Gain from repeatedly selling syndicated conservation easement LLC interests is ordinary income under section 1221

Plain-English summary

A promoter ran syndicated conservation easement (SCE) deals: it would buy into land-holding LLCs, subdivide the land, package interests into new LLCs, and sell those interests to investors who were promised outsized charitable-contribution deductions when the LLCs donated easements or land to charity. The promoter treated its gains on selling the LLC interests as long-term capital gain. The IRS field office asked the Office of Chief Counsel how those gains should be characterized. This Chief Counsel Advice concludes the gains are ordinary income, not capital gain. Normally selling a partnership (LLC) interest is a capital-asset sale under section 741, but the CCA reasons that section 741 only protects interests that are actually capital assets, and here the promoter created and sold these interests frequently as products in the ordinary course of its business, so section 1221(a)(1) treats them as inventory-type property. On a second theory (that sections 741 and 751 make the gain ordinary because the underlying land was held for sale), the CCA says no on the current facts: nothing shows the LLCs or the promoter were in the business of selling land, since the land was donated to charity rather than sold. The advice is fact-dependent and notes the second theory could apply if more facts were developed.

Ruling snapshot

• Question: Is a promoter's gain on frequent sales of conservation-easement LLC interests ordinary income (under section 1221 despite section 741, or under section 751)?
• Outcome: Advice. Issue 1: yes, section 1221 makes the gain ordinary income despite section 741. Issue 2: no, sections 741 and 751(d)(1)/(d)(3) do not on these facts, because the taxpayer was not in the business of selling land.
• Key authorities: IRC §§ 1221(a)(1), 741, 751(a)(2), 751(d)(1), 751(d)(3); Malat v. Riddell, 383 U.S. 569 (1966); Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955).

Full text (IRS public release)

           Office of Chief Counsel
           Internal Revenue Service
           Memorandum
           Number: 202309015
           Release Date: 3/3/2023
           CC:PSI:B03:ALi                                  Third Party Communication: None
           POSTF-104330-22                                 Date of Communication: Not Applicable

 UILC:     741.00-00, 741.02-00, 751.01-00, 751.04-00, 1221.00-00, 1221.01-00, 1221.02-00

  date:    November 15, 2022

     to:   Anita A. Gill, Senior Counsel
           (Small Business/Self-Employed)

  from:    Margaret Burow, Senior Counsel
           (Passthroughs & Special Industries)


subject:   Character of gain on sales of limited liability company (LLC) interests

                 This Chief Counsel Advice responds to your request for assistance. This advice
           should not be used or cited as precedent.

           LEGEND

            Taxpayer = ------------------------

            X           = ----------------------------------------

            Y           = ------------------------------------------

            A           = -------------------

            B           = ------------------------

            Year 1      = -------

            Year 2      = -------

            Year 3      = -------

            Year 4      = -------

            State       = -----------

 a            = ---

 b            = --

 c            = --------

 d            = ------

 e            = --------------

 f            = -----

ISSUES

       1. Whether § 1221 applies, despite § 741, to treat Taxpayer’s gain on the sales
          of LLC interests as ordinary income because Taxpayer held the LLC interests
          primarily for sale to customers in the ordinary course of a trade or business
          during Year 3 through Year 4.

       2. Whether §§ 741 and 751(d)(1) and (d)(3) apply collectively to treat Taxpayer’s
          gain on the sales of LLC interests by Taxpayer as ordinary income because
          Taxpayer was engaged in a trade or business of selling land during Year 3
          through Year 4.

CONCLUSIONS

       1. Yes. Despite § 741, § 1221 applies to treat Taxpayer’s gain on the sales of
          LLC interests as ordinary income because Taxpayer held the LLC interests
          primarily for sale to customers in the ordinary course of a trade or business
          during Year 3 through Year 4.

       2. No. Sections 741 and 751(d)(1) and (d)(3) do not collectively apply to treat
          Taxpayer’s gain on the sales of LLC interests as ordinary income because
          Taxpayer was not engaged in a trade or business of selling land during Year
          3 through Year 4.

