In reversing the Tax Court, the 11^th Circuit in Long v. Comm’r allowed a real estate developer favorable capital gain treatment upon the sale of its rights to a land purchase contract for a condominium development, even though sale of the condo units themselves would have been ordinary income.

Facts

The taxpayer originally had a contract to buy land that it was going to use to develop luxury condominiums.  When the seller backed out, the taxpayer sued for specific performance and won.  While the seller was appealing the decision, the taxpayer sold its position in the litigation and reported capital gain on the sale.  The IRS disagreed and said the income should be ordinary income under the “substitution for ordinary income doctrine” (since the taxpayer would have recognized ordinary income had it actually developed the condominium and sold individual condo units).  The taxpayer disagreed.

Court analysis

The Tax Court concluded that the income should be ordinary because the taxpayer would have ultimately recognized ordinary income had it been able to complete its original plan to sell condos.  In reversing the Tax Court, the 11^th Circuit Court of Appeals concluded that the Tax Court erred in not recognizing that the taxpayer never owned the land, but merely had a contract to acquire land.  The court observed that the taxpayer never entered into the land purchase contract with an intent to sell that contract right in the ordinary course of business.  Rather, the taxpayer had always intended to fulfill the terms of the contract and develop the project itself.  Further the court found that the “substitute for ordinary income doctrine” did not apply since receipt of the lump sum payment for the taxpayer’s lawsuit rights was not a substitute for ordinary income that was already earned.  Instead the taxpayer was selling a right to develop the condo.