                           T.C. Summary Opinion 2013-6



                         UNITED STATES TAX COURT



      PHILLIP SCOT SUTTON AND LISA MARIE SUTTON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 14369-11S.                          Filed February 6, 2013.



      Phillip Scot Sutton, pro se.

      Craig A. Ashford, for respondent.



                              SUMMARY OPINION


      VASQUEZ, Judge: This case was heard pursuant to the provisions of section

7463 of the Internal Revenue Code in effect when the petition was filed.1 Pursuant


      1
        Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue. All Rule references are to the Tax
                                                                        (continued...)
                                          -2-

to section 7463(b), the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other case.     Respondent

determined a deficiency of $5,443 and a section 6662(a) accuracy-related penalty of

$1,089 in petitioners’ Federal income tax for 2008. After concessions,2 the sole

issue for decision is whether petitioners are entitled to a capital or ordinary loss

deduction on the abandonment of an option to purchase real property.

                                      Background

      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. At the time

they filed their petition, petitioners resided in California. Lisa Marie Sutton is a

party to this proceeding only by virtue of having filed a joint return with her

husband.




      1
        (...continued)
Court Rules of Practice and Procedure. All amounts are rounded to the nearest
dollar.
      2
         Respondent concedes that petitioners are entitled to deduct on Schedule C,
Profit or Loss From Business, travel expenses of $3,104, car and truck expenses of
$8,888, and “other” expenses (apart from the loss at issue) of $1,353 for 2008.
Respondent also concedes the accuracy-related penalty. The other adjustments in
the notice of deficiency are computational.
                                        -3-

      In 1997 Phillip Scot Sutton (petitioner) received a master’s degree in business

administration with a concentration in finance and real estate. In 2003 he accepted

employment as the general manager of the Jon Gibson Co. (Gibson), a real estate

developer in California. His duties included purchasing and developing real

property for Gibson and managing real property that had already been developed by

Gibson. He was compensated as an employee whose wages were reported on Form

W-2, Wage and Tax Statement.

      In 2005 petitioner formed Sutton Enterprises, LLC (Sutton LLC), with the

intent to purchase and develop real property part time for his own account. That

same year he purchased a dilapidated property which he intended to fix up and flip

for a profit. He continued to work for Gibson but began receiving compensation in

two separate capacities. He was compensated as an employee for managing

Gibson’s existing properties and as an independent contractor through Sutton LLC

for purchasing and developing new properties for Gibson. Gibson provided him

with a Form W-2 for work he performed as an employee and a Form 1099-MISC,

Miscellaneous Income, for work he performed as an independent contractor.

      In 2006 petitioner purchased five additional properties for his own account.

Two of the properties were dilapidated properties similar to the property he had

purchased in 2005. The other three properties were purchased as rentals or as
                                          -4-

investments. Petitioner improved the dilapidated properties and listed them for sale

with several real estate firms but was unable to find any buyers on account of the

economic downturn.

      In early 2007 petitioner received a California real estate license. On February

16, 2007, he entered into a “Residential Purchase Agreement” (option)3 to purchase

real property in El Dorado Hills, California (El Dorado Hills property), for $3.35

million.4 The option contract, as amended on May 14, 2007, provided that

petitioner would make an initial deposit of $30,000 into an escrow account on or

before May 21, 2007, and make additional monthly deposits of $3,000 beginning on

September 1, 2007, until the escrow closed.5 It further provided that “the period of

time between 5/21/07 and close of escrow is given to the Buyer in order to develop

the property for its highest and best use as determined by Buyer.”




      3
          The parties stipulated that the option is an option to purchase real property.
      4
         The El Dorado Hills property is also referred to as the Bass Lake Property
in the record.
      5
        The deposits were not refundable, but they would be applied toward the
purchase price if the escrow closed.
                                        -5-

      Petitioner spent approximately 20 hours per week working on the El Dorado

Hills property. The work included searching for partners and investors and vetting,

investigating, and developing the property. However, on account of the economic

downturn, he was unsuccessful in his efforts. On March 18, 2008, he signed a

“Release of Contract” abandoning the option and forfeiting $48,000 in deposits that

he had made in 2007 and 2008. On June 30, 2008, he ended his employment with

Gibson. The following year he closed Sutton LLC.

