United States Tax Court

United States Tax Court

T.C. Memo. 2022-57

WILLIAM E. MUSSELWHITE, JR. AND MELISSA MUSSELWHITE,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket No. 14380-16.

Filed June 8, 2022.

—————

Felicia L. Branch, for petitioners.

Scott Lyons and Tammie A. Geier, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

ASHFORD, Judge: By statutory notice of deficiency dated March

30, 2016, respondent determined a deficiency in petitioners’ federal

income tax of $356,607 and an accuracy-related penalty pursuant to

section 6662(a) of $71,321 for the 2012 taxable year. 1 After certain

concessions by the parties, 2 the sole issue remaining for decision is

whether Mr. Musselwhite’s sale of four land lots resulted in a $1,022,726

1Unless

otherwise indicated, all statutory references are to the Internal

Revenue Code, Title 26 U.S.C., in effect at all relevant times, and all Rule references

are to the Tax Court Rules of Practice and Procedure.

2As set forth in a Joint Stipulation of Settled Issues filed by the parties before

the trial of this case, the parties agree that for 2012 petitioners (1) are entitled to a

$2,847 additional deduction for “Self-employed SEP, Simple, and Qualified Plans,”

(2) received but failed to report a state income tax refund of $84, (3) have Schedule E,

Supplemental Income and Loss, passive income from a partnership of $4,594, and

(4) are not liable for the accuracy-related penalty.

Served 06/08/22

2

[*2] ordinary loss as petitioners reported on Schedule C, Profit or Loss

From Business. 3 We resolve this issue in favor of respondent.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The

stipulation of facts and the attached exhibits are incorporated herein by

this reference. Petitioners resided in North Carolina when their petition

was timely filed with the Court.

I.

Mr. Musselwhite’s Background

Mr. Musselwhite received his undergraduate degree, majoring in

business, from Wake Forest University and his law degree from

Campbell University. Since 1981 (the year he graduated from Campbell

University’s law school) he has been a personal injury attorney at the

law firm started by his father and uncle in 1955 in Lumberton, North

Carolina.

In addition to being actively engaged in the practice of law, Mr.

Musselwhite has been involved in several real estate ventures, as

further discussed below.

II.

Mr. Musselwhite’s Real Estate Ventures

Mr. Musselwhite’s first real estate venture was in 1986 with his

father, uncle, and brother. 4 The four of them, along with two engineers,

purchased 100 acres of undeveloped land adjacent to an existing

residential subdivision in Lumberton. The land was divided into

approximately 90 lots that were developed with homes in phases,

creating a new subdivision called Wycliffe East. The project lasted 13

years, and all 90 lots were eventually sold.

During the development of Wycliffe East, Mr. Musselwhite and

his brother were approached to participate in another real estate

venture, also in Lumberton. They formed Carolina Group Partnership

(CGP), and CGP purchased 100 acres of undeveloped land which was

developed in phases into a residential subdivision called Northwoods.

3Mrs.

Musselwhite is a party to this case because she filed a joint federal

income tax return for 2012 with her husband, Mr. Musselwhite.

4Mr. Musselwhite’s brother attended Campbell University’s law school at the

same time he did, and his brother also practiced law at the family’s law firm.

3

[*3] In 1989 Mr. Musselwhite purchased a lot in Wrightsville Beach,

North Carolina, with the intent to build a home for his family.

Ultimately, Mr. Musselwhite became good friends with the builder who

built that home, and because of that relationship Mr. Musselwhite

became interested in getting involved in real estate ventures in the

Wrightsville Beach-Wilmington, North Carolina, area.

Mr. Musselwhite’s first real estate venture in the Wrightsville

Beach-Wilmington area was with David Stephenson. Mr. Stephenson

had been a successful businessman with an existing real estate

development company in Lumberton and initially had been friends with

Mr. Musselwhite’s father. Mr. Stephenson and Mr. Musselwhite got to

know each other well in 2003, when Mr. Stephenson bought a house

across the street from Mr. Musselwhite in Wrightsville Beach. In 2005

Mr. Stephenson approached Mr. Musselwhite seeking a business

partner (as Mr. Stephenson’s two previous business partners had passed

away), and on or about June 22, 2005, they formed DS & EM

Investments, LLC (DS & EM Investments), as a two-member limited

liability company.

DS & EM Investments’ Limited Liability Company Annual

Report filed with the State of North Carolina (LLC report) for 2005

indicated that the nature of its business was real estate investment. DS

& EM Investments’ 2006–12 LLC reports continued to report the nature

of its business as real estate investment.

