                                           GEORGE H. TEMPEL AND GEORGETTA TEMPEL, PETITIONERS
                                                  v. COMMISSIONER OF INTERNAL REVENUE,
                                                               RESPONDENT
                                                        Docket No. 23689–08.                           Filed April 5, 2011.

                                                  In 2004 Ps donated a qualified conservation easement to a
                                               qualified charitable organization. As a result, Ps received con-
                                               servation easement income tax credits from the State of Colo-
                                               rado. These credits were transferable to other taxpayers. That
                                               same year Ps sold a portion of those credits. Ps reported
                                               short-term capital gains from the sales of the State credits. Ps
                                               claimed an allocated portion of the professional fees they
                                               incurred to complete the conservation easement donation, as
                                               adjusted basis in the State tax credits they sold. R determined
                                               the State income tax credits that Ps sold were not capital
                                               assets and that Ps had no adjusted basis in the credits. R
                                               filed a motion for partial summary judgment and Ps filed a
                                               cross-motion. In their cross-motion, Ps also claim that pro-
                                               ceeds from their sales of State tax credits should have been
                                               reported as long-term capital gains. Held: The State tax
                                               credits Ps sold are capital assets. Held, further, Ps do not
                                               have any basis in their State tax credits. Held, further, Ps’
                                               holding period in their State tax credits is insufficient to
                                               qualify for long-term capital gains treatment.

                                         James R. Walker and Christopher D. Freeman, for peti-
                                      tioners.
                                         Tamara L. Kotzker and Sara J. Barkley, for respondent.

                                                                                   OPINION

                                       WHERRY, Judge: This case involves a petition for redeter-
                                      mination of income tax deficiencies determined by
                                                                                                                                       341




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                                      342                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                      respondent for petitioners’ 2004 and 2005 tax years. It is
                                      before the Court on respondent’s August 3, 2009, motion for
                                      partial summary judgment and petitioners’ August 31, 2009,
                                      cross-motion for partial summary judgment. See Rule
                                      121(a). 1 Respondent argues that petitioners’ gains from sales
                                      of their transferable Colorado income tax credits (State tax
                                      credits) are not capital gains and instead should be taxed as
                                      ordinary income. Respondent also argues in the alternative
                                      that petitioners do not have any basis in their State tax
                                      credits.
                                        Petitioners filed a cross-motion for partial summary judg-
                                      ment in which they agree that summary judgment is appro-
                                      priate. Petitioners claim that their gains from the sales of
                                      their State tax credits, reported as short-term capital gains,
                                      should have been reported as long-term capital gains. They
                                      also assert they are entitled to reduce those gains by their
                                      allocable basis in the credits they sold. For the reasons dis-
                                      cussed below, we agree with petitioners that the transferable
                                      State tax credits at issue are capital assets, and we agree
                                      with respondent that petitioners had neither basis, nor a
                                      long-term holding period, in their State tax credits.

                                                                               Background
                                         On December 17, 2004, petitioners, George and Georgetta
                                      Tempel, husband and wife, donated a qualified conservation
                                      easement to the Greenlands Reserve, a qualified organiza-
                                      tion, on approximately 54 acres of petitioners’ land in Colo-
                                      rado. Petitioners claimed the fair market value of their dona-
                                      tion was $836,500. They incurred $11,574.74 of expenses in
                                      connection with the donation that primarily consisted of var-
                                      ious professional fees. As a result of the donation petitioners
                                      received $260,000 of conservation easement income tax
                                      credits from the State of Colorado.
                                         Throughout 2004 Colorado granted its eligible residents
                                      income tax credits for donating perpetual conservation ease-
                                      ments. Colo. Rev. Stat. sec. 39–22–522 (2010). For 2004 the
                                      State granted an income tax credit equal to 100 percent of
                                      the value of such a donation up to $100,000. Id. sec. 39–22–
                                         1 Rule references are to the Tax Court Rules of Practice and Procedure. Unless otherwise

                                      noted, section references are to the Internal Revenue Code of 1986 (Code), as amended and in
                                      effect for the tax years at issue.




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                                      (341)                             TEMPEL v. COMMISSIONER                                          343


