Braunstein v. Commissioner

Background

Three taxpayers — two builders and one architect — joined to build a Queens County apartment project. In 1948 they formed two corporations and each received one-third of the stock in each company. After construction, unused mortgage loan funds remained, and in 1950 the men sold their stock and received distributions that included those funds. They reported the excess over their stock bases as long-term capital gains of about $313,854.17 each. The Commissioner treated the gain as ordinary income under the collapsible-corporation rule in §117(m). The Tax Court and the Court of Appeals sustained that treatment, and the Supreme Court granted review on a limited question about whether the rule applies when the owners would have received capital-gains treatment if they had owned the property individually.

Reasoning

The Court relied on the plain language of §117(m). It explained that the statute defines a collapsible corporation and applies when shareholders realize gain “attributable to” the constructed property and more than 70% of the gain is from that property. The Court rejected the taxpayers’ argument that the rule should reach only cases where the corporation was used specifically to convert ordinary income into capital gain. The Justices found no support in the statute or legislative history for a case-by-case inquiry into the taxpayers’ motives, and they emphasized practical difficulties in trying to decide whether a given use of the corporate form was a tax-avoidance device. The Court therefore affirmed the lower courts’ judgments.

Real world impact

Owners who form companies to construct property and then sell their stock can have those sale profits taxed as ordinary income under §117(m) when the gain is largely generated by the constructed property. Builders, architects, and small developers should expect that gains tied to project value may be taxed as ordinary income rather than at lower capital-gains rates.

Dissents or concurrances

Justice Douglas dissented.