Once in a while a real head-scratcher of a tax case comes along, and they always seem to involve in one way or another the definition of a capital asset. One that happened to be decided when I was in law school (and was used as the basis for an exam question in a course on tax law) involved someone with a rare blood type who received payments — tens of thousands of dollars, because we’re talking really rare — for permitting her blood plasma to be drawn repeatedly. Was she providing a service? Or selling a capital asset? If the latter, did she have any basis in the asset?
Then there was the case where a casino provided millions of dollars in advances to a high roller in the form of chips, which the customer proceeded to lose gambling at the casino. When the customer became unable to pay, and the casino settled for a fraction of the amount owed, the IRS said the customer had cancellation of debt income. The IRS won in the Tax Court but the decision was reversed on appeal, with the reasoning turning in part on the question of whether the chips constituted “property.”
Now we have a case involving a couple who became entitled to a Colorado tax credit by donating a conservation easement. State law permitted them to transfer the credit to other taxpayers, and they sold portions of the credit through a broker. The question before the court was how to treat the proceeds of this sale.
The IRS made various arguments that the credit was not a capital asset, but none succeeded. Most interesting was the discussion of the “replacement of income” doctrine, a rule that says an item that might otherwise be treated as capital gain becomes ordinary income if the payment is a substitute for an item of ordinary income. The Tax Court found that this situation did not fit within the doctrine.
Having found that the credit was a capital asset, the court had to consider its holding period and its basis. The taxpayer argued that they had in effect converted part of their ownership interest in the property into a tax credit, so the credit should have a long-term holding period. The court rejected this argument, and similarly rejected the argument that part of the taxpayers’ basis in the property could be allocated to the credit.
Cases of this nature rarely become significant in affecting a broad array of taxpayers, but they offer a way for law professors to test the ability of their students to apply what they’ve learned in a thoughtful way to unusual facts.
- Tempel v. Commissioner (PDF)