      On October 17, 2009, petitioners filed their Form 1040, U.S. Individual

Income Tax Return, for 2008. On Schedule C, petitioner reported his principal

business or profession as “real estate investment and development”, and he

reported gross income of $85,625 and expenses of $40,146. Among the expenses

he reported was a loss of $16,000 on the abandonment of the option. Respondent

concedes that petitioner provided sufficient documentation at Appeals to establish

that he sustained a loss of $48,000. On May 26, 2011, respondent mailed

petitioners a notice of deficiency for 2008 in which he determined that the loss

was a capital loss which should have been reported on Schedule D, Capital Gains

and Losses, instead of Schedule C. We must determine whether the loss is a

capital loss as respondent contends or an ordinary loss as petitioner contends.
                                         -6-

                                      Discussion

I.    Burden of Proof

      As a general rule, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of proving that

those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). Petitioner has neither claimed nor established that he satisfies the

requirements of section 7491(a) to shift the burden of proof to respondent with

regard to any factual issue. Accordingly, the burden of proof is on petitioner to show

that respondent’s determinations set forth in the notice of deficiency are incorrect.

See id.

II.   Capital or Ordinary Loss on the Abandonment of the Option

      A.     General Rules

      Deductions are a matter of legislative grace, and the taxpayer bears the

burden of proving that he or she is entitled to any claimed deductions. INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering,

292 U.S. 435, 440 (1934). Section 165 generally allows a deduction for any loss

sustained during the taxable year and not compensated by insurance or otherwise.

However, section 165(f) provides that a loss from the sale or exchange of a capital
                                          -7-

asset is allowed only to the extent allowed under sections 1211 and 1212.6 Section

1221 defines a capital asset as any property held by the taxpayer, whether or not

connected with his or her trade or business. Section 1221(a)(1) creates an exception

to the definition of a capital asset for “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”.

      Section 1234(a)(1) provides as a general rule:

      Gain or loss attributable to the sale or exchange of, or loss attributable
      to failure to exercise, an option to buy or sell property shall be
      considered gain or loss from the sale or exchange of property which
      has the same character as the property to which the option relates has
      in the hands of the taxpayer (or would have in the hands of the
      taxpayer if acquired by him).

Therefore, the character of petitioner’s loss on the abandonment of the option is

the same as the character the El Dorado Hills property, the underlying property to

which the option relates, would have had in his hands.




      6
         Sec. 1211(b) limits the allowance of such losses to the extent of gains from
such sales or exchanges, plus the lower of (1) $3,000 ($1,500 in the case of a
married individual filing a separate return), or (2) the excess of such losses over
such gains.
                                         -8-

      B.     The Parties’ Arguments

      Respondent contends that the El Dorado Hills property would have been a

capital asset in petitioner’s hands. He further contends that petitioner purchased the

option as an investment and that “neither Sutton LLC, nor Mr. Sutton ever held real

property for sale to customers in the ordinary course of their trade or business.”

Respondent does not dispute that petitioner was in a trade or business; instead, he

takes the position that petitioner was “only in the trade or business of locating,

developing, and selling real property for third parties, including Gibson.”

      Petitioner contends that he did not purchase the El Dorado Hills property with

the hope that it would appreciate over time like an investment. Instead, he

purchased the property with the intent “to create value by actively improving it and

selling to multiple buyers/builders for profit and income”. He further contends that

during the year in issue he was in the trade or business of, among other things,

“[i]mproving dilapidated properties for sale and profit (flipping)” and “developing

raw land with the intent to actively work to improve value and sell at a profit.” We

interpret petitioner’s argument, as did respondent, to be that the El Dorado Hills

property would have been an ordinary asset in his hands--excluded from the

definition of a capital asset under section 1221(a)(1) as property that would have
                                          -9-

been held primarily for sale to customers in the ordinary course of his trade or

business.

      C.     The El Dorado Hills Property: Capital or Ordinary Asset

      We must determine whether the El Dorado Hills property would have been a

capital asset or an ordinary asset in petitioner’s hands. That question turns on a

purely factual matter--whether the property would have been held primarily for sale

to customers in the ordinary course of petitioner’s trade or business. See Pritchett v.