                                      522(4)(a)(I). To the extent a donation’s value exceeded
                                      $100,000, additional credit was limited to 40 percent of the
                                      value in excess of $100,000. Id. The maximum allowable
                                      credit was $260,000 for each donation. Id.
                                         Colorado allowed conservation easement credit recipients
                                      to use their credits to receive a limited refund provided that
                                      the State had exceeded constitutional tax collection limits
                                      commonly known as ‘‘Amendment 1’’ or the ‘‘Douglas Bruce
                                      Amendment’’ establishing the taxpayer bill of rights
                                      (‘‘TABOR’’). Id. sec. 39–22–522(5)(b). The refund in certain cir-
                                      cumstances could reach a maximum of $50,000. Id. Unused
                                      credits could be carried forward for up to 20 tax years or
                                      transferred to certain eligible taxpayers. Id. sec. 39–22–
                                      522(5)(a), (7). Transferees may use their credits only to offset
                                      a tax liability. Id. sec. 39–22–522(7). Transferees are ineli-
                                      gible for a refund and may not transfer their credits. Id.
                                         On December 22, 2004, with the assistance of brokers,
                                      petitioners sold $40,500 of their State tax credits to an unre-
                                      lated third party for net proceeds of $30,375. 2 On December
                                      31, 2004, with the assistance of brokers, petitioners sold an
                                      additional $69,500 of their credits to another unrelated third
                                      party for net proceeds of $52,125. 3 On December 31, 2004,
                                      petitioners gave away $10,000 of their credits.
                                         On their 2004 Form 1040, U.S. Individual Income Tax
                                      Return, petitioners reported $77,603 of short-term capital
                                      gains from the sale of their State tax credits. Schedule D,
                                      Capital Gains and Losses, of their 2004 tax return reflects
                                      total proceeds from the sales of the State tax credits of
                                      $82,500 and a basis of $4,897 in those credits. Petitioners
                                      reported their basis in the State tax credits by allocating the
                                      $11,574.74 of expenses they incurred to make the donation to
                                      the portion of the credits they sold (i.e., $110,000 of credits
                                      sold/$260,000 of total credits × $11,574.74 = $4,897).
                                         On June 26, 2008, respondent issued a notice of deficiency
                                      to petitioners for their 2004 and 2005 tax years. Respondent
                                      determined petitioners owed additional tax and penalties
                                      partially arising from respondent’s adjustments to peti-
                                      tioners’ reported gains from the sales of the State tax credits.
                                      Respondent concluded that petitioners did not have any basis
                                           2 The   proceeds are net of $4,050 paid to the brokers.
                                           3 The   proceeds are net of $6,950 paid to the brokers.




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                                      344                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                      in their State tax credits and that the gains were ordinary
                                      rather than capital.
                                         Petitioners timely petitioned this Court. At the time the
                                      petition was filed, petitioners resided in Colorado.
                                      Respondent moved for partial summary judgment. Peti-
                                      tioners also moved for partial summary judgment.

                                                                                Discussion
                                        Respondent’s motion for partial summary judgment and
                                      petitioners’ cross-motion dispute (i) whether petitioners’
                                      State tax credits were capital assets, (ii) whether the sales
                                      resulted in long-term or short-term capital gains, and (iii) the
                                      amount of basis, if any, petitioners had in those credits.
                                      Respondent contends and petitioners do not contend other-
                                      wise that petitioners’ receipt of State tax credits as a result
                                      of their conservation easement contribution was neither a
                                      sale or exchange of the easement nor a quid pro quo trans-
                                      action. For our discussion we accept those deemed conces-
                                      sions.
                                      A. Summary Judgment
                                         Rule 121(a) allows a party to move ‘‘for a summary adju-
                                      dication in the moving party’s favor upon all or any part of
                                      the legal issues in controversy.’’ Summary judgment is appro-
                                      priate ‘‘if the pleadings, answers to interrogatories, deposi-
                                      tions, admissions, and any other acceptable materials,
                                      together with the affidavits, if any, show that there is no
                                      genuine issue as to any material fact and that a decision may
                                      be rendered as a matter of law.’’ Rule 121(b). Facts are
                                      viewed in the light most favorable to the nonmoving party.
                                      Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985).
                                         The moving party bears the burden of demonstrating that
                                      no genuine issue of material fact exists and that the moving
                                      party is entitled to judgment as a matter of law. Sundstrand
                                      Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d
                                      965 (7th Cir. 1994). The Court has considered the pleadings
                                      and other materials of record and concludes that as to the
                                      points of law at issue here there is no genuine issue of mate-
                                      rial fact. Whether petitioners’ transferable State tax credits
                                      are capital assets and what basis, if any, and the holding
                                      period petitioners have in their State tax credits are novel




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                                      (341)                           TEMPEL v. COMMISSIONER                                           345


                                      legal questions appropriate for decision by summary judg-
                                      ment.
                                      B. Character of Gain
                                         Capital gains are derived from the sale or exchange of cap-
                                      ital assets. Sec. 1222. Section 1221 defines ‘‘capital asset’’ as
                                      property 4 held by a taxpayer, except for eight categories of
                                      property specifically excluded from the definition. 5 None of
                                      the excluded categories is applicable to the State tax credits
                                      at issue. 6
                                         The purpose of capital gains treatment is to provide some
                                      relief to taxpayers from the excessive burdens of taxation of
                                      an entire gain in 1 year in those instances ‘‘typically
                                      involving the realization of appreciation in value accrued
                                      over a substantial period of time’’. Commissioner v. Gillette
                                        4 Respondent does not challenge that the State tax credits at issue here are property. See also

                                      Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011) (concluding
                                      that nontransferable State tax credits were property), revg. and remanding T.C. Memo. 2009–
                                      295.
                                        5 Sec. 1221(a) provides in part as follows:


                                      SEC. 1221. CAPITAL ASSET DEFINED.
                                        (a) IN GENERAL.—For purposes of this subtitle, the term ‘‘capital asset’’ means property held
                                      by the taxpayer (whether or not connected with his trade or business), but does not include—
                                          (1) stock in trade of the taxpayer or other property of a kind which would properly be in-
                                        cluded 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;
                                          (2) property, used in his trade or business, of a character which is subject to the allowance
                                        for depreciation provided in section 167, or real property used in his trade or business;
                                          (3) a copyright, a literary, musical, or artistic composition, a letter or memorandum, or simi-
                                        lar property, held by—

