T.C. M em o . 2 0 1 8 -2 1

UNITED STATES TAX COURT

SUGAR LAND RANCH DEVELOPM ENT, LLC, SUGAR LAND ADVISORS,

L LC, TAX M ATTERS PARTNER, Pet i t i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 5 8 3 5-1 6. Fi l edFeb ru ary 2 2 , 2 0 1 8
.

Geo rg e W . Co nn el l y , J r., an dRi t a Ren ee Hu ey , fo r p et i t i o n er. Can d ace M . W i l l i am s an dCaro l Bi ng h am M cCl ure, fo r res po n den t .

M EM ORANDUM FINDINGS OF FACT AND OPINION THORNTON, Jud g e: Pu rs u an tt o s ect i o n 6 2 2 3 1 res p o n den ti s s u eda n o t i ce
o f fi n al p art n ers hi p ad m i n i s t rat i v e ad ju s tm en t(FPAA) fo r 2 01 2 t o Su g ar Lan d

1 Al l s ect i o n referen ces are t o th e In tern al Rev en u e Co d e i n effect atal l rel ev an t t i m es , an d al l Ru l e referen ces are t o the Tax Co urtRu l es o f Pract ice an d Pro cedure, u n les s o t h erwi s e i n d i cat ed . M o n et ary am o u n t s are ro un d edt o t h e n eares td o l l ar. Acreag es are ro u n d edt o th e n eares tt en t h o f an acre.- 2
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[* 2 ] Ad v i s o rs , LLC (SLA), the t ax m at t ers p art n er o f Su g ar Lan d Ran ch Dev el o pm en t , LLC (SLRD). 2 Th e FPAA rech aract eri zes n etg ai n s fro m SLRD’ s
s al es o f t wo p arcel s o f real p ro p ert y i n 2 0 1 2 fro m cap it al g ai ns t o o rd i n ary i n co m e (al l o th er ad

ju st m en t s are co m

p u t at i o n al ). Pet i t i o n er fi l eda t i m el y p et i t i o n
co n tes t i ng th es e ad

j u s t m en t s . FINDINGS OF FACT SLRD was es t ab l i s h edas a Tex as l i m i t edl i ab i l i t y co m p an y o n Feb ru ary

2 7 , 1 9 9 8
. 3 Itwas fo rm edp ri n ci p al l y t o acq u i re co nt i g u o u s t ract s o f l an d i n Su g ar Lan d, Tex as , ju s t s ou t h wes to f Ho us t o n , an d t o d ev el o p t h atl an d i n t o s in g l efam i l y res i den t i al b u i l d i ng l o t s an dco m m erci al tract s . Ono r ab ou t M arch 1 8 , 1 9 9 8 , SLRD p u rch as edap p ro x i m at el y 8 83 .5 acres . Anad d i t i o nal 5 9 .1 acres was
co n vey edt o SLRD o n o r ab o u tNo v em b er 2 4 , 1 9 9 8 . W e s o m et i m es refer t o al l t h i s acreag e co l l ect iv el y

as th e p ro p ert y .

2 Wh enthe p et i t i o n was fi l ed , Tex as was th e p ri n ci p al p l ace o f b u s i n es s fo r SLRD.

3 SLRD i s o wn edb y

Su g ar Lan d Ho l d i n g Co rp . (SLHC) (8 5 %) an dSLA (1 5 %). SLHC i s o wn ed b y Lawren ce W o n g an d Ro cky Lai . SLA i s o wn edb y Om n i In v es t m en t s LP (3 3 .3 3 %) an dLarry J o h n s on (6 6 .6 7 % ). Om

n i In v es t m en t s LP i s o w n edb y

Larry J o h n s o n ’ s s p o u s e Su zan n e J o hn s on (9 9.9 %) an dOm n i In v es t m en t s GP, LLC (0 .1 %). Om n i In ves t m en t s GP, LLC i s o wn edb y Larry J o h n so n (3 3 .3 3 %) an dSu zan n e J o h n s o n (6 6 .6 7 %).- 3
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[* 3 ] Th e p ro p ert y h ad fo rm erl y b een an o i l fi el dan dwas wes t o f, an dad jacen t t o , th e Ri v ers t o n e M as t er-Pl an n ed Co m m u n it y (Ri v ers to n e Co m

m u n it y ), wh i ch
was b ei n g d ev el o p edb y

p art i es rel at edt o SLRD. SLRD’ s o ri g i nal p l an was t o cl ean up t h e p ro p ert y

an ds ubd i v i d e i ti n t o res i d en t i al u n i t s fo r i n cl u s i on i n th e Ri v ers t o n e Co m

m u n i t y . To th aten d , b et ween 1 9 98 an d 2 0 08 SLRD cap pedo i l wel l s , rem o v ed oi l g ath eri n g l i n es , d i ds o m e en v i ro n m en tal cl ean up , b u i l t a l ev ee,
an d en t ered i n t o a d ev el o pm en tag reem en twi t h t h e Ci t y o f Su g ar Lan d , Tex as , wh i ch s p eci fi edth e ru l es th atwo u l dap p l y t o th e p ro p ert y , s ho u l di tb e d ev el o p ed
. SLRD s o ldo r o th erwi se d i s po s edo f rel at i v el y s m al l p o rt i o n s o f th e p ro p ert y b et ween 1 9 98 an d2 0 08 . Th e 8 2 4 .7 acres SLRD co n t i n uedt o o wn as o f 2 0 0 8 were co n t i g u o u s b u td i v i d edb y th ree eas em en t s . Th e fi rs teas em en t , th e HLP eas em en t , 4 ran g en eral l y fro m n o rt h t o s o ut h n ear t h e eas t ern en do f t h e p ro p ert y . Th e s eco n deas em en twas fo r a p l an n edro ad , Un i vers i t y Bo u l ev ard , an d
ran fro m eas t t o wes t . Fi n al l y , th ere was an eas em en tfo r a l ev ee ru n n in g g en eral l y fro m n o rth t o s o u t h n ear t he wes t ern en do f t h e p ro p ert y . 5

