The tax code draws a distinction between ordinary income and income derived from the sale of a capital asset, or “capital gain.” In most instances, this distinction is straightforward and there is little confusion about whether income falls into one category or the other. However, there are some areas where the distinction becomes obfuscated and more difficult to decipher. And, when your capital gains are taxed at a lower rate than your ordinary income, figuring out what qualifies can either save you or cost you.
The case of Byram v United States (1983) provides one example of the difficulty involved in distinguishing between a “business” sale – which would trigger ordinary income – and an investment sale. The tax code recognizes a number of general characteristics of business sales and investment sales; sometimes a transaction possesses characteristics of both a business sale and an investment sale, or it lacks enough characteristics of one type of sale to merit a definitive classification.
Knowing the characteristics of both so you can quickly identify what’s a capital gain vs income is essential to avoiding any unpleasant surprises when tax time rolls around.
Byram V United States: The Case
John Byram was a wealthy land owner in the 70s. Between the years 1971 and 1973, Byram sold a total of 22 properties for a gross return of $9 million and a net profit of $3.4 million.
More importantly, Byram did not have a business office. He did not advertise his services or utilize a broker (both of which would make it clear this was a business transaction). He did not subdivide the land and he only spent a small amount of time and effort engaging in the actual transactions; all transactions were initiated by the purchasers.
So What’s the Law Say?
The question of whether a transaction – or set of transactions – can receive “capital gain treatment” (and therefore be subject to the rates applicable to capital gains) depends on the characteristics of the transaction. Courts recognize the 7 “pillars” of capital gain treatment when deciding whether a given transaction should be deemed either an investment sale or business sale.
The 7 Pillars of Capital Gain Treatment can be summed up as follows:
- (1) purpose of the acquisition of the property and duration of ownership;
- (2) extent of the efforts to sell the property;
- (3) number, extent, continuity and magnitude of the sales;
- (4) time and effort devoted to developing the land and advertising to increase sales;
- (5) use of a business office;
- (6) degree of supervision exercised by the owner over any representative selling the property;
- (7) overall time and energy dedicated to the sales.
The question before the court was: do the transactions made by Byram between 1971-1973 merit capital gain treatment based on the guidelines established through the 7 pillars?
Ruling in Favor of Byram
The court (the Court of Appeals for the Fifth Circuit) affirmed the ruling of the lower court in favor of Byram. The transactions engaged in by Byram (and his buyers) possessed enough characteristics of an investment sale to trigger capital gains treatment. These determinations require an independent third-party to analyze the sales and in Byram’s case, it was clear that the evidence supported the conclusion that the properties were not sold as part of a business enterprise but as investments.
The Byram case is highly useful for people who own multiple pieces of real estate and are considering selling these pieces in the future. It’s important for these owners to be conscious of the facts of Byram so that they can be certain to receive capital gains treatment.
Photo by Saúl Bucio on Unsplash