                                                           *          *         *          *          *         *        *
                                             (4) accounts or notes receivable acquired in the ordinary course of trade or business for serv-
                                           ices rendered or from the sale of property described in paragraph (1);
                                             (5) a publication of the United States Government (including the Congressional Record)
                                           which is received from the United States Government or any agency thereof, other than by
                                           purchase at the price at which it is offered for sale to the public, and which is held by—

                                                         *          *          *         *       *         *        *
                                             (6) any commodities derivative financial instrument held by a commodities derivatives deal-
                                           er, unless—

                                                         *         *          *         *        *         *        *
                                           (7) any hedging transaction which is clearly identified as such before the close of the day
                                        on which it was acquired, originated, or entered into (or such other time as the Secretary may
                                        by regulations prescribe); or
                                           (8) supplies of a type regularly used or consumed by the taxpayer in the ordinary course
                                        of a trade or business of the taxpayer.
                                        6 Respondent concedes that none of the eight categories delineated in sec. 1221(a) is applicable

                                      to the State tax credits. Neither party asserts the State tax credits petitioners sold properly
                                      come within any other Internal Revenue Code section determining the character of assets; e.g.,
                                      sec. 1253 (specifying the character of franchises, trademarks, and trade names).




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                                      346                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                      Motor Transp., Inc., 364 U.S. 130, 134 (1960). Capital gains
                                      treatment also alleviates the pernicious effects of inflation
                                      which creates phantom profits and mitigates the deterrent
                                      effect taxation may have on a taxpayer’s decision to convert
                                      assets that have appreciated. Burnet v. Harmel, 287 U.S.
                                      103, 106 (1932); Snowa v. Commissioner, 123 F.3d 190, 193
                                      (4th Cir. 1997). However, it has also been acknowledged that
                                      section 1221 makes no mention of these judicially perceived
                                      motivations for capital asset treatment. Commissioner v.
                                      Ferrer, 304 F.2d 125, 133 (2d Cir. 1962), revg. and
                                      remanding 35 T.C. 617 (1961).
                                         There is ‘‘no single definitive’’ definition of a capital asset.
                                      Gladden v. Commissioner, 112 T.C. 209, 218 (1999), revd. on
                                      a different issue 262 F.3d 851 (9th Cir. 2001). Instead, it is
                                      a very broad term. As the Supreme Court observed:
                                      The body of § 1221 establishes a general definition of the term ‘‘capital
                                      asset,’’ and the phrase ‘‘does not include’’ takes out of that broad definition
                                      only the classes of property that are specifically mentioned. * * * [Ark.
                                      Best Corp. v. Commissioner, 485 U.S. 212, 218 (1988).]

                                      While Congress created a definition of capital asset under
                                      section 1221 that is inherently expansive, many courts,
                                      including the Supreme Court, have recognized that the term
                                      is not without limits beyond those imposed by statute.
                                      Commissioner v. Gillette Motor Transp., Inc., supra at 135;
                                      Womack v. Commissioner, 510 F.3d 1295, 1299 (11th Cir.
                                      2007), affg. T.C. Memo. 2006–240; Watkins v. Commissioner,
                                      447 F.3d 1269, 1271 (10th Cir. 2006), affg. T.C. Memo. 2004–
                                      244; Gladden v. Commissioner, supra at 218–220.
                                         Faced with determining the character of assets that do not
                                      fit any of the section 1221 exceptions to the definition of a
                                      capital asset yet do not appear to properly fit that of a cap-
                                      ital asset, courts use the substitute for ordinary income doc-
                                      trine to exclude certain property. See Lattera v. Commis-
                                      sioner, 437 F.3d 399, 402–403 (3d Cir. 2006), affg. T.C.
                                      Memo. 2004–216. Under this doctrine, ‘‘capital asset’’ does
                                      not include mere rights to receive ordinary income. Commis-
                                      sioner v. P.G. Lake, Inc., 356 U.S. 260, 265–266 (1958).
                                         The practical effect of the substitute for ordinary income
                                      doctrine is that the Supreme Court ‘‘has consistently con-
                                      strued ‘capital asset’ to exclude property representing income
                                      items or accretions to the value of a capital asset themselves




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                                      (341)                         TEMPEL v. COMMISSIONER                                           347


                                      properly attributable to income.’’ United States v. Midland-
                                      Ross Corp., 381 U.S. 54, 57 (1965). The doctrine has been
                                      applied by courts directly and indirectly to exclude a variety
                                      of assets from the breadth of section 1221. 7 As we explained
                                      in Foy v. Commissioner, 84 T.C. 50, 66 (1985), the substitute
                                      for ordinary income doctrine is an important court-imposed
                                      limitation on the types of property that will qualify as a cap-
                                      ital asset. 8 It is now clear that the substitute for ordinary
                                      income doctrine is the only recognized judicial limit to the
                                      broad terms of section 1221. See Ark. Best Corp. v. Commis-
                                      sioner, supra at 217 n.5. Consequently, when determining
                                      whether property is a capital asset under section 1221,
                                      unless one of the eight exceptions or the substitute for ordi-
                                      nary income doctrine applies it is a capital asset.