DS & EM Investments initially purchased for investment five

condominiums in Wrightsville Beach; they immediately sold two, one to

a realtor friend. DS & EM Investments also acquired for investment

purposes undeveloped lots in Lumberton and in the Seawatch

subdivision in Brunswick County, North Carolina, and a house in

Wilmington (Wilmington House). 5

In summer 2006 Adam Lisk, a North Carolina real estate

developer, contacted DS & EM Investments, proposing an arrangement

whereby he would purchase the Wilmington House and DS & EM

Investments would purchase four undeveloped wooded lots in the

5Separate and apart from DS & EM Investments, Mr. Musselwhite owned

portions of several mobile home parks that Mr. Stephenson had conveyed to him.

Additionally, sometime in 2006 he and Mr. Stephenson, together with Nick Garrett,

formed Garrett & Stephenson, LLC, which in turn acquired 14 acres of undeveloped

land in the Landfall subdivision in the Wrightsville Beach-Wilmington area. Mr.

Musselwhite got out of that venture in 2010 before any development began.

4

[*4] Cypress Lakes subdivision in Brunswick County that Mr. Lisk

owned. From Mr. Musselwhite’s perspective the arrangement was an

opportunity to invest in a subdivision that Mr. Lisk was developing (the

subdivision consisted of nine undeveloped wooded lots owned by Mr.

Lisk). After several weeks of discussions that included creating an

implementable plan as to all nine lots, on August 30, 2006, Mr. Lisk and

DS & EM Investments entered into a written agreement memorializing

the plan.

Pursuant to this agreement, Mr. Lisk agreed to give DS & EM

Investments a one-year personal guaranty that the four lots it was

purchasing would sell within one year and that it would net $1 million

from such a sale or he would buy back the remaining unsold lots.

Additionally, Mr. Lisk and DS & EM Investments agreed that Mr. Lisk

would receive the first $49,000 of potential profit on the four lots over

the net $1 million, with Mr. Lisk and DS & EM Investments splitting

50/50 any additional profit over the $49,000. Mr. Lisk also agreed that

he and his real estate agent, Amanda Carpenter of Intracoastal Realty

(Intracoastal), would, in good faith, equally market all nine lots, and he

agreed to give DS & EM Investments a deed of trust covering his five

lots. DS & EM investments agreed to release the first three of the five

lots from the deed of trust upon Mr. Lisk’s sale of those three lots with

some mutually agreed-upon payment to it. Mr. Lisk and DS & EM

Investments further agreed that Mr. Lisk could not sell his remaining

two lots until DS & EM Investments had only two of its four lots

remaining, at which time Mr. Lisk could sell one of his remaining lots,

and Mr. Lisk could only sell his final remaining lot once DS & EM

Investments had only one lot remaining of its four lots. Finally,

although this arrangement was not reflected in the agreement, Mr. Lisk

agreed to complete certain improvements to all nine lots so that the lots

could be effectively marketed by Ms. Carpenter.

On August 31, 2006, in accordance with the agreement, DS & EM

Investments purchased the four lots from Mr. Lisk for $1 million and

Mr. Lisk purchased the Wilmington House from DS & EM Investments

for $2,069,000. DS & EM Investments partially financed its purchase

with a $750,000 loan from BB&T Bank (BB&T), which was secured by

a deed of trust covering the four lots in favor of BB&T; to purchase the

Wilmington House, Mr. Lisk used $1,069,000 of his own money and the

$1 million he received from DS & EM Investments for the four lots.

In 2007 the real estate market across the country began to take

an ugly turn. It was even worse in Brunswick County than across the

5

[*5] country because the developer of the Seawatch subdivision, Mark

Saunders, had not completed all the improvements he had promised;

consequently, he was being sued by multiple landowners alleging that

he had misrepresented the Seawatch subdivision development, and he

had started to flood the market in Brunswick County with hundreds of

distressed properties. Mr. Lisk felt the crunch of the downwardspiraling and distressed real estate market and slowed on completing

the improvements for all nine lots. He had multiple other business

partners filing for bankruptcy or having serious financial problems. He

started having financial problems himself, as well as family problems.

The four lots did not sell within one year; and on or about

November 15, 2007, DS & EM Investments filed a complaint against Mr.

