Assignment of rights in lawsuit results in capital gain.

• Author: Beavers, James A.

The Eleventh Circuit held that a taxpayer's assignment of his rights in an ongoing lawsuit over a land sales contract was the sale of a right to purchase the land subject to the contract, not the sale of the land, and resulted in long-term capital gains to the taxpayer.

Background

From 1994 to 2006, Philip Long, as sole proprietor, owned and operated Las Olas Tower Co. Inc. (LOTC), which was created to design and build a luxury high-rise condominium called the Las Olas Tower on property owned by the Las Olas Riverside Hotel (LORH). LOTC never filed any corporate income tax returns and did not have a valid employer identification number. Instead, Long reported LOTC's income on the Schedule C, Profit or Loss From Business (Sole Proprietorship), of his individual tax return.

In 2002, Long, on behalf of LOTC, entered into an agreement with LORH (the Riverside agreement) whereby LOTC agreed to buy land owned by LORH for $8,282,800, with a set closing date of Dec. 31,2004. LORH subsequently terminated the contract unilaterally and, in 2004, LOTC filed suit in Florida state court against LORH for specific performance of the contract and other damages. LOTC won at trial, and the court ordered LORH to sell the land to LOTC pursuant to the Riverside agreement. LORH appealed the judgment. In 2006, Long entered into an agreement with Louis Ferris Jr. (the assignment agreement), under which Long sold his position as plaintiff in the Riverside agreement lawsuit to Ferris for $5.75 million.

On his 2006 tax return filed in October 2007, Long reported the income from the assignment agreement as capital gains. In September 2010, the IRS issued a notice of deficiency for 2006 to Long, claiming among other things, that the income from the assignment agreement was ordinary income, not capital gains. Long challenged the IRS's determination in Tax Court.

In Tax Court, the IRS argued that Long received the $5.75 million in lieu of future ordinary income payments and, therefore, that money should be counted as ordinary income under the "substitution for ordinary income doctrine. "The Tax Court, treating the assignment agreement as a sale of the land under the Riverside agreement, found that Long intended to sell the land to a developer and concluded that the applicability of the capital gains statute depended on whether Long intended to sell the land to customers in the ordinary course of his business. The Tax Court determined that, while Long intended to sell only...