                                         7 See, e.g., Watkins v. Commissioner, 447 F.3d 1269, 1273 (10th Cir. 2006) (treating the trans-

                                      fer of rights to lottery payments as ordinary income), affg. T.C. Memo. 2004–244; Saviano v.
                                      Commissioner, 765 F.2d 643, 653–654 (7th Cir. 1985) (holding that the sale of a ‘‘gold option’’
                                      did not result in capital gains when the option represented a right of first refusal to net profits
                                      from mining), affg. 80 T.C. 955 (1983); Freese v. United States, 455 F.2d 1146, 1152 (10th Cir.
                                      1972) (determining that a settlement payment was a substitute for the taxpayer’s services as
                                      an employee); Hallcraft Homes, Inc. v. Commissioner, 336 F.2d 701, 705 (9th Cir. 1964) (finding
                                      sale of water refund agreements resulted in ordinary income), affg. 40 T.C. 199 (1963); Bisbee-
                                      Baldwin Corp. v. Tomlinson, 320 F.2d 929, 936 (5th Cir. 1963) (treating consideration for mort-
                                      gage servicing contracts as a substitute for commissions); Dyer v. Commissioner, 294 F.2d 123,
                                      126 (10th Cir. 1961) (finding sale of fractional interests in mineral leaseholds was a substitute
                                      for future income), affg. 34 T.C. 513 (1960); Forrer v. Commissioner, T.C. Memo. 1981–418 (con-
                                      cluding that assignment of rights to book royalties was a transfer of an ordinary income asset).
                                         8 In Foy v. Commissioner, 84 T.C. 50, 65–66 (1985), the Court acknowledged that there were

                                      two court-imposed limitations on what type of property qualifies for capital asset treatment, the
                                      first being for assets that were held as an integral part of a taxpayer’s business as explained
                                      by the Supreme Court in Corn Prods. Ref. Co. v. Commissioner, 350 U.S. 46, 51 (1955), and
                                      the second being assets that were substitutes for ordinary income. Since our decision in Foy,
                                      the Supreme Court has clarified that there is no separate rule for assets that are an integral
                                      part of a taxpayer’s business. Ark. Best Corp. v. Commissioner, 485 U.S. 212, 217, 221 (1988).
                                      Accordingly, there remains only one court-imposed limitation on what type of property qualifies
                                      for capital asset treatment. See FNMA v. Commissioner, 100 T.C. 541, 573 (1993).
                                         We further acknowledged in Foy that after the ordinary income limitation was squarely estab-
                                      lished by the Supreme Court in Commissioner v. P.G. Lake, Inc., 356 U.S. 260 (1958), ‘‘subse-
                                      quent decisions have attempted to clarify’’ this limitation. Foy v. Commissioner, supra at 66. We
                                      then reviewed the cases subsequent to P.G. Lake that have analyzed whether a transfer of a
                                      contractual right constituted more than a mere right to receive income. These cases applied the
                                      substitute for ordinary income doctrine to the transfer of contractual rights by analyzing the
                                      ‘‘entire economics of a transaction.’’ Id. at 67. We noted there are typically six factors courts
                                      will consider to determine whether the substitute for ordinary income doctrine applies. There-
                                      fore, the six-factor test originated and has been used as a means of determining the character
                                      of gain or loss on the transfer of contractual rights that possess an element of income where
                                      those rights may represent more than a mere right to income. Accordingly, there must be con-
                                      tractual rights at issue that convey rights to income in order for the factors specified in Gladden
                                      v. Commissioner, 112 T.C. 209 (1999), revd. on a different issue 262 F.3d 851 (9th Cir. 2001),
                                      to become the appropriate analysis to apply.




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                                      348                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                           1. Inapplicability of Gladden v. Commissioner
                                        Respondent asserts that the appropriate framework for
                                      determining the character of petitioners’ gains is the analysis
                                      the Court employed in Gladden v. Commissioner, supra. 9
                                      The taxpayers in Gladden agreed to relinquish intangible
                                      water rights in exchange for cash. The Court applied contract
                                      analysis, specifically a six-factor test (Gladden factors), 10 to
                                      determine the character of the taxpayers’ gain on the relin-
                                      quishment of those rights. Id. at 221. Respondent argues the
                                      Gladden factors point to ordinary income treatment for the
                                      proceeds of the State tax credit sales.
                                        We find that respondent’s argument extends the Gladden
                                      analysis beyond its historical use and the purpose it serves.
                                      The Gladden factors arose from a judicial need to analyze the
                                      underlying nature of contract rights. This Court cannot con-
                                      clude that a government-granted tax credit is a contract
                                      right. There is nothing in the Colorado statutes granting the
                                      tax credits that could be understood to create a contract. As
                                      the Supreme Court stated in Natl. R.R. Passenger Corp. v.
                                      Atchison, Topeka & Santa Fe R. Co., 470 U.S. 451, 465–466
                                      (1985):
                                      For many decades this Court has maintained that absent some clear
                                      indication that the legislature intends to bind itself contractually, the
                                      presumption is that ‘‘a law is not intended to create private contractual or
                                      vested rights but merely declares a policy to be pursued until the legisla-
                                      ture shall ordain otherwise.’’ This well-established presumption is
                                      grounded in the elementary proposition that the principal function of a
                                      legislature is not to make contracts, but to make laws that establish the
                                      policy of the state. Policies, unlike contracts, are inherently subject to revi-
                                      sion and repeal, and to construe laws as contracts when the obligation is
                                      not clearly and unequivocally expressed would be to limit drastically the
                                      essential powers of a legislative body. Indeed, ‘‘ ‘[t]he continued existence
                                      of a government would be of no great value, if by implications and
                                      presumptions, it was disarmed of the powers necessary to accomplish the
                                      ends of its creation.’ ’’ Thus, the party asserting the creation of a contract
                                      must overcome this well-founded presumption, and we proceed cautiously
                                      both in identifying a contract within the language of a regulatory statute
                                      and in defining the contours of any contractual obligation. [Citations
                                      omitted.]