Lisk in the General Court of Justice, Superior Court Division, in

Robeson County, North Carolina, alleging that he was in breach of the

August 30, 2006, agreement and that his actions were fraudulent in that

he had failed to (1) complete all planned improvements, (2) properly

market the four lots, (3) buy back the four lots (and instead spent large

sums of money on the Wilmington House), and (4) provide a deed of trust

covering his five lots.

DS & EM Investments sought specific

performance of the agreement or alternatively an order that Mr. Lisk

reconvey the Wilmington House and transfer his five lots to it, and

punitive damages and costs.

Ultimately, DS & EM Investments and Mr. Lisk came to an

agreement resolving all issues in the Robeson County court action. Mr.

Lisk agreed to complete the rest of the improvements and transfer his

five lots to DS & EM Investments so that DS & EM Investments would

have the whole subdivision, and in exchange DS & EM Investments

agreed to voluntarily dismiss its lawsuit against Mr. Lisk.

On December 22, 2008, Mr. Lisk transferred his five lots to DS &

EM Investments, and on or about January 8, 2009, DS & EM

Investments voluntarily dismissed its lawsuit against Mr. Lisk. After

December 22, 2008, Mr. Lisk had no involvement with the Cypress

Lakes subdivision, any of the nine lots, or DS & EM Investments.

With respect to the lots, Mr. Lisk as of December 22, 2008, had:

(1) removed trees to build a road; (2) removed underbrush from the lots;

(3) completed grading for the creation of a road; (4) completed grading

for the creation of storm water drainage; (5) paved a road (with a curb

and gutter added); (6) obtained septic tank permits; (7) designed a gate

and fence; (8) obtained a Coastal Area Management Act permit for a

6

[*6] kayak dock; (9) requested additional entrance approval from the

North Carolina Department of Transportation; and (10) confirmed that

the lots could support well systems and were close to electric service and

water lines. After December 22, 2008, no improvements were made to

the lots by DS & EM Investments except to occasionally clean up the

lots.

After December 22, 2008, Intracoastal’s for sale signs remained

on the lots for an unspecified period (but no later than the end of

September 2011, when BB&T prepared an appraisal of the lots, as

discussed below), although by May 2008 Ms. Carpenter had left

Intracoastal to work with another real estate company in Wilmington.

The record is unclear as to what, if any, additional marketing of the lots

was done.

BB&T had appraisals prepared with respect to the four lots on or

about May 1, 2009, September 29, 2011, and June 27, 2012. The

appraised values reflect the continued effect of the housing market

crash; the appraised value of the four lots was $55,000 in May 2009,

$23,500 in September 2011, and $17,500 in June 2012. 6 The 2011 and

2012 appraisals also recited the following with respect to the four lots:

“THE SUBJECT HAS NO KNOWN PRIOR SALES HISTORY WITHIN

THE PAST 3 YEARS AND IS NOT KNOWN TO BE CURRENTLY FOR

SALE.”

In the light of the continued depressed housing market, BB&T’s

mounting pressure with respect to the four lots as the holder of a deed

of trust covering these lots, and both Mr. Musselwhite’s and Mr.

Stephenson’s personal debt exposure with respect to the mobile home

parks, Mr. Musselwhite and Mr. Stephenson agreed that it was prudent

to distribute or convey to each other some of their properties (including

properties of DS & EM Investments), dividing up the debt. Accordingly,

Mr. Musselwhite conveyed his interest in the mobile home parks to Mr.

Stephenson (and Mr. Stephenson promised to remove Mr. Musselwhite

from the personal guaranty). Additionally, sometime in either 2011 or

2012 DS & EM Investments distributed a condominium to Mr.

Musselwhite, and on July 27, 2012, it distributed the four lots to Mr.

Musselwhite.

6BB&T also had an appraisal prepared with respect to the four lots on or about

June 2, 2006; the appraised value of the four lots was $952,000 in June of 2006.

7

[*7] On August 3, 2012, Mr. Musselwhite sold the condominium for

$515,250, resulting in a $137,780 loss. Regarding the four lots, Mr.

Musselwhite hired Donna Cote, a licensed real estate broker in North

Carolina with her own company in Wilmington, to market the lots and

bring them to sale. The record in this case includes a January 8, 2016,

letter from Ms. Cote to petitioners’ former counsel of record. 7 In this

letter Ms. Cote recites that in early summer 2012 she met with Mr.

