United States v Winthrop (1969) is a case in which the court rejected the capital gain classification and ruled that certain transactions were sales made in the ordinary course of business.
Understanding the distinction between business income and capital gains is critical for any taxpayer as capital gains tend to be taxed a lower rate. In the case of real estate, the line between the two can get murky, which is where cases like the United States v Winthrop come in handy.
Prior to being heard by the Fifth Circuit Court of Appeals, the facts of this case were found to support a capital gain classification at the trial court; the Fifth Circuit actually had to overturn this finding to reach its conclusion. What’s more, there was no dispute between the trial court and appellate court over any matter of facts. It’s a case that calls into question the judiciary reasoning as many have cited that there were multiple, more compelling cases, cited by Winthrop, so it’s intriguing from that angle alone.
United States V Winthrop: The Court Case
Over several years, Mr. Winthrop (respondent in appellate case) inherited several pieces of real estate. Collectively, these pieces were referred to as “Betton Hills.” Mr. Winthrop inherited his first piece of land in 1932, and began to develop on that land a few years later in 1936. Mr. Winthrop inherited additional pieces of land at various other dates (1946, 1948 and 1960).
In 1936, Mr. Winthrop made his first sale by selling a portion of the land he had began developing earlier that same year. Mr. Winthrop continued to develop his land and sell portions of it to interested buyers up until his death in 1963. Hence, his sales operation spanned multiple decades. Though he did not create a business office, he devoted massive amounts of energy to developing the land so as to make it more marketable. What’s more, the income derived from real estate sales constituted the majority of his entire income for many years prior to his death. Mr. Winthrop also began to include “real estate” as his occupation for a number of years in official documents before his death. The question before the court was: should Mr. Winthrop’s activities receive capital gain treatment given the facts which underlay them?
What Does The Law Say?
There are a number of common law tests which have been developed to aid the court in its determination of capital gain treatment. Though this is true, the court must also be certain to view each case as an independent matter and provide each case with its own analysis.
In United States v Winthrop, there was no disagreement made by the Fifth Circuit regarding the fact that the land was held “primarily for sale” by Mr. Winthrop. The only remaining issue was whether the sales executed could be classified as sales made in the ordinary course of business. The Fifth Circuit stated that the ordinary course of business determination depends on whether selling the land was Mr. Winthrop’s primary purpose in holding the land.
Ruling Against Winthrop
The Fifth Circuit overturned the trial court’s finding and determined that the sales made by Mr. Winthrop were made in the ordinary course of business and therefore should be disqualified from capital gain treatment. Mr. Winthrop clearly had a reasonably strong case given that he did not actively and aggressively advertise his properties, he did not maintain a sales office, did not reinvest his profits in other real estate (for the purpose of growing his business) and he initially acquired the real estate through inheritance rather than purchase. There were certainly many facts capable of supporting his position. Ultimately, the fact that Mr. Winthrop only used the properties for the purpose of selling to customers proved to be the decisive factor.
This issue of delineating between investment sales and business sales continued for some time until Byram v. United States (1983) established a clear distinction between business sales and investment sales. In that case, the court sided with Byram despite some similarities between his real estate practices and Mr. Winthrop’s.