                                        9 The analysis was first discussed and applied by the Court in Foy v. Commissioner, supra

                                      at 65–70.
                                        10 Despite the factors’ origination in Foy v. Commissioner, supra, for convenience to the parties

                                      we refer to the analysis as the Gladden factors.




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                                        Here there is no clear indication that the Colorado legisla-
                                      ture intended to bind itself contractually. The presumption
                                      that Colorado’s State tax credit has not created any private
                                      contractual rights has not been overcome.
                                        State tax credits, as respondent concedes, are not contract
                                      rights. Respondent has asserted no reason, nor can we think
                                      of one, to expand the applicability of the Gladden analysis to
                                      the State tax credits at issue.
                                           2. Inapplicability of the Substitute for Ordinary Income
                                              Doctrine
                                        Respondent also asserts that petitioners’ gains from the
                                      sales of their State tax credits are ordinary because they are
                                      merely a substitute for ordinary income. First, respondent
                                      asserts that petitioners’ proceeds from selling the State tax
                                      credits are merely a substitute for a refund from Colorado
                                      that would have been ordinary income. Respondent’s argu-
                                      ment assumes that a refundable credit would not be excluded
                                      from income. 11 Consequently, respondent’s position is that
                                      the proceeds petitioners received from the sales of their
                                      credits are a substitute for the up to $50,000 tax refund that
                                      a Colorado taxpayer could receive in a year the State incurs
                                      a budget surplus. 12 Yet respondent also concedes that there
                                      was no opportunity for a refund from the State either during
                                      2004 (the year petitioners sold their credits) or in 2006
                                      through 2010. 13
                                        Petitioners sold $110,000 and gave away $10,000 of their
                                      $260,000 of State tax credits, leaving them with $140,000 of
                                      State tax credits to use. There is no evidence and respondent
                                      does not assert that petitioners sold credits they could have
                                         11 Respondent’s motion for summary judgment states that ‘‘Generally, a payment from a state

                                      attributable to the portion of a refundable credit that exceeds a taxpayer’s liability would be
                                      ordinary income’’. As support respondent cites Rev. Rul. 85–39, 1985–1 C.B. 21, amplified by
                                      Rev. Rul. 90–56, 1990–2 C.B. 102. Neither revenue ruling addresses the Federal income tax im-
                                      plications of a State tax refund attributable to State tax credits. Instead, the revenue rulings
                                      analyze whether distributions from the State of Alaska’s annual resident dividend program are
                                      income or gifts to the State’s residents. Respondent does not provide any reason Colorado’s re-
                                      fundable tax credit program should be treated similarly for Federal tax purposes to Alaska’s div-
                                      idend program rather than to the tax and deemed refund programs implemented by the States
                                      of Iowa and California. See Rev. Rul. 79–315, 1979–2 C.B. 27 and Rev. Rul. 70–86, 1970–1 C.B.
                                      23, respectively.
                                         12 A transferee of the State tax credits is never eligible for a refund. Colo. Rev. Stat. sec. 39–

                                      22–522(7)(c).
                                         13 Colorado taxpayers have been able to receive a refund for their conservation easement cred-

                                      its only in 2005.




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                                      350                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                      otherwise used to receive a refund. Therefore, petitioners’
                                      proceeds from the sale of their credits are not a substitute for
                                      a tax refund.
                                         Second, respondent maintains that to the extent a tax-
                                      payer could use a credit to reduce a State tax liability but
                                      instead sells that credit, that taxpayer has the economic
                                      equivalent of ordinary income. Respondent appears to reason
                                      that if an individual taxpayer who sells credits itemizes
                                      deductions (ignoring phase-outs), that taxpayer’s section 164
                                      Federal income tax deduction is greater than it would have
                                      been had that taxpayer retained and used the credits. There-
                                      fore, the taxpayer who sells credits has more Federal income
                                      tax deductions and owes less Federal income tax. Assuming
                                      arguendo that petitioners sold credits that they could some
                                      day have used to offset a State tax liability and that they
                                      could have deducted that liability for Federal tax purposes
                                      were it not offset, respondent’s argument still fails. A reduc-
                                      tion in a tax liability is not an accession to wealth. Con-
                                      sequently, a taxpayer who has more section 164 deductions
                                      has not received any income. 14
                                         Having addressed respondent’s arguments and finding
                                      them unpersuasive, we turn to whether there is any reason
                                      the substitute for ordinary income doctrine is applicable to
                                      the sales of petitioners’ State tax credits. The parties and
                                      this Court agree that the receipt of a State tax credit is not
                                      an accession to wealth that results in income under section
                                      61. See Browning v. Commissioner, 109 T.C. 303, 324–325
                                      (1997); Rev. Rul. 79–315, 1979–2 C.B 27. We know of no
                                      authority, and respondent has not cited any, for the propo-
                                      sition that a State income tax credit results in ordinary
                                      income upon its later sale. 15 On the contrary, courts and the
                                      Commissioner’s rulings frequently treat government-granted
                                      rights as capital assets. 16
                                        14 Even respondent recognizes that a reduction in taxes does not create income. ‘‘The end re-