Musselwhite to discuss assisting him with aggressively marketing the

lots and bringing them to sale. She further recites that just after DS &

EM Investments distributed the four lots to Mr. Musselwhite, she met

with him again, spending much of a day at the lots assessing them and

assessing the general geographical area to discern what other properties

were for sale and their values. According to Ms. Cote, she immediately

began to aggressively market the four lots and explore various options

for their disposition; to wit, with an extensive network of developers,

builders, investors, realtors, and potential purchasers from having

actively participated in the development and sale of lots in so many

subdivisions in Brunswick and neighboring New Hanover Counties, she

consistently presented information on the lots to multiple people and

spent substantial time and effort marketing the lots for sale.

Ultimately, on or about November 14, 2012, Mr. Musselwhite was able

to sell the four lots for a total of $17,500, resulting in a $1,022,726 loss.

III.

DS & EM Investments’ and Petitioners’ Tax Reporting

Mr. Musselwhite hired Charles Edwards, a certified public

accountant (CPA) with his own CPA firm in Lumberton to prepare and

file DS & EM Investments’ 2005–12 Forms 1065, U.S. Return of

Partnership Income, and petitioners’ 2011–13 Forms 1040, U.S.

Individual Income Tax Return. 8

A.

DS & EM Investments

DS & EM Investments’ 2005–12 Forms 1065 reported that (1) DS

& EM Investments’ principal business activity was “INVESTMENT,”

(2) its principal product or service was “PROPERTY,” and (3) it had no

7On November 1, 2017, the Court granted this individual’s Motion to Withdraw

as counsel in this case. Five days before that, petitioners’ current counsel of record

entered an appearance in this case.

8Although the record includes only these tax returns, Mr. Edwards has been

doing tax preparation work for Mr. Musselwhite’s entire family and their various

business entities since at least 1981.

8

[*8] gross receipts or sales. However, capital gains and/or losses with

respect to sales of real property were reported on DS & EM Investments’

2006, 2007, 2009, 2010, and 2012 Forms 1065 (and also reflected on

Schedules D, Capital Gains and Losses, which were attached to those

forms); no sales of real property were reported on its Forms 1065 for

2005, 2008, and 2011 (and no Schedules D were attached to those forms).

The Schedules L, Balance Sheets per Books, of DS & EM

Investments’ 2005–10 Forms 1065 reported that DS & EM Investments

had no “[i]nventories”; these Schedules L reflected, inter alia, that DS &

EM Investments had “[o]ther investments,” which included

“INVESTMENT-REAL ESTATE.”

It was on DS & EM Investments’ Schedule L of the 2011 Form

1065 that the four lots (as well as the five lots that Mr. Lisk had

transferred to DS & EM Investments in 2008) were first reported as

being held as “[i]nventories” at the beginning and end of the taxable

year. When DS & EM Investments’ 2011 Form 1065 was filed on April

29, 2012, DS & EM Investments and Mr. Musselwhite were aware that

the fair market values of the nine lots were less than DS & EM

Investments’ bases in the lots. The Schedule L of DS & EM Investments’

2012 Form 1065 also reported “[i]nventories” at the beginning of the

taxable year but with a blank as to the end of the taxable year.

Despite the fact that (1) the four lots were reported as being held

as “[i]nventories” on DS & EM Investments’ 2011 and 2012 Schedules L

and (2) Mr. Edwards testified at trial that it was his professional

judgment that the lots were always held as inventory (upon reviewing

the August 30, 2006, agreement, which Mr. Musselwhite first presented

to him in the 2010–11 timeframe), Mr. Edwards did not file amended

Forms 1065 for DS & EM Investments as to the prior taxable years

reporting the lots’ purported status as inventory. Additionally, the

record is unclear as to whether Mr. Edwards had any discussions with

Mr. Musselwhite regarding the lots’ reclassification from investment to

inventory before filing either the 2011 or the 2012 Form 1065 for DS &

EM Investments.

B.

Petitioners

Petitioners’ 2011 Form 1040 reported total income of $928,332,

the bulk of which consisted of (1) $111,679 of capital gain primarily

attributable to the sale of various stocks and (2) $750,154 of income from

partnerships and S corporations, zero of which was attributable to DS

9

[*9] & EM Investments but most of which was attributable to $708,042

of income Mr. Musselwhite received from his family’s law firm. The

return also claimed various deductions (including various itemized

deductions as detailed on Schedule A, Itemized Deductions) and

reported four exemptions, a credit from Form 8801, Credit for Prior Year

Minimum Tax—Individuals, Estates, and Trusts, and payments for

federal income tax withheld and “2011 estimated tax payments and

amount applied from 2010 return.” No Schedule C relating to Mr.