4 Th e reco rdd o es n o t d i s cl o s e wh at“ HLP” s t an d s fo r, th o u g h we n o t e t h ati t res em b l es th e acro n ym

fo r Ho u s t o n Li g ht in g & Po wer. 5 By 2 0 1 6 SLRD h ads o l d o r co nv ey ed al l th e l an deas t o f t h e HLP eas em en t, ap p aren tl y

t o rel at edp art ies . Th e t ax treat m en to f t h e p arcel s eas to f t h e HLP eas em en ti s n o t i n d i s p u t e, al t ho u g h res p o n d en targ u es th atth e ch aract eri zat i o n o f (co n ti n u ed ...)- 4
-

[* 4 ] Th e l an dwes to f th e HLP eas em en t co n s i s t ed o f fo u r l arg e p arcel s . Th e
wes tern m o s t p arcel co m

p ri s edal l th e l an d b el o w the l ev ee, i .e., o n th e ri v er s i d e o f t h e l ev ee; i twas ev en tual l y co n v ey ed t o t h e Ci t y o f Su g ar Lan d
. 6 Th e rem ai n i n g t h ree p arcel s (co m

pri s i n g al l the acreag e b et ween th e l ev ee an dth e HLP eas em en t --a t o tal o f ap p ro x i m at el y 5 8 0
. 2 acres ) were s o l dt o a m ajo r h o m eb u i ld er, Tay l o r M o rri s on o f Tex as , In c. (Tay l o r M o rri so n ), i n 2 0 11 an d2 0 1 2 . W e wi l l refer t o t h es e p arcel s as TM -1 , TM -2 , an d TM -3 (co l lect i v el y , th e TM p arcel s ). 7 Lat e i n 2 0 0 8 t h e m an ag ers o f SLRD--LarryJ o h n s o n an dLawren ce W o n g -- d eci d ed th atSLRD wo u l dn o t at t em p tt o s ub d i v i de o r o t h erwi s e d ev el op th e p ro p ert y i th el d . Fro m

th ei r l o n g ex p eri en ce i n th e real es t at e d ev el o p m en t b u s i n es s , th ey b el i ev edth atSLRD wo u l db e u n ab le t o d ev el o p , s ub d iv i d e, an ds el l

5 (...co n t in u ed ) t h e g ai n s o r l o s s es fro m

tho s e s al es i s rel ev an t t o d et erm in i n g th e t ax t reat m en to f t h e s al es wh i ch are at i s s u e.

6 Th i s p arcel ap p ears t o h av e b een ap p ro x i m at el y 1 10 acres an ds eem i n g l y co u ldn o tb e d ev el o p edb ecau s e i twas b el o w, i .e., o n th e ri v er s i d e o f, t h e l ev ee. Ot h er s m al l p o rt i o n s o f th e p ro p ert y ad jacen t t o th e l ev ee were al s o co n v ey edt o t h e Ci t y o f Su g ar Lan d.
7 TM -1 was 1 1 0 .5 acres . Itab u t t ed t he HLP eas em en t t o t h e eas tan dran fro m Un i v ers i t y

Bo u l ev ard n o rt h t o the p ro pert y l i n e. TM -2 was 3 9 6 acres an d co m p ri s edth e en t i re area s ou t h o f Un i v ers i t y Bo u l ev ardb et ween th e l ev ee an dth e HLP eas em en t . TM -3 was 7 3
. 7 acres . Itab u t t edTM -1 t o the eas tan d t h e l ev ee t o t h e wes tan dran fro m

Un i v ers i t y

Bo u l ev ard n o rt h t o t h e p ro p ert y l i n e.- 5
-

[* 5 ] res i den ti al an d co m

m erci al l o t s fro m

th e p ro p ert y

b ecau s e o f t he effect s o f t h e
s ub p ri m e m o rt g ag e cri s i s o n t h e l o cal h o u s i n g m ark etan dthe s carci t y o r
u n av ai l ab i l i t y

o f fi n an ci n g fo r h o u s i n g p ro j ect s i n t h e wak e o f t h e fi nan ci al cri s i s. In s t ead , M es s rs . J o hn s on an dW o n g d eci d edth atSLRD wo u l d h ol d t h e p ro p ert y
as an i n v es t m en tu n t i l the m ark etreco v ered en o u g h t o s el l i to ff. Th es e d eci s i o n s
were m em o ri al i zedi n a “ Un an im o u s Co n s en t ” d o cu m en td at edDecem b er 1 6 , 2 0 0 8 (s i g n edb y

M es s rs . J o h n s o n an dW o n g ), as wel l as i n an SLRD m em b er
res o l ut i o n ad o pt edo n No v em b er 1 9 , 2 0 0 9 , t o fu rt h er cl ari fy SLRD’ s p ol i cy . Bet ween 2 0 0 8 an d2 0 1 2 th e TM p arcel s “ ju s ts atth ere” (as M r. J o hn s o n cred i b l y t es t ifi ed ); th ati s, SLRD d i dn o td ev el o p t h o se p arcel s i n an y way . SLRD d i dn o t l i s tth e TM p arcel s wi th an y b ro k ers o r o t h erwi s e m ark etth e p arcel s b ecau s e SLRD’ s m an ag ers b el iev edth atthere was n o m ark etfo r l arg e t ract s o f l an do n acco u n to f th e s ub p ri m e m o rt g ag e cri s is
. In 2 0 1 1 Tay l o r M o rri s o n ap p ro ach ed SLRD ab o u tb u y i n g TM -1 an d TM -3 (i
. e., th e 1 8 4 .2 acres b et w een th e l ev ee an d t h e HLP eas em en t an d n o rt h o f Un i vers it y

