In the
United States Court of Appeals
For the Seventh Circuit

No. 00-1747

Gary K. Bielfeldt and Carlotta J. Bielfeldt,

Petitioners-Appellants,

v.

Commissioner of Internal Revenue,

Respondent-Appellee.



Petition to Review Decision
of the United States Tax Court.
No. 5936-96--David Laro, Judge.


Argued September 27, 2000--Decided November 8,
2000



  Before Posner, Coffey, and Kanne, Circuit
Judges.

  Posner, Circuit Judge. Gary Bielfeldt
(and his wife, but she is a party only by
virtue of having filed a joint return
with her husband), a large trader in U.S.
Treasury notes and bonds, seeks to
overturn a decision by the Tax Court
denying him the right to offset immense
trading losses that he incurred in the
1980s against all but $3,000 a year in
ordinary income. He claims to be not a
trader but a dealer and that the losses
he incurred in the sale of the Treasury
securities were losses connected with his
dealer’s "stock in trade"; such losses,
even when they result as his did from the
sale of a capital asset, are treated as
ordinary rather than capital losses and
can therefore be fully offset against
ordinary income. 26 U.S.C. sec. 1221(1).
In contrast, capital losses, while they
can be fully offset against capital
gains, can be offset against ordinary
income only up to $3,000 a year. 26
U.S.C. sec. 1211(b); Marrin v. IRS, 147
F.3d 147, 150-52 (2d Cir. 1998). Although
the amount is arbitrary, the rationale
for limiting such offsets is not; it is
to reduce taxpayers’ incentives to so
structure their capital transactions as
to realize losses today and defer gains
to the future. See Robert H. Scarborough,
"Risk, Diversification, and the Design of
Loss Limitations Under a Realization-
Based Income Tax," 48 Tax L. Rev. 677,
680-81 (1993); Alvin C. Warren, Jr., "The
Deductibility by Individuals of Capital
Losses Under the Federal Income Tax," 40
U. Chi. L. Rev. 291, 310-14 (1973). If
Bielfeldt’s characterization of his
status is sound, he is entitled to some
$85 million in refunds of his federal
income tax.

  The standard distinction between a
dealer and a trader is that the dealer’s
income is based on the service he
provides in the chain of distribution of
the goods he buys and resells, rather
than on fluctuations in the market value
of those goods, while the trader’s income
is based not on any service he provides
but rather on, precisely, fluctuations in
the market value of the securities or
other assets that he transacts in. Marrin
v. IRS, supra, 147 F.3d at 151; United
States v. Wood, 943 F.2d 1048, 1051-52
(9th Cir. 1991); United States v.
Diamond, 788 F.2d 1025, 1029 (4th Cir.
1986). This is not to deny that a trader,
whether he is a speculator, a hedger, or
an arbitrageur, serves the financial
system by tending through his activities
to bring prices closer to underlying
values, by supplying liquidity, and by
satisfying different preferences with
regard to risk; he is not a parasite, as
the communists believed. But he is not
paid for these services. His income from
trading depends on changes in the market
value of his securities between the time
he acquired them and the time he sells
them.

  Although one thinks of a dealer’s
inventory or stock in trade as made up of
physical assets, it can be made up of
securities instead. A stockbroker who
owned shares that he sold to his
customers at market price plus a
commission would be a bona fide dealer.
The example of a recognized "dealer" in
securities that is closest to Bielfeldt’s
self-description because it blurs the
distinction between deriving income from
providing a service in the purchase or
sale of an asset and deriving income from
changes in the market value of an asset
is a floor specialist on one of the stock
exchanges. The specialist maintains an
inventory in a specified stock in order
to maintain liquidity. If its price
soars, indicating that demand is
outrunning supply, he sells from his
inventory to meet the additional demand,
and if the price of the stock plunges, he
buys in the open market in order to
provide a market for the people who are
trying to sell. See Bradford v. United
States, 444 F.2d 1133, 1135 (Ct. Claims
1971) (per curiam); Louis Loss,
Fundamentals of Securities Regulation
671, 792-93 (1983); Zvi Bodie, Alex Kane
& Alan J. Marcus, Investments 89-91 (3d
ed. 1996). He is not paid by the stock
market for this service, but is
compensated by the income he makes from
his purchase and sales and by commissions
on limit orders (orders contingent on a
stock’s price hitting a specified level)
placed with him by brokers. United States
v. Bleznak, 153 F.3d 16, 18 (2d Cir.
1998); Fridrich v. Bradford, 542 F.2d
307, 309 n. 5 (6th Cir. 1976); Loss,
supra, at 671; Bodie, Kane & Marcus,
supra, at 90. The Internal Revenue
Service treats his gains and losses as
ordinary income because the Internal
Revenue Code classifies him as a dealer.
See 26 U.S.C. sec.sec. 1236(a), (d).