Musselwhite’s real estate activities was attached to this return. 9

Petitioners’ 2012 Form 1040 reported total income of $225,568,

the bulk of which was attributable to $1,202,943 of income from

partnerships and S corporations, zero of which was attributable to DS

& EM Investments but most of which was attributable to $1,182,664 of

income Mr. Musselwhite received from his family’s law firm, which was

offset by a deduction for a $1,022,726 business loss as detailed on an

attached Schedule C. This Schedule C was for Mr. Musselwhite’s

“ACTIVTIES RELATED TO REAL ESTATE”; to wit, the sale of the four

lots on or about November 14, 2012. The lots’ price ($17,500) was

reported as gross receipts or sales, and Mr. Musselwhite’s adjusted

bases in the lots ($1,040,226) were reported as cost of goods sold. Mr.

Musselwhite’s $137,780 loss from the sale of the condominium on

August 3, 2012 (i.e., “SALE OF INVESTMENT CONDO”) was reported,

together with a net long-term capital gain of $108,500, on an attached

Schedule D; but because of section 1211(b), petitioners’ total income

included only the maximum amount allowed for a net capital loss

(−$3,000). Petitioners’ 2012 Form 1040 also claimed various deductions

(including various itemized deductions as reflected on Schedule A) and

reported three exemptions and payments for federal income tax

withheld and “2012 estimated tax payments and amount applied from

2011 return.” 10

Petitioners’ 2013 Form 1040 reported total income of $936,699,

the bulk of which consisted of $846,465 of income from partnerships and

S corporations, nearly all of which was attributable to $845,786 of

income Mr. Musselwhite received from his family’s law firm.

Petitioners’ total income also included business income of $4,431,

consisting of gross receipts or sales of that same amount from “LEGAL

9Ultimately, this return reported a refund, which was directed to be applied to

petitioners’ 2012 estimated tax.

10Ultimately, this return reported a refund, which was directed to be applied

to petitioners’ 2013 estimated tax.

10

[*10] SERVICES” of Mr. Musselwhite as reflected on an attached

Schedule C. No other Schedule C was attached to this return. This

return claimed various deductions (including various itemized

deductions as detailed on Schedule A) and reported two exemptions, a

credit from Form 8801, and payments for federal income tax withheld

and “2013 estimated tax payments and amount applied from 2012

return.” 11

IV.

Notice of Deficiency

Following an examination of petitioners’ 2012 Form 1040,

respondent determined in pertinent part that petitioners are not

entitled to the reported $1,022,726 Schedule C loss because the four lots

were capital assets and thus their sale generated a capital (and not

ordinary) loss. The March 30, 2016, notice of deficiency issued to

petitioners reflects this determination.

OPINION

I.

Applicable Law Regarding the Character of Petitioners’ Reported

Loss

On or about November 14, 2012, less than four months after DS

& EM Investments distributed the four lots to Mr. Musselwhite, he sold

them for $17,500, realizing a loss of $1,022,726. The sole dispute here

is whether that loss should be characterized as an ordinary loss, as

petitioners contend, or as a capital loss, as respondent contends. Both

parties agree that the resolution of this dispute centers around whether

the lots were

stock in trade of the taxpayer or other property of a kind

which would properly be included in the inventory of the

taxpayer if on hand at the close of the taxable year, or

property held by the taxpayer primarily for sale to

customers in the ordinary course of his trade or business.

See § 1221(a)(1). If they were, then their sale resulted in an ordinary

loss and not a capital loss.

The purpose of section 1221(a)(1) is to “differentiate between the

‘profits and losses arising from the everyday operation of a business’ on

11Ultimately, this return reported a refund, which was directed to be applied

to petitioners’ 2014 estimated tax.

11

[*11] the one hand . . . and ‘the realization of appreciation in value

accrued over a substantial period of time’ on the other hand.” Malat v.

Riddell, 383 U.S. 569, 572 (1966) (first quoting Corn Prods. Refining Co.

v. Commissioner, 350 U.S. 46, 52 (1955); and then quoting Commissioner

v. Gillette Motor Transp., Inc., 364 U.S. 130, 134 (1960)).

The Supreme Court has defined “primarily” as used in section

1221(a)(1) to mean “of first importance” or “principally.” Malat, 383 U.S.

at 572. Additionally, whether property is property described in section

1221(a)(1) is purely a factual question, and the burden of proof is on

petitioners to demonstrate that Mr. Musselwhite held the four lots as

described in section 1221(a)(1) (and not as a capital asset). 12 See

Pasqualini v. Commissioner, 103 T.C. 1, 6 (1994) (and cases cited

thereat); Maddux Constr. Co. v. Commissioner, 54 T.C. 1278, 1284

(1970); see also Rule 142(a).