Bo u l ev ard ). Tay l or M o rri so n u l t i m at el y d eci d edt o b u y

al l t h ree TM p arcel s . SLRD s o l dTM -1 t o Tay l o r M o rri s o n i n 2 0 1 1 8 an dTM -2 an dTM -3 t o

8 Th e 2 0 11 s al e i s n o tati s s u e i n th i s cas e. Res p o n d en t as s ert s th at SLRD rep o rt edth e g ai n s fro m

th e 2 0 1 1 s al e as o rd i n ary i n co m e al t h ou g h th e reco rdi s

(co n ti n u ed ...)- 6
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[* 6 ] Tay l o r M orri s o n o n Decem b er 2 1 an d2 8, 2 0 12 , res p ect i v el y . SLRD an d Tay l o r M o rri s o n ex ecu t edtwo s al e co n t ract s fo r t h i s p u rp o s e. On e s al e co n t ract (TM -3 co n t ract ), wh i ch was ex ecu tedb y SLRD an dTay l o r M o rri s o n , p ro vi d edfo r t h e s al e o f TM -1 an dTM -3 i n 2 0 1 1 an d2 0 1 2 , res pect i v el y . Th e s eco nds al e
co n tract (TM -2 co n t ract ), wh i ch was ex ecu t edb y SLRD, Tay lo r M o rri s o n , an d Hi l l s bo ro Es t at es , LLC (a t h i rdp art y ap p aren t l y

rel at edt o SLRD), p ro v i d edfo r t h e s al e o f TM -2 i n 2 0 12 an dfo r t h e s al e o f a p ro p ert y d i rect ly t o t h e s o u t h o f TM

2 (wh ich was o wn edb y

Hi l l s b o ro Es t at es , LLC). Th e TM -2 an d TM -3 co n t ract s each cal l ed fo r Tay lo r M o rri s o n t o p ay a l u m p s u m t o SLRD i n 2 0 1 2 fo r t h e l arg el y u nd ev el op edTM -2 an d TM -3 p arcel s . Th e TM -2 co n tract al s o p ro v i d edth atTay l o r M orri s o n was o b li g at edt o p ay SLRD 2 % o f t he fi n al s al e p ri ce o f each fu tu re h o m e ev en tual l y d ev el o p edan ds o l do u t
o f TM -2 . Th e TM -2 co n t racts p eci fi edth ateach 2 % p aym en two u l daccru e wh en each h o m e s al e cl o s ed . SLRD was al s o t o recei ve $ 3 ,5 0 0 fo r each p l atreco rd ed
o n TM -2
. Un l ik e t he TM -2 co n t ract , th e TM -3 co nt ract d i d n o tp ro v id e fo r a 2 % p er-h o m e p aym en t , b u td i d p ro v i d e fo r a p aym en to f $ 2 ,0 0 0 fo r each p l atreco rd ed
o n TM -3
. Th e TM -2 an dTM -3 co n t ract s al s o l i s t edo th er d ev el op m en t

8 (...co n t in u ed ) i n co n cl u s i v e o n th i s p o in t.- 7
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[* 7 ] o b l i g at i o n s fo r wh i ch th e p art i es were res p o n s i b l e. Th es e d ev el o p m en t
o b l i g at i o ns fel l al m o s ten t i rel y o n Tay l o r M o rri s o n . No p arto f t h e p aym en t s recei v edb y SLRD fro m Tay l o r M o rri s o n i n 2 0 1 2 i n cl u d edei t h er t he 2 % p er-h o m e o r p er-p latfees p ro v i dedfo r i n t h e TM -2 an d TM -3 co nt ract s . Th ati s , th e n etg ai n ati s su e i n th i s cas e rep res en t s o n l y t he l u m p s u m p aym en t s SLRD recei v edi n 2 0 1 2 fo r t h e l arg el y u n d ev el o pedTM -2 an dTM
3 p arcel s . Res p o nd en th as n o targ u ed , n o r d o es th e reco rds u g g es t, th atth e l u m p
s u m s SLRD recei v edi n 2 01 2 rep res en tp aym en tfo r an yt h i n g o th er t h anth e fai r
m ark etv al u e o f t h e l arg el y u n dev el o p edTM -2 an dTM -3 p arcel s . Aft er co m