                                      sult of the Act is the issuance by the State of cash payments to all individual income taxpayers.
                                      Thus, the Act is merely a means of effecting a statutory decrease in the tax liability of each
                                      individual taxpayer’’. See Rev. Rul. 79–315, 1979–2 C.B. at 27.
                                        15 Carrying this proposition through to its logical conclusion would mean that inherited and

                                      gifted property, also typically received tax free, should receive ordinary income treatment when
                                      sold. See Lattera v. Commissioner, 437 F.3d 399, 405 (3d Cir. 2006) (discussing a similarly illogi-
                                      cal result where a taxpayer has not made any underlying investment in an asset), affg. T.C.
                                      Memo. 2004–216.
                                        16 See Caboara v. Commissioner, T.C. Memo. 1977–355 (deciding a liquor license is a capital

                                      asset); Curtis v. United States, 72–1 USTC par. 9330, 29 AFTR 2d 72–924 (W.D. Wash. 1972)
                                      (accepting the parties’ characterization of government-allotted milk base rights as capital assets




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                                      (341)                         TEMPEL v. COMMISSIONER                                           351


                                         It is also apparent that the transferred State tax credits
                                      never represented a right to receive income from the State.
                                      Instead, they merely represented the right to reduce a tax-
                                      payer’s State tax liability. It is without question that a
                                      government’s decision to tax one taxpayer at a lower rate
                                      than another taxpayer is not income to the taxpayer who
                                      pays lower taxes. A lesser tax detriment to a taxpayer is not
                                      an accession to wealth and therefore does not give rise to
                                      income. 17
                                         It follows that the taxpayer who is able to claim a deduc-
                                      tion or credit has no more income by virtue of having that
                                      right than the taxpayer who is unable to make such a
                                      claim. 18 Had petitioners used all of their credits to offset
                                      their State tax liability, rather than selling them, it appears
                                      that respondent would agree there would have been no
                                      income to petitioners. 19 Using a tax credit to offset a tax
                                      liability is not an accession to wealth.
                                         Petitioners never possessed a right to income from the
                                      receipt of the credits. They did not sell a right either to
                                      and deciding whether those rights were long-term or short-term capital assets); Rev. Rul. 70–
                                      644, 1970–2 C.B. 167 (treating milk allocation rights as capital assets); Rev. Rul. 70–248, 1970–
                                      1 C.B. 172 (treating liquor business license as a capital asset); Rev. Rul. 66–58, 1966–1 C.B.
                                      186 (treating a cotton acreage allotments as capital assets). Sec. 197 as contended by regulations
                                      may have the effect of characterizing certain intangibles used in a trade or business as sec. 1231
                                      assets. Sec. 197(f)(7); sec. 1.197–2(g)(8), Income Tax Regs.
                                         17 All ‘‘accessions to wealth, clearly realized, and over which the taxpayers have complete do-

                                      minion’’ are income. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
                                         Some commentators have suggested a State’s grant of State income tax credits to taxpayers
                                      who make charitable donations of qualified conservation easements should be treated as a trans-
                                      action that is in part a sale and in part a gift. The Commissioner has eschewed this approach,
                                      and neither party has advocated it here. See Chief Counsel Advice 201105010 (Feb. 4, 2011);
                                      see also Browning v. Commissioner, 109 T.C. 303 (1997).
                                         We discern no reason to disturb this practice. Credits do not increase a donor’s wealth, as
                                      long as they are used to offset or reduce the donor’s own State tax responsibility. A reduced
                                      tax is not an accession to wealth. It is only, as occurred in the instant case, when the donor
                                      sells or exchanges a State tax credit to a third party for consideration that an accession to
                                      wealth has occurred. A lower tax is not the same as or comparable with the State of Alaska’s
                                      distribution of oil revenues, derived from third parties, to its residents, which was treated as
                                      income to them in Rev. Rul. 85–39, supra.
                                         18 In a revenue ruling the Commissioner reasoned that a tax rebate, applied in the form of

                                      a State income tax credit, was not income because it was ‘‘merely a means of effecting a statu-
                                      tory decrease in the tax liability’’ of those taxpayers. Rev. Rul. 79–315, 1979–2 C.B. at 27.
                                         19 The Commissioner’s longstanding administrative position has been that the receipt and use

                                      of a State tax credit is not income. Rev. Rul. 79–315, supra; Rev. Rul. 70–86, supra; Chief Coun-
                                      sel Advice 200842002 (Oct. 17, 2008). The general exception is that a refund of a tax claimed
                                      as a Federal income tax deduction in a prior year is income. Sec. 111.
                                         Respondent does not assert, and there is no evidence, that petitioners sold credits that they
                                      could have claimed against a State income tax liability. Therefore, whether a taxpayer who sells
                                      credits at a discount that he could have used, pays his State tax liability, and deducts that li-
                                      ability for Federal tax purposes may receive capital gains treatment on the sale of those credits
                                      is not at issue here.