The U.S. Court of Appeals for the Fourth Circuit, the court to

which an appeal of this case would lie absent stipulation of the parties

otherwise, see § 7482(b)(1)(A), (2), 13 has held that several factors are

relevant in resolving a section 1221(a)(1) dispute. Among the factors to

be considered are (1) the purpose for which the property was acquired;

(2) the purpose for which the property was held; (3) improvements, and

their extent, made to the property by the taxpayer; (4) the frequency,

number, and continuity of sales; (5) the extent and substantiality of the

transaction; (6) the nature and extent of the taxpayer’s business; (7) the

extent of advertising or lack thereof; and (8) the listing of the property

for sale directly or through a broker. Graves v. Commissioner, 867 F.2d

199, 202 (4th Cir. 1989) (citing Mathews v. Commissioner, 315 F.2d 101

(6th Cir. 1963), aff’g T.C. Memo. 1961-213, 1961 Tax Ct. Memo LEXIS

136). However, no one factor or group of factors is determinative, id.,

and not all factors may be relevant in a particular case or factors may

have varying degrees of relevance depending on the facts of a particular

case, S&H, Inc. v. Commissioner, 78 T.C. 234, 243–44 (1982).

Additionally, objective factors carry more weight than the taxpayer’s

subjective statements of intent.

See Guardian Indus. Corp. v.

12Petitioners do not otherwise contend that the burden of proof should shift to

respondent under section 7491(a) as to any relevant issue of fact, nor have they

established that they met the requirements for shifting the burden of proof.

Accordingly, the burden of proof remains on petitioners. See § 7491(a)(2).

13We follow the relevant precedent of the Court of Appeals to which an appeal

would generally lie. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445

F.2d 985 (10th Cir. 1971).

12

[*12] Commissioner, 97 T.C. 308, 316 (1991), aff’d without published

opinion, 21 F.3d 427 (6th Cir. 1994).

Accordingly, we will consider and weigh these factors to resolve

the sole dispute here concerning the character of petitioners’ reported

loss arising from Mr. Musselwhite’s sale of the four lots.

II.

Analysis

A.

The Purpose for Which the Property Was Initially Acquired

and Subsequently Held (Factors 1 and 2)

Mr. Musselwhite acquired the four lots via a distribution by DS

& EM Investments as part of an agreement with Mr. Stephenson to deal

with the mounting pressure DS & EM Investments was facing from

BB&T as the holder of a deed of trust covering these lots and his and

Mr. Stephenson’s personal debt exposure with respect to certain mobile

home parks.

Mr. Musselwhite had no intention whatsoever of

developing the lots when he acquired them and thereafter while holding

them, and he never undertook any development of the lots during the

few months he held them before they were sold; investment was his

principal (or really sole) purpose. Indeed, as part of the agreement with

Mr. Stephenson, DS & EM Investments also distributed a condominium

to Mr. Musselwhite. Like the four lots, he sold the condominium in 2012,

but he reported the condominium sale as a Schedule D loss.

Furthermore, in point of fact, when the four lots were distributed

to Mr. Musselwhite, there was no change in purpose. We are very much

convinced that DS & EM Investments purchased and held the lots for

investment, the same purpose it had with respect to all of its property.

Mr. Musselwhite testified that all the things he and Mr. Stephenson

were doing through DS & EM Investments were “really investment” and

that specifically with respect to DS & EM Investments’ acquisition of

the four lots, it was an opportunity to invest in a subdivision that Mr.

Lisk (who was an established developer) was already developing (as the

owner of the other five lots in the subdivision). His testimony is

consistent with the representations made on (1) DS & EM Investments’

2005–12 Forms 1065 that its principal business activity was

“INVESTMENT” and (2) DS & EM Investments’ 2005–12 LLC reports

that its business was real estate investment. The 2005–12 Forms 1065

also reported no gross receipts or sales, but sales of real property were

reported on DS & EM Investments’ 2006, 2007, 2009, 2010, and 2012

Forms 1065 (as well as detailed on attached Schedules D), while no sales

13

[*13] whatsoever of real property were reported on DS & EM

Investments’ 2005, 2008, and 2011 Forms 1065 (and no Schedules D

were attached to those forms). Additionally, the August 30, 2006,

agreement between DS & EM Investments and Mr. Lisk, together with

the testimony of Messrs. Musselwhite and Lisk, shows that DS & EM

Investments had no responsibility at all for developing and marketing

the four lots (and did none), but, rather, Mr. Lisk did.