m en ci n g th e s al e o f t h e TM p arcel s , SLRD d eci d edt o cl o s e o u ti t s p ro p ert y h o l di ng s b y co n vey i n g th e rem ai n d er o f i t s p ro p ert y t o rel at edp art i es (ex cep tfo r l an d t h atwas ev en tu al l y co n v ey edt o th e Ci t y o f Su g ar Lan d fo r n o
co n si d erat io n an dex cep tfo r a o n e-acre p arcel thatap p ears t o h av e b een s o l dt o a
co u nt y ) i n fo u r s al es i n 2 0 1 2 , 2 0 1 3 , 2 0 1 4, an d 2 01 6
. Th es e p arcel s were al l t o th e
eas to f t he HLP eas em en t an dwere 8 6 .9 , 1 2.1 , 3 2 , an d2 .2 acres , res p ect iv el y . Th es e p arcel s were u l t i m at el y i n cl u d edi n th e Ri v ers t o n e Co m m u n i t y an dap p ear t o h av e b een d ev el o p ed b y p art i es rel at edt o SLRD. Th e reco rdco n t ai ns SLRD’ s Fo rm s 1 0 6 5, U.S. Retu rn o f Part n ers hi p In co m e, fo r 2 0 0 5, 2 0 0 6 , an d 2 0 1 2 . Onth es e t h ree ret u rn s , SLRD s t at edth ati t s- 8
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[* 8 ] p ri n ci p al b us i n es s act i v i t y was “ Dev el o p m en t ” an dthati t s p ri n ci p al p ro du ct
o r s erv i ce was “ Real Es t at e”. On i t s 2 0 1 2 Fo rm 1 0 6 5 SLRD rep o rt edan $ 1 1 ,0 8 6 ,6 4 0 cap i tal g ai n fro m i t s s al e o f t h e TM -2 p arcel an d a $ 1 ,5 6 9,3 9 3 cap i t al l o s s fro m i t s s al e o f t h e TM -3 p arcel . Inth e FPAA res p o n d en t d et erm i n edth atth e ag g reg at e n eti n co m e fro m th es e t wo tran s act io n s s h o u l db e t ax edas o rd i n ary i n co m e. OPINION In th i s p ro ceed i ng , we rev i ew u n der s ect i o n 6 2 2 6 res p on d en t ’ s ad ju s t m en t s t o SLRD’ s 2 0 1 2 p art n ers h i p ret u rn . 9 Th e Co m m i s si on er’ s ad

ju s t m en t s i n an FPAA are g en eral l y

p res u m ed co rrect , an dthe t ax p ay er b ears th e b u rd eno f p ro v in g t h o s e ad

ju s t m en t s erro n eo u s. Ru l e 1 4 2 (a); Rep ub l i c Pl aza Pro p s . P’ s h i p
v . Co m m i s s i o n er, 1 0 7 T.C. 9 4, 1 0 4 (1 9 9 6 ). Th e i s s u e p res en t edi s wh et her SLRD’ s s al es o f t h e TM -2 an dTM -3 p arcel s
s h o u ldb e t reat edas g i v i n g ri s e t o cap i t al g ai n s o r o rd i n ary i nco m e. A cap i t al

9 Ou r ju ri s d ict i o n i s l i m i t edt o d et erm i n at i o n o f p art n ers hi p i t em s , al l o cat i o n o f p art n ers h ip i t em s am on g th e p art n ers , an dth e ap p li cab i li t y o f an y p en al ty , ad d it i o n t o t ax , o r ad d i t io nal am o u n t wh i ch rel at es t o an ad ju s t m en tt o a p art n ers h i p i t em . Sec. 6 2 26 (f). Th e o n l y i s s u e i n thi s cas e i s wh et h er n etp ro ceed s o f t wo o f SLRD’ s s al es i n 2 01 2 s h o ul db e t reat edas cap i t al g ai n s o r o rd i naryi n co m e. It em s o f g ai n o f t he p art n ers h i p are p art n ers h ip i t em s . Sec. 3 0 1 .6 2 31 (a)(3 )- 1 (a)(1 )(i ), Pro ced
. & Ad m i n. Reg s .; s ee s ec. 6 23 1
. Th erefo re, we h av e ju ri s d i ct i o n o v er t h e i s su e p res en tedi n t h i s cas e.- 9
-

[* 9 ] as s eti s “p ro p ert y

h el db y th e t ax p ay er (wh et h er o r n o tco nn ect edwi t h h i s t rad e o r b u si n es s )” b u tex cl u des , am o n g o t h er t h i n g s , “ i n ven to ry ” an d“p ro p ert y h el db y th e t ax p ay er p ri m ari l y

fo r s al e t o cu st o m ers i n t h e o rd i n ary co u rs e o f h i s t rad e o r b u si n es s ”. Sec. 1 2 2 1(a)(1 ). Th e Co u rto f Ap p eal s fo r t h e Fi ft h Ci rcu i t --t h e co u rtt o wh i ch t h i s cas e i s ap p eal ab l e ab s en t a s t i p ul at i o n t o th e co n t rary , s ee s ec. 7 4 8 2(b )(1 )(E)--h as h el d t h atth e th ree p ri n ci p al qu es t i o n s t o b e co ns i d ered i n d eci d i n g wh et h er g ai n i s cap i t al i n ch aract er are: (1 ) “ [W ] as t ax pay er en g ag edi n a t rad e o r b u s i nes s , an d , i f
s o , wh atb u s in es s ? ” (2 ) “ [W ] as t ax p ay er h ol d i n g th e p ro pert y p ri m ari l y fo r s al e i n t h atb u s i n es s ? ” An d (3 ) “ [W ] ere t h e s al es co nt em p l at edb y t ax pay er ‘ o rd in ary ’ i n t h e co u rs e o f t hatb us i nes s? ” Sub u rb an Real ty Co . v . Un i t ed St at es , 6 1 5 F.2 d 1 7 1 , 1 7 8 (5 t h Ci r. 1 9 8 0 ). Th e Co u rto f Ap p eal s fo r t h e Fi ft h Ci rcu i th as al s o i n d i cat edth atv ari o u s fact ors m ay

b e rel ev an tt o thes e i n qui ri es : th e freq u en cy an ds ub st an t i al i t y

o f
s al es o f p ro p ert y ; the t ax p ay er’ s p urp o s e i n acq u i ri n g th e p ro p ert y an dth e du rat i o n
o f o wn ers h i p ; th e p u rp o s e fo r wh i ch th e p ro p ert y was s ub s eq u en t l y

h el d ; th e
ex t en to f d ev el o pi n g an di m p ro v i n g th e p ro p ert y

t o i ncreas e th e s al es rev en u e; th e
u s e o f a b u s i n es s o ffi ce fo r t h e s al e o f p ro p ert y ; th e ex t en tt o wh i ch th e t ax p ay er
u s ed ad v ert i s i n g , p ro m o t io n, o r o t h er act i vi t i es t o i n creas e s al es ; an dth e t i m e an d- 1 0 -