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                                      352                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                      earned income or to earn income. Consequently, the sale pro-
                                      ceeds are not a substitute for rights to ordinary income. 20
                                           3. Conclusion
                                        The State tax credits petitioners sold do not represent a
                                      right to income; therefore, the substitute for ordinary income
                                      doctrine is inapplicable. None of the categories of property in
                                      section 1221 that Congress specifically excepted from the
                                      term ‘‘capital asset’’ is applicable to the State tax credits.
                                      Accordingly, we hold the State tax credits petitioners sold are
                                      capital assets.
                                      C. Basis
                                         Section 1012 sets forth the foundational principle that the
                                      basis of property for tax purposes shall be the cost of the
                                      property. Cost, in turn, is defined by regulation as the
                                      amount paid for the property in cash or other property. Sec.
                                      1.1012–1(a), Income Tax Regs.
                                         Petitioners argue that they have a cost basis in their State
                                      tax credits. On their tax return they claimed a cost basis in
                                      the credits based upon an allocation of $11,574.74 of profes-
                                      sional fees they incurred in connection with establishing and
                                      donating the conservation easement. 21 In their cross-motion
                                      for partial summary judgment petitioners appear also to
                                      argue some portion of their basis in their land should be allo-
                                      cable to the State tax credits. 22 We find neither position ten-
                                      able.
                                         The first position assumes the expenses petitioners
                                      incurred to donate the conservation easement are properly
                                      allocable in their entirety to petitioners’ State tax credits.
                                      However, individual taxpayers may deduct ordinary and nec-
                                      essary expenses incurred ‘‘in connection with the determina-
                                      tion, collection, or refund of any tax’’ as an itemized deduc-
                                      tion. Secs. 211 and 212. Appraisal fees and other ordinary
                                      and necessary expenses to determine a taxpayer’s tax
                                      liability as the result of a charitable contribution may be
                                        20 Respondent’s reliance upon the Gladden factors is misplaced. We previously determined the

                                      State tax credits do not represent contractual rights. We have also determined these credits do
                                      not represent a right to income. Therefore, it is inappropriate to apply the Gladden factors to
                                      the State tax credits.
                                        21 The fees consisted of accounting, appraisal, surveying, and other professional services.
                                        22 While petitioners did not raise their position in their pleadings, raising it in their motion

                                      has not prejudiced respondent.




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                                      (341)                         TEMPEL v. COMMISSIONER                                           353


                                      deductible under section 212(3). See Neely v. Commissioner,
                                      85 T.C. 934, 950–951 (1985); Robson v. Commissioner, T.C.
                                      Memo. 1997–176, affd. without published opinion 172 F.3d
                                      876 (9th Cir. 1999); Biagiotti v. Commissioner, T.C. Memo.
                                      1986–460. Expenses incurred to determine any State tax,
                                      including State income tax credits, are also expenses that
                                      may fall within the ambit of section 212(3). Sec. 1.212–1(l),
                                      Income Tax Regs.
                                         Section 212 aside, petitioners’ argument also glosses over
                                      section 1012. Under section 1012, cost basis generally is
                                      what a taxpayer paid to acquire an asset. See Solitron
                                      Devices, Inc. v. Commissioner, 80 T.C. 1, 16–17 (1983), affd.
                                      without published opinion 744 F.2d 95 (11th Cir. 1984). Peti-
                                      tioners paid transaction fees to establish a conservation ease-
                                      ment that they donated to an unrelated third party. Peti-
                                      tioners did not acquire the State tax credits by purchase. 23
                                      It was the State’s unilateral decision to grant petitioners the
                                      State tax credits as a consequence of their compliance with
                                      certain State statutes. Accordingly, petitioners easement
                                      costs are not allocable as cost basis to their State tax credits.
                                         Petitioners appear to take a second position in their motion
                                      without fully articulating that position. Petitioners cite
                                      Fasken v. Commissioner, 71 T.C. 650 (1979), for the propo-
                                      sition that where a taxpayer sells a portion of property any
                                      gain or loss is calculated separately for each part sold and
                                      the adjusted basis of the entire property is allocated to the
                                      portion sold. In Fasken the Court decided whether the
                                      consideration the taxpayers received for easement grants
                                      should be applied against their basis in all their land or
                                      applied to the portion of the basis allocable to the acreage
                                      upon which the easements were granted. Id. at 655–660.
                                      Unlike the taxpayers in Fasken, petitioners did not sell an
                                      easement; they made a charitable contribution. Petitioners
                                      assert that the rationale of Fasken should apply to their
                                      State tax credits. They appear to contend, like the taxpayers
                                      in Fasken, that their State tax credits are a portion of their
                                      land and that the basis in their land is allocable to their
                                      credits.
                                        23 This Court also notes that it has previously declined to adopt the ‘‘unusual concept that

                                      cost basis can be allocated to property other than * * * property purchased.’’ Solitron Devices,
                                      Inc. v. Commissioner, 80 T.C. 1, 17 (1988), affd. without published opinion 744 F.2d 95 (11th
                                      Cir. 1984).