FACTS

       Between Year 1 and Year 4, Taxpayer directly, and indirectly through entities
owned and managed by Taxpayer (Managed LLCs),1 engaged in the promotion and
sale of interests in LLCs. The only asset held by the LLCs was land. Each of the LLCs
engaged in transactions involving the donation of an easement with respect to the land,
1 Taxpayer held, through disregarded entities, interests in the Managed LLCs with A and B through which
Taxpayer engaged in the transactions described herein. Taxpayer reported the activities of the Managed
LLCs as partnerships for federal tax purposes.

in exchange for a charitable contribution deduction, as described in Notice 2017-10,2
and/or the donation of a fee simple interest in the land in exchange for a charitable
contribution deduction. Hereinafter, because the analysis is the same and for ease of
discussion, we refer to these transactions, collectively, as the SCE transactions and to
the LLCs that donated the easements and/or land as the SCE LLCs. The character of
the gain Taxpayer recognized on the sales of the SCE LLCs is the subject of this
advice.

        According to information provided by Taxpayer, Taxpayer has been engaged in a
variety of business activities including real estate management, acquisition, and
investment activities.3 In at least Year 2, Taxpayer represented that Taxpayer and the
Managed LLCs did not sell real property and were not engaged in a trade or business of
selling real property.4 Promotional materials for the sale of the SCE transactions
described certain principals of Managed LLCs as “only providing additional information
regarding the potential acquisition of membership interests to prospective members and
are not acting as a real estate broker nor are they acting as a broker or dealer in
securities.”5 During the audit of Taxpayer, LB&I Examination found that Taxpayer’s
activities are primarily operated through X, located in State, and that X conducts its
activities through various Managed LLCs.

Transaction Steps6

   Taxpayer, or Taxpayer through a Managed LLC, managed, marketed, and
negotiated all transaction steps. From Year 1 through Year 4, Taxpayer generally
undertook the following steps to promote and sell the SCE LLC interests. Taxpayer:

    1. Identified a third-party owner of an undeveloped piece of land who held the land
       for more than one year (Landowner). Landowner formed an LLC (Land LLC) and
       contributed the undeveloped land to Land LLC.

    2. Formed a Managed LLC that purchased a% of the interests in Land LLC from
       Landowner in exchange for cash.

    3. Directed Land LLC to subdivide the undeveloped land into parcels, contribute
       one parcel each to several newly formed LLCs (SCE LLC),7 and distribute the
       SCE LLC interests b% to Landowner and a% to Managed LLC, the same
       ownership percentages each held in Land LLC. Land LLC continued to hold one
       of the parcels.


2 2017-4 I.R.B. 544.
3 30-day Letter Protest Taxpayer Resp. 2 for Year 2 Form 1040, p. 2.
4 30-day Letter Protest Taxpayer Resp. 2 for Year 2 Form 1040, p. 4.
5 X, Year 3 Information Package for: Y, p. 4.
6 In general, the transaction steps were the same when the SCE LLC donated easements and/or the land.
7 Taxpayer reported the activities of the SCE LLCs as partnerships for federal tax purposes.

    4. Directed Managed LLC to either continue to hold a% interest in each SCE LLC,
       or distribute the interest to its partners, Taxpayer, A, and B.

    5. Managed LLC, or Taxpayer, A, and B, then sold c% of the SCE LLC interests to
       a newly formed LLC (Investor LLC) of which Managed LLC or Taxpayer was the
       managing member. Taxpayer used a different newly formed Managed LLC to
       sell the SCE LLC interests every year. Individual investors contributed tens of
       thousands of dollars into the Investor LLC to purchase the SCE LLC interests.
       Managed LLC, or Taxpayer, A, and B, continued to hold d% interest in and act as
       the managing member of SCE LLC.

        Typically, within one to four months from the date of Land LLC’s formation, the
SCE LLC donated the easement and/or the land to a § 501(c)(3) organization.8 The
SCE LLC reported the donation as a charitable contribution on its federal tax returns.
Taxpayer and the investors, through Investor LLC, claimed a deduction for their
distributive shares of the charitable contribution deduction.

       Taxpayer, through Investor LLC, made oral and written promises to the investors
that they would receive a charitable contribution deduction with respect to the donation
of the easement and/or the land many times the amount the investors contributed to
Investor LLC.9 Although the promotional materials for the Investor LLCs offered the
investors several investment options, Taxpayer, acting as managing member of the
SCE LLCs caused all the SCE LLCs to donate easements and/or the land to § 501(c)(3)
organizations. Taxpayer, through Investor LLC, received a promotional fee or other
consideration in connection with the sales of the SCE LLC interests to the investors.10

        From Year 1 through Year 4, Taxpayer and the Managed LLCs, collectively,
reported about $e of gain on the sales of their interests in f SCE LLCs to the Investor
LLCs. Other than in Year 4, Taxpayer reported the gain from the sales of the SCE LLC
interests as long-term capital gain.11 In Year 4, Taxpayer sold SCE LLC interests
directly and reported the gain from these sales as long-term capital gain. During Year 4,
Taxpayer also formed an entity that elected to be treated as an S corporation for federal
tax purposes. Taxpayer contributed SCE LLC interests to the S corporation that then
sold the SCE LLC interests. Taxpayer reported gain on the sales of the SCE LLC
interests sold by the S corporation as Schedule E ordinary income. On Taxpayer’s
personal tax return, Taxpayer reported no other source of income other than the income
generated by Taxpayer from the promotion and sale of the SCE transactions.