[* 1 0 ] effo rtth e t ax p ay er h ab i tu al l y d ev o t edt o th e s al es . See i d . at1 7 8 -1 7 9 ; s ee al s o Bram

b l et tv . Co m

m i s s i o ner, 9 6 0 F.2 d5 2 6 , 5 3 0 -5 3 1 (5 t h Ci r. 1 9 9 2 ), rev ’ g T.C. M em o . 1 99 0 -2 9 6 ; Bi ed en h arn Real t y Co . v . Un i tedSt at es , 5 2 6 F.2 d4 0 9 , 4 1 5 (5 t h Ci r. 1 9 7 6 ); Un i tedSt at es v . W i n t h ro p , 4 1 7 F.2 d9 0 5, 9 1 0 (5 t h Ci r. 1 9 6 9 ); M ad du x Co n s t r. Co . v . Co m m i s s i o n er, 5 4 T.C. 1 2 7 8, 1 2 8 4 (1 9 7 0 ). Freq u en cy an d
s ub s t an t i al i t y

o f s al es i s t h e m o s ti m

p o rt an tfact o r. Sub u rb an Real t y , 6 1 5 F.2 d at 1 7 8
. I. Cap i t al Ch aract er o f Net Gai n s Fro m Sal es Th e p art i es ag ree t h atSLRD was fo rm ed t o en g ag e i n real es t at e d ev el o p m en t --s p eci fi cal l y , t o acq u i re t h e p ro p ert y an dd ev el o p i ti n to s i n g l efam i l y res i den t i al b u i l d i ng l o t s an dco m m erci al tract s . Th e reco rds up p o rt s t h i s
co n cl u s i o n : SLRD’ s t ax retu rn s , the d ev el o p m en t ag reem en t , SLRD’ s fo rm at i o n d o cu m en t s , an dth e t es t im o ny o f M es s rs . J o h n s o n an dW o ng al l cl earl y s h o w th at SLRD o ri g i n al l y

i n t en d edt o b e i n th e b u s i n es s o f s el l i ng res i d en ti al an d
co m m erci al l o ts t o cu s t om ers . Bu tth e ev i d en ce al s o cl earl y s h o ws t hati n 2 0 08 SLRD ceas edt o h o l di t s p ro p ert y p ri m ari l y fo r s al e i n thatb u s i n es s an db eg ant o h o l d i to n ly fo r i n v es t m en t . SLRD’ s p art ners d eci d edn o tt o d ev el o p the p ro p ert y an y fu rt h er, an d t h ey d eci d edn o tt o s el l lo t s fro m th o s e p arcel s. Th is co n cl u s i on i s s up p ort edb y- 1 1 -

[* 1 1 ] th e h i g hl y

cred i b l e t es t im o n y o f M es srs . J o h n s o n an d W o n g an d b y th e 2 0 0 8
u n an im o u s co n s en tan d t he 2 0 0 9 m em b er res ol u t i o n. In fact , fro m 2 00 8 o n SLRD d i dn o t d ev el op o r s el l l o t s fro m th o s e p arcel s (an d t h e ev i d en ce d o es n ots u g g es t t h atSLRD ev er s o l dev en a s i n g l e res i d en t i al o r co m m erci al l o tt o a cu s t om er at
an y p o i n t i n i t s ex i s t en ce). Res p o n d en tco n ced es th atSLRD n ev er s ubd i v i d edth e p ro p ert y . M o re p art i cu l arl y , wh en th e TM p arcel s were s o l d , th ey were n o ts o l di n the
o rd i n ary co u rs e o f SLRD’ s b u s i n es s : SLRD d idn o t m ark etth e p arcel s b y ad v ert i s in g o r o th er p ro m o t i o n al act i v i ti es . SLRD d idn o t s o l i ci t p u rch as ers fo r t h e TM p arcel s, n o r d o es an y ev i d en ce s u g g es tth atSLRD’ s m an ag ers o r m em b ers d ev ot ed an y

t i m e o r effo rtt o s el l i n g th e p ro p ert y ; Tay l o r M o rri s o n ap p ro ach ed SLRD. M o s ti m

p o rt an t l y , s al e o f t h e TM p arcel s was es s en ti al ly a b u l k s al e o f a
s i ng l e, l arg e, an d co n t i g u o u s tract o f l an d(wh i ch was cl earl y s ep arat edfro m

an y
o t h er p ro p ert i es b y

th e HLP eas em en tan dth e l ev ee) t o a s i n g le s el l er--cl earl y n o t a freq uen to ccu rren ce i n SLRD’ s o rd i naryb u s i n es s . Becau s e t he Tay l o r M o rri s o n p arcel s were h el dfo r i n v es t m en t an dwere n o t
s o l das p arto f t h e o rd i n ary co urs e o f SLRD’ s b u s i n es s , we h o l dth atn et g ai n s fro m th e s al es o f TM -2 an dTM -3 were cap i tal i n ch aract er.- 1 2 -