   Treasury securities, at least the ones
in which Bielfeldt transacted, are not
sold on an organized exchange, and so
there are no floor specialists--there is
no floor. The market for Treasury
securities is an over-the-counter market,
like the NASDAQ. But the economic
function that the specialists on the
organized exchanges perform is
independent of the form of the market,
and dealers who specialize in Treasury
securities (called "primary dealers," and
discussed in the next paragraph) are
close analogues of the floor specialists,
just as NASD market makers are. There is
even a new law that requires the primary
dealers in Treasury securities, with some
exceptions, to register with the SEC or
the NASD. Government Securities Act of
1986, Pub. L. 99-571, sec.sec. 102(e) and
(f), 100 Stat. 3218, 15 U.S.C. sec. 78o-
5.

  Bielfeldt claims that he performs this
function too, though he is not a
registered or primary dealer. The
securities in question are used to
finance the national debt. During the
period in which he incurred losses, there
was no talk of paying off the debt--on
the contrary, the debt was growing. To
finance growth and redemptions, the
Treasury would periodically auction large
quantities of bonds and notes, which
would be underwritten by a relative
handful of primary dealers. Bielfeldt
would buy in huge quantities from these
dealers and resell in smaller batches,
often to the same dealers, a few weeks
later. His theory, which worked well for
a few years and then turned sour, was
that the Treasury auctions were so large
that each one would create a temporary
glut of Treasury securities, driving
price down. He would buy at the depressed
price and hold the securities off the
market until, the glut having disappeared
(because he was hoarding the securities),
price rose, and then he would sell. He
argues that had it not been for this
service that he performed in the
marketing of Treasury securities, the
price the Treasury got at its auctions
would have been depressed, with the
result that interest on the national debt
would be even higher than it is.

  What he is describing is simply the
social benefit of speculation. Think back
to the Biblical story of Joseph. During
the seven fat years, years of glut,
Joseph "hoarded" foodstuffs so that there
would be an adequate supply in the seven
lean years that he correctly predicted
would follow. In a money economy, he
would have financed the program by buying
cheap, which would be easy to do in a
period of glut, and selling dear, which
would be easy to do in a period of
scarcity and would help to ration
supplies in that period. He would buy
cheap yet pay higher prices than people
who were buying for consumption, since he
would anticipate a profit from the later
sale during the period of scarcity.
Similarly, Bielfeldt hoarded Treasury
securities during the fat weeks
immediately after an auction so that
there would be an adequate supply in the
lean weeks (the weeks between auctions)
that followed. That activity may have
been socially beneficial, as he argues,
but it is no different from the social
benefits of speculation generally. His
argument if accepted would turn every
speculator into a dealer for purposes of
the Internal Revenue Code. United States
v. Diamond, 788 F.2d 1025, 1030 (4th Cir.
1986).

  Unlike a floor specialist, Bielfeldt
undertook no obligation to maintain an
orderly market in Treasury securities. He
did not maintain an inventory of
securities; and because he skipped
auctions that didn’t seem likely to
produce the glut that was the basis of
his speculative profits, there were
months on end in which he could not have
provided liquidity by selling from
inventory because he had no Treasury
securities. In some of the tax years in
question he participated in as a few as 6
percent of the auctions, and never did he
participate in more than 15 percent. As a
result, he was out of the market for as
much as 200 days a year. He was a
speculator, period. As the Federal
Reserve Bank of New York, which kept
track of Bielfeldt’s trading in Treasury
securities and sent updates to the IRS,
put it, "his activities are in most cases
outright speculation of interest rate
movements."

  In saying that Bielfeldt was not a
specialist, we don’t mean to imply that
the Internal Revenue Service would be
required to recognize as a dealer a
trader who structured his operation to
resemble that of a floor specialist but
was not a floor specialist as defined in
26 U.S.C. sec. 1236(d)(2). That issue is
not before us. Nor is the bearing of a
1997 statute, 26 U.S.C. sec. 475(f),
which allows a securities trader to treat
paper gains and losses as ordinary rather
than capital income by marking to market
the securities he owns at the end of the
tax year, that is, by pretending they had
been sold then. We note finally that
Bielfeldt’s alternative argument, that
Treasury securities are "notes receivable
acquired in the ordinary course of trade
or business" and therefore are not
capital assets within the meaning of 26
U.S.C. sec. 1221(4), is frivolous. It
implies that no bonds, government or
private, are capital assets, since a
bond, like a note receivable, is a
promise to pay the holder of the
instrument.

Affirmed.
