-not the fortuitous collection of one or more installments in one year.

It has been held that notes not readily discountable are not to be regarded as the equivalent of cash in determining whether the first payment is substantial,29

Sale of real estate in lots.

REGULATION. Where a tract of land is purchased with a view to dividing it into lots or parcels of ground to be sold as such the cost shall be equitably apportioned to the several lots or parcels and made a matter of record on the books of the taxpayer, to the end that any gain derived from the sale of any such lots or parcels which constitutes taxable income may be returned as income for the year in which the sale was made. This rule contemplates that there will be a measure of gain or loss on every lot or parcel sold, and not that the capital invested in the entire tract shall be extinguished before any taxable income shall be returned. The sale of each lot or parcel will be treated as a separate transaction and the gain or loss will be accounted for as provided in article 1591. (Art. 43.)

This article refers to any gain "which constitutes taxable income." For discussion of those transactions in which no gain is deemed to be realized, see Chapter XXIII.

RULINGS. . . . . For income tax purposes the sale of a perpetual easement on a specified number of acres of land to a railroad company is to be treated as though it were an outright sale of land where legal title passes at the time of sale, unless for some reason the fee of the owner has more than a merely nominal value, as for example, where the land is underlaid by a mine. (C. B. 5, page 89; O. D. 1072.)

The word "equitably" as used in article 43 of Regulations 45, relating to the apportionment of the cost of a tract of land to the parcels sold, does not mean "ratably." When a taxpayer has purchased a tract of land containing acreage so varied in character that he would not pay the same price for the poorer quality of land as he would for that which was more tillable, the taxpayer should be permitted to show by competent evidence the actual proportion of the cost of the entire tract which is properly allocable to the portion sold. (C. B. II-2, page 72; I. T. 1843.)

ESTIMATED DEVELOPMENT WORK MAY BE INCLUDED IN COST.—

RULING. Profit realized on the sale of lots, the selling price of which includes the cost of certain development work already made or to be made in accordance with the contract of sale, should be based on the cost of the land to the vendor, or its fair market value as of March 1, 1913, if acquired prior to that date, plus the actual and estimated future expenditures for development. If the estimated future expenditures should be subsequently ascertained to be incorrect, amended returns should be filed as the basis for an adjustment of the tax for the years

2o C. B. 1, page 76; O. D. 181; and C. B. II-2, page 76; A. R. R. 2698.

affected. The cost of such development having been taken into consideration in determining profit, expenditures for this purpose can not be deducted from gross income in subsequent returns. (C. B. 3, page 108; O. D. 567.)

The subject of carrying charges is discussed in Chapter XXIV.

REPOSSESSION OF REAL ESTATE SOLD ON INSTALLMENT PLAN.Article 42 states that in case of repossession "the property repossessed must be included in the inventory at its original cost." The regulation merely provides that the cost of real estate sold and returned must not be written down. The net proceeds arising from the sale and return are of course taxable.

Under another ruling real estate dealers are not permitted to inventory real estate,30 Article 46,31 which refers to real estate sales not on the installment plan, uses similar language, as does article 42, which deals with sales of personal property on the installment plan. Although real estate dealers may not use the inventory method, they are deprived of the benefits of the capital gains provisions 32 since the real estate owned by them is "held primarily for sale."

Lease of real estate with option to purchase. In the case of a ninety-nine year lease with option to purchase at the end of fifty years for a nominal amount and where it was alleged that "the arrangement was intended at the time of making as a contract for purchase and sale of the land," the Treasury held :

RULING. ... Hence, even though only a small sum is to be paid in addition to the rents to complete the purchase, or even because of an initial deposit, it is practically certain that the lessee will buy the property, courts have really treated the agreement as a lease until the option to buy is exercised. Although no one of these provisions perhaps conclusively determines that this agreement is a lease rather than a contract to purchase, the sum total of them, and the absence of provisions indicating that the agreement was purely a contract of purchase and sale, is very persuasive that the agreement should be treated as a lease until and unless the option to buy is exercised by the lessee.

For these reasons, this office holds that the annual payments received under the terms of the lease should be considered as rent, and not as installments on the purchase price of the property. (C. B. II-2, page 73; I. T. 1819.)