[* 1 2 ] II. Res p o n den t ’ s Arg u m en t s Res p o n d en targ u es th atth e ex t en to f d ev el o p m en t o f t h e TM p arcel s s h o w s t h atth es e p ro p ert i es were h el dp ri m ari l y fo r s al e i n th e o rd i n ary

co u rs e o f SLRD’ s b u s i n es s . W e are n otp ers u ad ed . Iti s cl ear t hatfro m 1 99 8 t o s o m et i m e b efo re 2 0 0 8 SLRD d ev el o p edth e p ro p ert y t o a cert ai n ex t en t . Bu t i ti s al s o cl ear t h at i n 2 0 0 8 SLRD’ s m an ag ers d eci d edn o tt o d ev el o p t h o se p arcel s i n t o a s ub d i v i s i o n
an d d eci ded n o tt o m ark etth e l an das i to rd i n ari l y wo u l dh av e. As th e Co u rto f Ap p eal s fo r t h e Fi ft h Ci rcu i th el di n Sub u rb an Real t y , 6 1 5 F.2 dat1 8 4 , a t ax p ay er i s “ en t i t l edt o s h o wth ati t s p ri m ary p urp o s e ch an g ed t o , o r b ack t o, ‘ fo r i n v es t m en t .’ ” SLRD h as m ad e s u ch a s h o wi n g . An y d ev el o p m en tact i v it y

th at
o ccu rredb efo re t he m ark edch an ge i n p urp o s e i n 2 0 0 8 (i ncl u d i n g wh at ev er
res p o n d en t t h i nk s was rep o rt edo n SLRD’ s 2 0 0 5 an d 2 0 0 6 Fo rm s 1 0 6 5 ) i s l arg el y i rrel ev an t . Res p o n d en tal s o arg u es th atthe freq u en cy o f s al es , al o n g wi th t he n atu re
an d ex t en to f SLRD’ s b u s i n es s , s h o ws t h atg ai n s fro m th e s al e o f t h e TM p arcel s
s h o u ldb e o rd i n ary

i n ch aract er. Bu t SLRD’ s s al es were i nfreq u en t , an dth e ex t en t
o f SLRD’ s b u s i n es s was ex t rem el y l i m i t ed . Aft er 2 0 0 8 SLRD d i s p o s edo f i t s
en t i re p ro p ert y

i n ju s tn in e s al es o ver ei g h ty ears (n o tco un t i n g co n vey an ces t o th e Ci t y o f Su g ar Lan d , fo r wh i ch SLRD recei v edn o co ns i d erat i o n ). Cf. Byram v .- 1 3 -

[* 1 3 ] Un i t edSt at es , 7 0 5 F.2 d 14 1 8 , 1 4 2 5 (5 t h Ci r. 1 9 8 3 ) (h o ld i n g th atal t h o u g h t h e t ax p ay er m ad e 2 2 s al es o v er a t hree-y ear p eri o d, t he t ax p ay er d i dn oth o l dthe p ro p ert y fo r s al e). M o reo v er, t h e TM p arcel s h ad n o tb een d ev el o pedi n t o a
s ub d iv i s i o n wh en t h ey were s o l d , an d l it t l e o r n o d ev el o pm en tact i v i t y o ccu rred o n t h o s e p arcel s fo r atl eas tth ree y ears b efo re s al e. In an y ev en t , res p on d en t’ s d es cri p t i o n o f t he p at t ern o f s al es aft er 2 0 0 8 i s i n co n s i s t en twi t h t h e reco rd . Th e TM p arcel s were o n t h e wes t ern s i de o f t h e HLP
eas em en tan dwere al l s o l dt o Tay l o r M o rri so n i n a t h ree-p art t ran sact i o n b eg in n i n g i n 2 0 1 1 . Al l o f t h e o t h er p arcel s s o l db y SLRD, i .e., p arcel s o t h er t h an t h e TM p arcel s, were o n th e eas ts i d e o f t h e HLP eas em en tan dap p ear t o h av e b een co n v ey edt o rel at edp art i es (wi t h th e ex cep ti o n o f a o n e-acre p arcel s o l dt o a
co u nt y ). Th e b al an ce o f t h e p ro p ert y was co nv ey ed fo r n o co n s id erat i o n (rat h er t h an s o l d ) t o th e Ci t y

o f Su g ar Lan dat v ari o u s t i m es . Ins u m , l eav i n g as id e t h e l an dth atwas co n vey edfo r p ub l i c u s e, aft er 2 0 0 8 SLRD s o l dal l o f t h e
u n d ev el op edp ro p ert y

wes to f t h e HLP eas em en t (wel l o v er h al f i ts p ro p ert y h o l d i n g s ) i n a s i n g l e ex t en d edtran s act i o n t o a s i n g l e b u y er, Tay lo r M o rri s o n , an d
s o l dth e rem ai nd er (al l o f wh ich was t o th e eas to f t h e HLP eas em en t ) t o rel at ed
en t i t i es .- 1 4 -

[* 1 4 ] Res p o n d en ts eem s t o s u g g es tth at we s h o ul d i m p u t e t o SLRD d ev el o p m en t act i vi t y wh i ch h e s ay s was p erfo rm edo n t h e eas t ern p arcel s b y rel at edp art i es . Res po n d en th as n o t p o i nt edu s t o l eg al au t h o ri ty o r an y ev i d en ce i n s up p o rto f t h i s p o s i t i on . Th e cas el aw ap p ears t o b e t o th e co n t rary . See Bram bl et tv . Co m m i s s i o n er, 9 6 0 F.2 dat5 3 3-5 3 4 (reject i ng arg u m en tthatact iv i t i es o f
co rp o rat i o n i n s el l i n g an dd ev el o p i n g l an ds h o u l db e at t ri b u t edt o p art n ers h i p wh o s e p art n ers h el d own ers h i p i n teres ts i n the co rp o rat i o n); Ph el an v . Co m m i s s i o n er, T.C. M em o . 2 0 0 4 -2 0 6 (s im i l ar). Bu tev en i f we were t o as s u m e fo r t h e s ak e o f arg u m en tthatSLRD h ads ub s t an t i al d ev el o p m en tact iv it y o n , o r act i ve an dco n t i n u o u s s al es fro m , th e eas t ern p arcel s (b y i m p u t at i o n o r o t h erwi s e),
n ev ert h el es s --i n the ab sen ce o f a co n n ect i o n b et ween th e eas tern p arcel s an dth e TM p arcel s --we are n o tp ers u ad edth atthe b u l ks al e o f t h e TM p arcel s wo u l dh av e b een in th e o rd i n ary