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                                      354                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                         Colorado’s grant of State tax credits creates cognizable
                                      property rights in those credits for the recipients of those
                                      credits. Cf. United States v. Griffin, 324 F.3d 330, 353–355
                                      (5th Cir. 2003); Barrington Cove Ltd. Pship. v. R.I. Hous. &
                                      Mortg. Fin. Corp., 246 F.3d 1, 5 (1st Cir. 2001) (finding a
                                      developer did not have a cognizable property interest in Fed-
                                      eral income tax credits for purposes of a substantive due
                                      process claim where the developer had no entitlement to
                                      credits and held only a ‘‘unilateral expectation’’ and desire for
                                      the credits). Upon petitioners’ receipt of the credits, their
                                      expectation matured and they then possessed ownership
                                      rights in their State tax credits. However, these credits are
                                      not a right petitioners possessed in their land. Instead, their
                                      rights in the credits, although achieved because of the prop-
                                      erty, arose on account of the grant from the State. Unlike the
                                      easement granted in Fasken v. Commissioner, supra, the
                                      State tax credits are not a property right in land that would
                                      necessitate the allocation of basis in the land to the credits.
                                      Therefore, Fasken does not control the tax treatment of peti-
                                      tioners’ charitable contribution.
                                         Moreover, there are rules for determining a donor’s basis
                                      in the context of a conservation easement. The donor’s entire
                                      basis in the property is allocated to the conservation ease-
                                      ment according to the ratio that the fair market value of the
                                      easement bears to the total pre-easement fair market value
                                      of the property. Sec. 170(e)(2); Hughes v. Commissioner, T.C.
                                      Memo. 2009–94; sec. 1.170A–14(h)(3)(iii), Income Tax Regs.
                                      The donor reduces its basis in the retained property by the
                                      amount of basis allocated to the conservation easement. Sec.
                                      170(e)(2); Hughes v. Commissioner, supra; sec. 1.170A–
                                      14(h)(3)(iii), Income Tax Regs. These rules do not permit an
                                      allocation based upon the value of a State tax credit, only on
                                      the value of the easement. Therefore, it would be incon-
                                      sistent with these rules to allocate the donor’s land basis to
                                      the value of a State tax credit.
                                         There is nothing in the Code or the Commissioner’s regula-
                                      tions that justifies allocating petitioners’ basis in their land
                                      to the State tax credits. Therefore, we conclude petitioners do
                                      not have any basis in their State tax credits.




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                                      (341)                         TEMPEL v. COMMISSIONER                                           355


                                      D. Holding Period
                                         On their tax return petitioners reported a short-term cap-
                                      ital gain from the sale of their State tax credits. In their
                                      cross-motion for partial summary judgment petitioners claim
                                      the sale of their State tax credits resulted in long-term cap-
                                      ital gain. 24 The sale of capital assets held for more than 1
                                      year will result in long-term capital gain or loss. Sec. 1222.
                                      Petitioners assert that they held the land upon which they
                                      donated the charitable conservation easement for more than
                                      1 year and that their holding period in the land is attrib-
                                      utable to their holding period in the State tax credits.
                                         Assuming, without deciding, that petitioners have a
                                      holding period in their land that was greater than 1 year,
                                      their argument still fails. Petitioners’ reasoning, citing
                                      Fasken v. Commissioner, supra, appears to be that their
                                      holding period in their land and State tax credits are one and
                                      the same because they are both part of the bundle of their
                                      real property rights.
                                         As we explained supra p. 354, a Colorado taxpayer had no
                                      property rights in a conservation easement contribution
                                      State tax credit until the donation was complete and the
                                      credits were granted. The credits never were, nor did they
                                      become, part of petitioners’ real property rights.
                                         Instead, petitioners’ holding period in their credits began
                                      at the time the credits were granted and ended when peti-
                                      tioners sold them. Since petitioners sold their State tax
                                      credits in the same month in which they received them, the
                                      capital gains from the sale of the credits are short term.
                                      E. Conclusion
                                        The State tax credits that petitioners sold are capital
                                      assets. Petitioners have no basis in their State tax credits.
                                      Additionally, petitioners held their credits for less than 1
                                      year; therefore, the gains arising from their disposition are
                                      short-term capital gains.



                                        24 Respondent filed a response to petitioners’ assertion. Therefore, petitioners’ raising this

                                      issue in their motion has not prejudiced respondent.




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                                      356                136 UNITED STATES TAX COURT REPORTS                                         (341)


                                           To reflect the foregoing,
                                                                     An appropriate order will be issued
                                                                   granting in part and denying in part
                                                                   respondent’s motion for partial summary
                                                                   judgment and petitioners’ cross-motion for
                                                                   partial summary judgment.

                                                                               f




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