’t fit into any ordinary course of business because this is not an act of business, rather a
courtesy to the former CEO as part of their former agreement.
IRC § 1231 (b)(1) provides the definition for capital assets. For this situation, this is real property
which is used in business and held for more than 1 year. To build upon this, regulation § 1.12311 states that gains and losses related to capital assets will be subject to these limitations. Since
for this case the home does not clearly fit into the definition of a 1231 capital asset we can
reference the precedent set by similar court cases to determine how to treat this sale.
The precedent I will be following is in Chilton T. C. Au v. The United States. Even though in
Chilton’s situation his land did not clearly fit into the definition of a 1231 asset, the Claims Court
relied more heavily on the test of if the asset was an ordinary asset, and if it was part of his
ordinary course of business. Upon applying the same test to Berry Corporation’s situation, I
would reasonably conclude the loss is not an ordinary loss. This is because the purpose for
which the home was acquired, frequency of sales, and method employed in selling do not line
up with the actions which a business would take that would consider it to be part of its ordinary
course of business.
I conclude that the loss should be treated as capital because the purchase and consequent sale
of the home was not part of the businesses ordinary course of business nor was the purpose for
which the home was purchased part of Berry Corporations regular course of business.
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REFERENCES
IRC Section 65 Ordinary Losses Defined
IRC Section 1231(b)(1) Property Used In a Trade or Business
IRC § 1211 Limitation on capital losses
Treasury Regulation § 1.1231-1
Chilton T.C. Au v. The United Sates [84 -1 USTC ¶9256]