co u rs e o f SLRD’ s al l eg edd ev el o pm en tb u s i n es s, co ns i d eri n g t h atal l d ev el op m en t act i v i t y h adb een h al t edo n th e TM p arcel s atl eas tthree y ears b efo re t h e s al es ati s s u e an dth atth e TM p arcel s were n ev er d ev el o p edi n t o a
s ub d iv i s i o n b y SLRD. As th e Co u rto f Ap peal s fo r t h e Fi ft h Ci rcu i tn o t ed i n Sub u rb an Real t y , 6 1 5 F.2 dat1 7 9 n .2 4 , “ i f a t ax p ay er wh o en gag edi n a h i g h
v o l u m e s ub d iv i s i on b u s i n es s s o l d o n e cl earl y s eg reg at edtract i n b ul k , h e m i g h t wel l p rev ai l i n h i s cl ai m

t o cap i t al g ai n t reat m en to n th e s eg reg at edtract . ” Th ati s- 1 5 -

[* 1 5 ] p reci s el y

wh at h ap p en edh ere. Th e TM p arcel s were cl earl y s eg reg at edfro m t h e o t h er p arcel s b y

th e l ev ee an dHLP eas em en tan dwere s ol di n b u l kt o a s i n g l e b u y er. Res p o n d en targ u es th atth ere was a co n nect i o n b et ween th e TM p arcel s an d t h e p arcel s eas to f t h e HLP eas em en t : (1 ) t h ey were al l co v eredb y t h e s am e d ev el o p m en tag reem en twi t h th e Ci t y o f Su g ar Lan d ; (2 ) Tay l o r M o rri so n ag reed t o d ev el o p th e TM p arcel s i n acco rd an ce wi t h v ari o u s res t ri ct i o n s i n th e l an ds al e d eal ; an d(3 ) SLRD was t o recei v e cert ai n p aym en t s wh en ev er cert ai n co n di t i o n s
were m et . W e t h i nk , h o wev er, t h atth e fact s res p o n d en tp o i nt s o u tare ei t her i rrel ev an t t o the ad ju st m en ti n th e FPAA o r co n s i s ten twi t h i n ves t m en ti n t en t. Fo r ex am p l e, t h ere wo ul dh av e b een n o reas o n t o u n d o o r ev en m o d i fy th e d ev el o p m en t ag reem en taft er d eci d in g n o t t o d ev el o p th e TM p arcel s . Th ere s eem s t o b e l i t t l e d o ub tth atth e h i g hes tan db es tu s e o f t h i s l an d was fo r d ev el op m en t i nt o
res i den t ial an d co m

m erci al l o ts . An y b u y er wo u l dl i k el y h av e b een a d ev el o p er o f
s o m e k i nd . M ai n t en an ce o f t h e d ev el o p m en tag reem en t was therefo re co n si s t en t wi t h b ot h d ev el op m en ti n t en tan d i n v es t m en ti n t en t . Cf. Sub u rb an Real t y , 6 1 5 F.2 dat 1 78 -1 7 9 (“ [S] t an d i n g al o n e, s o m e d eg ree o f d ev el o p m en tact i v i t y i s n o t i n co n s i s t en twi t h h o l d i n g p ro p ert y fo r p u rp o ses o t h er t h an s al e.”).- 1 6 -

[* 1 6 ] As fo r t h e res t ri ct i o n s, we co n cl u d e th atthey were d i rect edaten s u ri n g th at Tay l o r M o rri s o n as s u m edan y o b l i g at i o n s o r l i ab i li t i es rel at i ng t o t h e TM p arcel s
an d aten s u ri ng th atTay l o r M o rri so n ’ s act i o n s wo u l d n o td ecreas e th e v al u e o f t he Ri v ers t o n e Co m

m u n i t y as a wh o l e. Su ch res t ri ct i on s are n o ti n co n s i s t en twi t h i n v es t m en ti nt en t --a s el l er o f p ro p ert y , wh et h er an i n ves t o r o r a d eal er, m i g h t
reas on ab l y

draft the s al e ag reem en ts o as t o en s ure t h ati two u l d n o tret ai n p ers o n al l i ab i l it y

wi th res p ectt o th e p ro p ert y o r t o en s u re t h atth e b u y er wo u l dn o t d ecreas e t h e v al u e o f ad

j o i ni ng p ro p ert i es th e s el l er co n t i n ues t o h o l d
. Fi n al l y , th e ad d i t i o n al p aym en t s p ro v i d edfo r i n th e TM -2 an dTM -3
co n tract s are l arg el y

i rrel ev an tt o th e ad

ju st m en tati s s u e i n th is cas e. Wh i l e i ti s t ru e t hatth e TM -2 an dTM -3 co n t ract s p ro v id edfo r v ari o u s ad d i t i o nal p aym en t s wh en a p l atwas reco rd edo r wh en a h o m e s al e cl o s ed , th e n atu re o f t hes e ad d it i o n al p aym en t s d o es n o ti l l u m i n at e t h e ch aract er o f t h e n etg ai n at i ss u e i n t h i s cas e. Res p o n d en th as n o targ u ed , n or d o es th e reco rds u gg es t , th atei t h er t h e l u m p s u m s p ai di n 2 0 1 2 fo r t h e TM -2 an dTM -3 p arcel s , o r an y o f t h e ad d i t i o n al p aym en t s, were i n co rrect l y p ri ced i n th e l an ds al e co n t ract . Ad di t i o n al ly , i ti s cl ear fro m

th e reco rdth atth e p aym en t s recei v edb y SLRD i n 2 0 1 2 fo r t he TM -2
an d TM -3 p arcel s d i dn ot i n cl u d e an y ad d it i o n al p er-l o to r p er-h o m e p aym en t s (n o r d o es the reco rds up p o rta co n cl u s i on th at an y ad d i t i o n al p er-l o to r p er-h o m e- 1 7 -