Even assuming, arguendo, that DS & EM Investments acquired

the four lots in 2006 for development purposes, all the evidence shows

that it abandoned its “development plan” by the end of 2008. On

December 22, 2008, in connection with DS & EM Investments’ agreeing

to voluntarily dismiss the lawsuit it had filed against Mr. Lisk, Mr. Lisk

transferred his five lots to DS & EM Investments. As of that date, Mr.

Lisk had completed certain development actions; after that date, he had

no involvement with the subdivision, any of the nine lots, or DS & EM

Investments, and DS & EM Investments did nothing to improve any of

the lots (except to occasionally clean them up) or market them for sale.

Indeed, the 2011 and 2012 appraisals of the lots by BB&T recited that

the lots were not listed for sale at the time the appraisals were made.

To be sure, “a taxpayer may hold lands primarily for sale to customers

in the ordinary course of his trade or business and, at the same time,

hold other lands for investment,” Gardner v. Commissioner, T.C. Memo.

2011-137, slip op. at 8 (quoting Mathews v. Commissioner, 315 F.2d at

106), but said taxpayer can cease holding property primarily for sale to

customers in the ordinary course of its business and begin to hold it only

for investment purposes, Sugar Land Ranch Dev., LLC v.

Commissioner, T.C. Memo. 2018-21, at *10–11.

Factors 1 and 2 weigh against petitioners (and in favor of

respondent).

B.

The Extent of Improvements to the Property (Factor 3)

Development activities may convert property originally acquired

for investment into property held for sale to customers in the ordinary

course of business. See Bush v. Commissioner, T.C. Memo. 1977-75,

aff’d, 610 F.2d 426 (6th Cir. 1979). The only improvements to the four

lots were made by Mr. Lisk, and he made them no later than December

22, 2008, the date he transferred the lots to DS & EM Investments,

which was approximately 3½ years before DS & EM Investments

distributed the lots to Mr. Musselwhite. After that date, as indicated

above, no improvements were made to the lots by DS & EM Investments

14

[*14] (except to occasionally clean them up) and after DS & EM

Investments distributed the lots to Mr. Musselwhite, he never made any

improvements to the lots during the approximate 3½ months that he

held them in 2012.

Factor 3 weighs against petitioners (and in favor of respondent).

C.

The Frequency, Number, and Continuity of Sales (Factor 4)

On the one hand, in the 1980s and 1990s, other entities that Mr.

Musselwhite and members of his family jointly owned developed land

lots and sold those lots. On the other hand, as indicated above, from its

inception in 2005 through 2012, DS & EM Investments did not report

on its Forms 1065 any gross receipts or sales; the only reported sales of

any kind were those from the sale of investment properties that resulted

in capital gain or loss (and those sales did not include any of the nine

lots during the time that DS & EM Investments held them). Ultimately,

given the facts of this case, Mr. Musselwhite’s activity alone should be

the focus. To this end, all evidence supports the isolated nature of Mr.

Musselwhite’s sale of the four lots, rather than an ongoing sole

proprietorship engaged in activities related to real estate.

Factor 4 weighs against petitioners (and in favor of respondent).

D.

The Extent and Substantiality of the Transaction (Factor 5)

Mr. Musselwhite’s sale of the four lots was the only sale

associated with the transaction, and the record is silent as to any

continued involvement by Mr. Musselwhite with the lots, e.g.,

development plans, after he sold them. Indeed, as indicated above, when

DS & EM Investments distributed the lots to him, he had no intention

of developing them, and by April 29, 2012, the date on which DS & EM

Investments’ Form 1065 was filed, he (and DS & EM Investments) knew

that the fair market values of the lots were less than DS & EM

Investments’ bases in the lots. Incredibly, the 2011 Form 1065 was the

first such form for DS & EM Investments on which the lots were

classified as being held as “[i]nventories.” To be sure, Mr. Musselwhite

was continuing to experience financial problems in 2012, but such

reclassification provided no incentive for him to hold on to the four lots

and develop them; the reclassification was his purported “ticket” to

getting a significant ordinary loss through a quick sale of the lots.

Factor 5 weighs against petitioners (and in favor of respondent).

15

[*15] E.