8 X, Year 3 Information Package for: Y, pp. 7, 14, 21.
9 X, Year 3 Information Package for: Y, pp. 14-15.
10 X, Year 3 Information Package for: Y, p. 7.
11 Each Managed LLC reported the sales of the SCE LLC interests as long-term capital gain, its share of
the charitable deduction from the SCE LLC, and other expenses associated with the SCE transactions.
Each Managed LLC also reported distributions of the SCE LLC sale proceeds.




LAW AND ANALYSIS

ISSUE 1

Ordinary income treatment under § 1221

       Section 1221(a)(1) provides that “the term ‘capital asset’ means property held by
the taxpayer (whether or not connected with his trade or business), but does not
include” “stock in trade of the taxpayer or other property of a kind which would properly
be included in the inventory of the taxpayer if on hand at the close of the taxable year,
or property held by the taxpayer primarily for sale to customers in the ordinary course of
his trade or business.”

        In Malat, the Supreme Court stated, “[a]s used in § 1221(1), ‘primarily’ means ‘of
first importance’ or ‘principally.’”12 The court also explained that the purpose of § 1221
“is to differentiate between the ‘profits and losses arising from the everyday operation of
a business’ on the one hand and ‘the realization of appreciation in value accrued over a
substantial period of time’ on the other.”13

        The following factors indicate whether property is held primarily for sale to
customers in the ordinary course of a trade or business: “(1) the frequency and
regularity of sales; (2) the substantiality of sales;” (3) duration of ownership; (4) whether
the property held for sale and property held for investment were separately identified;
(5) purpose for acquiring the property; (6) sales and advertising efforts; (7) the time and
effort devoted to the sales activity; and “(8) how the sales proceeds were used.” 14 “The
frequency and regularity of sales are among the most important factors in determining
whether an asset is held for investment or as inventory.”15 Applying these factors,
Taxpayer held directly, or through Managed LLCs, the SCE LLC interests primarily for
sale to customers (investors).

       (1) From Year 1 through Year 4, Taxpayer sold interests in f SCE LLCs to the
Investor LLCs, the sales took place every year, and there were multiple investors in
each Investor LLC.

12 Malat v. Riddell, 383 U.S. 569, 572 (1966).
13 Id. (quoting Corn Products Refining Co. v. Commissioner, 350 U.S. 46, 52 (1955); Commissioner v.
Gillette Motor Transport, Inc., 364 U.S. 130, 134 (1960)).
14 Williford v. Commissioner, T.C. Memo. 1992-450 (citing United States v. Winthrop, 417 F.2d 905, 910
(5th Cir.1969); Byram v. United States, 705 F.2d 1418, 1424 (5th Cir.1983); Ross v. Commissioner, 227
F.2d 265 (5th Cir.1955)).
15 David Taylor Enterprises, Inc. v. Commissioner, T.C. Memo. 2005-127 (citing Suburban Realty Co. v.
United States, 615 F.2d 171, 176 (5th Cir. 1980)).


        (2) From Year 1 through Year 4, Taxpayer recognized gain of about $e from
selling the SCE LLC interests to the Investor LLCs.

     (3) The length of time from the acquisition of the Land LLC interests to the sale of
Taxpayer’s interests in the SCE LLCs was usually less than a year.

       (4) Taxpayer did not separately identify property held for sale versus property
held for investment with respect to the SCE LLC interests.

       (5) Taxpayer directed Managed LLC to acquire an interest in the Land LLC from
Landowners to create the SCE LLCs and sell interests in these SCE LLCs quickly,
usually within a year.

        (6) Each year from Year 1 through Year 4, Taxpayer vigorously advertised the
SCE transactions, through promotional and other written materials and verbal
communications, to attract investors who would contribute a minimum of tens of
thousands of dollars to an Investor LLC. Taxpayer also engaged in significant sales
activities, resulting in sales of interests in f SCE LLCs with multiple investors buying
interests in Investor LLCs every year.