The foregoing case is an illustration of the devices to which

astute lawyers were driven in order to avoid confiscatory taxes under the laws enacted prior to 1921. At the present time it would not be necessary to make such an arrangement.

Effect of death of holder of installment notes.-The death of the holder of notes covering an installment sale changes the computation of profit.33 The ruling would work out as follows:

The value on March 1, 1913 was $75,000, and the sale price in 1919, $100,000. The gross profit is 25 per cent. The down payment is $20,000. There would be reported in A's 1919 return 1/4 thereof, or $5,000. The balance of the purchase price ($80,000) is represented by four notes of $20,000 each. A having bequeathed the notes to B, the latter collects each note and reports only the difference between $20,000 and the discounted value thereof at A's death.34 The Treasury loses the tax on the difference between the balance of profit on the sale of $20,000 ($25,000 profit on the entire transaction less $5,000 reported in A's 1919 return) and the discount on the notes applicable to the period between the date of testator's death and the maturity of the notes.

Capital gains in installment sales.-The Treasury has now definitely held that the profits on installment sales of real estate by other than dealers in real estate may be subject only to the 121⁄2 per cent tax on capital gains.35 The rule will also apply to sales of stocks or personal property when partial payments are made and which are not deemed to be closed transactions.

33

See C. B. I-1, page 78; I. T. 1192.

34 Section 204 (a-5).

C. B. II-2, page 44; I. T. 1737; as to dealers in real estate, see Chapter XXVI.

CHAPTER XXIII

INCOME FROM GAINS UPON SALE OR EXCHANGE OF PROPERTY-THE CLOSED TRANSACTION

The Federal Revenue Act, unlike the foreign laws which have usually followed the English model, includes in its definition of income gains realized from appreciations in property values. The theoretical correctness of this position is, in the opinion of the author, beyond reasonable question. Its legality has been established by decisions of the Supreme Court of the United States.1 How

Walsh v. Brewster, 255 U. S. 536, 41 Sup. Ct. 392, 65 L. Ed. 762; Eldorado Coal & Mining Co. v. Mager 255 U. S. 522, 41 Sup. Ct. 390, 65 L. Ed. 757; Goodrich v. Edwards, 255 U. S. 527, 41 Sup. Ct. 390, 65 L. Ed. 758; Merchants' Loan & Trust Co. v. Smietanka, 255 U. S. 509, 41 Sup. Ct. 386, 65 L. Ed. 751.

ever, the problems of administration which it raises are exceedingly troublesome, and the attempts to solve them in the past have caused so much dissatisfaction, that considerable sentiment has developed in favor of ignoring entirely "capital gains" and "capital losses" in arriving at taxable income. The sections dealing with gains upon sale or exchange of property have been entirely recast in the 1924 law but the alterations, while important, mark no radical changes in policy, unless the addition of the new "gift tax" may be so construed. Most of the changes made, including even the "gift tax," are efforts to correct so-called defects in the law which have been utilized in the past to avoid payment.2

The administrative difficulties which arise relate particularly to the time when the gains shall be brought into account for income tax purposes, the measurement of the amount of such gains, and the determination of the base from which to measure.

Four chapters of this book are devoted to the procedure relating to the taxation of gains arising from sales and exchanges. This chapter deals with the first set of difficulties. It discusses the vexed question of the "closed transaction." Chapter XXIV takes up the second set of difficulties, those relating to the measurement of the gain -the basis and the computation. Chapter XXV treats of the determination of value at March 1, 1913 and other basic dates. The last of the four chapters, Chapter XXVI, deals with the special method which has been established for taxing "capital gains," in the special sense in which the term is used in the statute.

The provision in the law requiring the taxation of gains from increases in property values reads as follows:

LAW. Section 213. .... (a) The term "gross income" includes gains, profits, and income derived from . . . . sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; . .

A general definition of gain appears in the following clause:

LAW. Section 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis over the amount realized.

The basis provided in subdivision (a) or (b) of section 204

2 In_referring to paragraph 7 and 8 of section 204 (a), the report of the Senate Finance Committee states (P. 18): "The purpose of this and the succeeding paragraph is to check evasions."