The Nature and Extent of the Taxpayer’s Business

(Factor 6)

Mr. Musselwhite’s everyday business was not the development

and sale of real estate. Since the 1980s Mr. Musselwhite has been

actively engaged in the practice of law as a personal injury attorney at

his family’s law firm in Lumberton, and his reported income from that

endeavor for at least 2011–13 was substantial. According to petitioners’

2011–13 Forms 1040, Mr. Musselwhite received income from his

family’s law firm of $708,042 in 2011, $1,182,664 in 2012, and $845,786

in 2013. As relevant here, he (and Mr. Stephenson) formed and operated

DS & EM Investments as a vehicle to invest in real estate and DS & EM

Investments’ federal and state filings bear this out.

Factor 6 weighs against petitioners (and in favor of respondent).

F.

The Extent of Advertising or Lack Thereof and the Listing

of the Property for Sale Directly or Through a Broker

(Factors 7 and 8)

Once DS & EM Investments distributed the four lots to Mr.

Musselwhite, he immediately hired Ms. Cote, a North Carolina-licensed

real estate broker with her own company in Wilmington, to market and

sell the lots. Although Ms. Cote did not testify at trial, the parties

stipulated a January 8, 2016, letter from her to petitioners’ former

counsel of record. In this letter Ms. Cote outlines her discussions with

Mr. Musselwhite regarding his desire to aggressively market the four

lots and bring them to sale. She also indicates in the letter that she

consistently presented information on the lots to multiple people and

spent substantial time and effort marketing the lots for sale. With there

being no objections reserved by respondent as to the letter, we have no

reason to doubt the veracity of its contents. 14

14We also note that the fact that Ms. Cote and not Mr. Musselwhite personally

marketed and sold the lots does not per se remove this case from section 1221(a)(1)

treatment. Courts have routinely held that the activities of brokers are attributable

to the taxpayer who hired them. See, e.g., Hansche v. Commissioner, 457 F.2d 429, 434

(7th Cir. 1972) (“That the actual advertising sales activities are here not performed by

the taxpayers does not mean that they were not holding the property ‘primarily for

sale to customers in the ordinary course of [the taxpayers’] trade or

business.’”), aff’g T.C. Memo. 1970-342; Gamble v. Commissioner, 242 F.2d 586, 592

(5th Cir. 1957) (“[P]roperty may be held primarily for sale in [the] ordinary course of

[the taxpayer’s] trade or business notwithstanding [that] sales are made only through

16

[*16] Factors 7 and 8 weigh in favor of petitioners (and against

respondent).

On the basis of our review of the record before us, the

overwhelming weight of these factors is against petitioners (and in favor

of respondent). Accordingly, under the factors discussed above, we hold

that the four lots in the hands of Mr. Musselwhite were neither his stock

in trade, inventory, or property he held primarily for sale to customers

in the ordinary course of business under section 1221(a)(1) but, rather,

were capital assets.

G.

Petitioners’ Other Argument

Separate and apart from arguing that the aforementioned factors

weigh in their favor, petitioners also argue that the four lots in DS &

EM Investments’ hands were inventory as defined in section 751(d) and

that pursuant to section 735(a), the lots retained their inventory

character, resulting in an ordinary loss to Mr. Musselwhite when he sold

them because he did so well within five years of DS & EM Investments’

distributing them to him.

Section 735(a)(2) provides that “[g]ain or loss on the sale or

exchange by a distributive partner of inventory items (as defined in

section 751(d)) distributed by a partnership shall, if sold or exchanged

within 5 years from the date of the distribution, be considered as

ordinary income or as ordinary loss, as the case may be.” Under section

751(d), inventory items are defined by reference to section 1221(a)(1).

On the basis of our analysis and holding above, section 735(a) is

inapplicable here and thus petitioners’ argument lacks merit.

H.

Conclusion

We sustain respondent’s determination that the $1,022,726 loss

resulting from Mr. Musselwhite’s sale of the four lots was a capital loss.

an agent.”), aff’g T.C. Memo. 1955-289; David Taylor Enters., Inc. & Subs. v.

Commissioner, T.C. Memo. 2005-127, slip op. at 23 (finding that the taxpayer’s sales

activities included those carried on through a broker); Mathews, 1961 Tax Ct. Memo

LEXIS 136, at *16 (finding that the “[taxpayer] continuously made numerous and

frequent sales of property” even though the taxpayer marketed and sold the property

through brokers rather than personally).

17

[*17] We have considered all of the arguments made by the parties and,

to the extent they are not addressed herein, we find them to be moot,

irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered under Rule 155.