Commissioner, 63 T.C. 149, 162 (1974); Maddux Constr. Co. v. Commissioner, 54

T.C. 1278, 1284 (1970).

      Over the years, courts have considered a variety of factors in determining a

taxpayer’s primary purpose for holding property, including (1) the taxpayer’s

purpose in acquiring the property and the duration of his ownership, (2) the purpose

for which the property was subsequently held; (3) the taxpayer’s everyday business

and the relationship of realty income to total income, (4) the frequency, continuity,

and substantiality of sales of property, (5) the extent of developing and improving

the property to increase sales, (6) the extent to which the taxpayer used advertising,

promotion, or other activities to increase sales, (7) the use of a business office for

the sale of property, (8) the character and degree of supervision or control the

taxpayer exercised over any representative selling the property, and (9) the time and
                                        - 10 -

effort the taxpayer habitually devoted to the sales. United States v. Winthrop, 417

F.2d 905, 910 (5th Cir. 1969); Cottle v. Commissioner, 89 T.C. 467, 487 (1987);

Raymond v. Commissioner, T.C. Memo. 2001-96; Neal T. Baker Enters., Inc. v.

Commissioner, T.C. Memo. 1998-302; Nadeau v. Commissioner, T.C. Memo.

1996-427; Tollis v. Commissioner, T.C. Memo. 1993-63, aff’d without published

opinion, 46 F.3d 1132 (6th Cir. 1995). Although these factors may aid the finder of

fact in determining, on the entire record, the taxpayer’s primary purpose for holding

property, they have no independent significance and individual comment on each

factor is not necessary or required. Cottle v. Commissioner, 89 T.C. at 487-489;

see also Suburban Realty Co. v. United States, 615 F.2d 171, 177-179 (5th Cir.

1980); Hay v. Commissioner, T.C. Memo. 1992-409.

      In 2005 petitioner formed Sutton LLC with the intent to purchase and develop

real property part time for his own account. Thereafter, he spent part of his time

working for Gibson managing real property as an employee and purchasing and

developing real property as an independent contractor and part of his time

purchasing and developing real property for his own account. In 2005 and 2006 he
                                         - 11 -

purchased, improved, and listed for sale three dilapidated properties.7 The

following year he purchased the option on the El Dorado Hills property and

continued to work for Gibson performing the same duties as in the prior years. We

find that petitioner was in the trade or business of purchasing and developing real

property for both himself and others. Respondent’s contention that petitioner was

“only in the trade or business of locating, developing, and selling real property for

third parties, including Gibson” is unpersuasive.

      Petitioner credibly testified that he purchased the option on the El Dorado

Hills property in 2007 with the intent to subdivide and develop the property. He

further credibly testified that he spent approximately 20 hours per week working on

the property in 2007 and until he abandoned the option on March 18, 2008. He

introduced into evidence a copy of the option contract, which corroborates his

testimony and specifically provides that he would be allowed the period between

May 21, 2007, and the close of escrow “to develop the property for its highest and

best use” and that the sellers of the property would “cooperate with * * *

[petitioner] in any and all ways necessary and in a timely way to develop the

property accordingly.”


      7
         His lack of success in selling the dilapidated properties did not reflect a
lack of effort on his part.
                                        - 12 -

      Petitioner spent considerable time and effort on the El Dorado Hills property

while holding merely an option to purchase it. In the light of the foregoing and on

the basis of all the facts and circumstances, we find that petitioner would have held

the property primarily for sale to customers in the ordinary course of his trade or

business, as opposed to some other purpose such as an investment, had he acquired

it. Thus, the property would have been an ordinary asset in his hands, and,

accordingly, petitioners are entitled to an ordinary loss deduction of $48,000 for

2008 on the abandonment of the option.

      In reaching all of our holdings herein, we have considered all arguments made

by the parties, and to the extent not mentioned above, we conclude they are

irrelevant or without merit.

      To reflect the foregoing,


                                                       Decision will be entered under

                                                 Rule 155.