[* 1 7 ] p aym en ts accru edi n 2 01 2 ). Co n s eq u en t l y , ev en i f we were t o as s u m e t h at t h e ad d i t i o n al p aym en t s wo u l db e t reat edas o rd i naryi n co m e i f an dwh en t h ey
s h o u ldaccru e, t h atci rcu m s t an ce wo u l ds h edl i t tl e l i g h to n t h e ch aract er o f t h e n et g ai n reco g n i zedi n 2 01 2 b ecau s e t h e 2 0 1 2 n etg ai n i n cl u d edn o s u ch ad d it i o n al p aym en t s. W e al so n o t e t hatn ot h i n g i n t h e l an ds al e ag reem en t(o r i n th e reco rd g en eral l y ) s u g g es t s th atSLRD was u n d er an y o b li gat i o n t o d ev el o p t h e TM p arcel s aft er t h e s al e. Nex t , res p o n d en tp o i nt s o u t t h ato n i t s 2 0 12 Fo rm 1 06 5 SLRD l i s t edi t s p ri n ci p al b u s i n es s act i v i t y as “ Dev el o p m en t ” an d i t s p ri n ci p al p ro du cto r s erv i ce
as “ Real Es t at e”. Al th o u g h th i s ci rcu m s tan ce m ay co u n tag ai n stp et it i on ers t o
s o m e l i m i t edd eg ree, we b el i ev e t h at t h es e s tat em en t s “ are b y n o m ean s co n cl u s i v e
o f t h e i s su e.” See Su b u rb an Real ty , 6 1 5 F.2 dat1 8 1 . Co ns i d eri n g the reco rdas a wh o l e, we are i ncl i n edt o b el i ev e t h atth es e s t o ckd es cri pt i o n s were i n ad v ert en t l y carri ed o ver fro m earl i er ret u rn s . Fi n al l y , o n b ri ef res p o n den tas s ert s i n p as si n g thata s ti pu l at ed s ch edu l e o f SLRD’ s cap i t al i zedex p en s es s h o w s th at SLRD “ co n ti n u edt o i n cu r d ev el o p m en t
ex p en s es up u n t i l i ts o l dthe Tay l o r M o rri so n l an d .” Bu t t h e reco rdas a wh o l e cl earl y s h o ws th atth e TM p arcel s were n o t d ev el o p edb et ween 2 00 8 an dth e s al e t o Tay l o r M orri s o n, an dres p o n d en tco n ced es th atSLRD n ev er s ub d i vi d edth e TM- 1 8 -

[* 1 8 ] p arcel s (o r an y

o f i t s p ro p ert y ). Al s o , m o sto f t h e p o s t -2 00 8 ex p en di tu res o n t h e s ch edu l e o f cap i t al i zedex p en d i tu res are ei t h er co ns i s t en t wi t h i nv es t m en t i n t en to r ap p ear t o h av e b een i n cu rred wi th res p ectt o p arcel s o t h er t h an th e TM p arcel s . 1 0 Fo r t hes e reas o ns we acco rdth e l i s t i n g o f cap it al izedex p en s es l it t l e wei g h t --cert ai nl y

n oten ou g h t o o v erri d e t h e fact o rs i n SLRD’ s fav o r, s u ch as th e i n freq u en cy

o f s al es b y SLRD (wh i ch i s t he m o s ti m p o rt an tfact o r i n o ur an al y si s , s ee Su b u rb an Real t y , 6 1 5 F.2 d at1 7 8 ). Th erefo re, o n th e b as i s o f al l th e ev i d en ce, we co n cl u d e th atSLRD was n o t
en g ag edi n a d ev el o p m en t b u s i n es s aft er 2 0 0 8 an dh el dth e TM -2 an d TM -3 p ro p ert i es as i n v es t m en ts . Acco rd i n g l y , we h ol dth atSLRD p ro p erl y ch aract eri zedth e g ai n s an d l o s s es fro m the s al es o f t h es e p ro p ert i es as i n co m e fro m cap i t al as s et s . To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t eredfo r p et i t i o ner.

1 0 Th ere are t w o ex p en d i tu res i n 2 0 1 1 an d 2 0 1 2 ($ 3 4 0 , 0 00 an d$ 1 ,7 2 3 ,8 3 5 , res p ect i vel y ) wh i ch are l i st edas “ M an ag em en t/ Dev el o p m en tFees ”. Nei t h er p art y h as o fferedan ex p l an at i on fo r t h es e fees , b u tco n s i d eri n g th at s im i l ar fees were p ai dco n s i s t en tl y

each y ear fro m

1 9 9 9 t o 2 0 06 , an dthen were n o tp ai dag ai n u n t i l 2 0 1 1 an d2 0 1 2 (wh en Tay l or M o rri s o n o ffered t o p urch as e t h e TM p arcel s ), i t s eem s m o s tl ik el y

th atth e 2 0 1 1 an d2 01 2 fees (i f t h ey ev en rel at edt o t he TM p arcel s ) were i ncu rred as p arto f t h e s al e p ro ces s rat h er t h anas p art o f a co n t i n u i n g effo rtt o d ev el o p th e TM p arcel s .