       (7) Taxpayer devoted a substantial amount of time to the SCE transactions.
Taxpayer found Landowner with whom Taxpayer negotiated a land purchase price,
convinced the Landowner to structure the land sale as a sale of a% interest in Land LLC
with Landowner keeping b% in Land LLC.16 Taxpayer determined the scope and nature
of the SCE transactions and arranged financing. Taxpayer directed the subdivision of
land in Land LLC, the creation of SCE LLCs and placement of the subdivided land
parcels into them, hired appraisers and other professionals, directed the creation of
Investor LLC and the promotion and sale of interests therein to investors. As managing
member of Investor LLC and in other ways, Taxpayer caused the SCE LLCs to donate
the easement and/or the land. Taxpayer repeated these steps every year from Year 1
through Year 4.

       (8) “Use of sales proceeds to replenish inventory indicates property is held for
sale.”17 Taxpayer clearly intended to replace the SCE LLC interests being sold. From
Year 1 through Year 4, Taxpayer created new SCE LLCs and sold Taxpayer’s interests
in them. The frequency and size of these transactions support that Taxpayer used the
proceeds from the sales of the SCE LLC interests to purchase replacement properties
for subsequent similar transactions.

      In selling the SCE LLC interests, Taxpayer met each factor relevant to whether
property is held primarily for sale to customers in the ordinary course of a trade or

16 X, Year 3 Information Package for: Y, p. 2.
17 Williford, T.C. Memo. 1992-450.


business. This confirms that, under § 1221(a)(1), Taxpayer held the SCE LLC interests
as inventory “or property held… primarily for sale to customers in the ordinary course of
Taxpayer’s trade or business,” not as capital assets. In addition, Taxpayer sold the
SCE LLC interests quickly, generally within a year, and did not hold them on a long-term
basis. Thus, under Malat, Taxpayer realized income “from the everyday operation of a
business” and not “the realization of appreciation in value accrued over a substantial
period of time.” Therefore, Taxpayer’s gain on the sales of the SCE LLC interests is
ordinary income.

       In Corn Products Refining Co., a corn products manufacturer's profits and losses
from trading in corn futures were held to be ordinary income, not capital gains under the
predecessor to § 1221.18 The court determined that trading in corn futures was not
“separate and apart from [the company’s] manufacturing operations,” but “a form of
insurance against increases in the price of raw corn,” which was “closely geared to [the]
company's manufacturing enterprise [and very] important to its successful operation.”19

       The SCE LLC interests sold by Taxpayer are also excepted from the capital
asset definition under Corn Products, as the SCE LLC interests are not “separate and
apart from” Taxpayer’s operations but are rather “closely geared to” Taxpayer’s
business, promoting SCE LLC interests, and are critically “important to its successful
operation.”20

Section 1221 applies despite § 741

       Section 741 provides that in the case of a sale or exchange of an interest in a
partnership, gain or loss shall be recognized to the transferor partner. Such gain or loss
shall be considered as gain or loss from the sale or exchange of a capital asset, except
as otherwise provided in § 751 (relating to unrealized receivables and inventory items).

       While the general rule under § 741 treats the sale of partnership interests as a
sale of a capital asset, here § 1221 applies, despite § 741, because the legislative
history indicates that § 741 contemplates only the sale of partnership assets that are in
fact capital assets.

       The legislative history of § 741 shows that Congress intended to codify a line of
court decisions that held that the sale of a partnership interest is generally considered to
be a sale of a capital asset.21 In enacting § 741, Congress stated that “[u]nder present
decisions the sale of a partnership interest is generally considered to be a sale of a
capital asset, and any gain or loss realized is treated as a capital gain or loss.”22
Further, Congress intended that “[t]he House and your committee’s bill retain the

18 Corn Products Refining Co. v. Commissioner, 350 U.S. 46 (1955).
19 Id. at 49-50.
20 Id.
21 See Pollack v. Commissioner, 69 T.C. 142, 148 (1977) (Tannenwald, J., dissenting).
22 H. Rept. No. 1337, 83d Cong., 2d Sess. (1954) (emphasis added).


general rule of present law that the sale of an interest in a partnership is to be treated as
the sale of a capital asset.”23

       In the cases prior to the enactment of § 741, the government took the position
that the aggregate theory of partnership determined the result such that the sale of a
partnership interest was a sale of the selling partner’s undivided interest in each specific
partnership asset.24 The courts rejected the government’s position and found that the
sale of a partnership interest was the sale of a capital asset under § 117 (the
predecessor to § 1221).25 The courts that addressed the question of the treatment of
the sale of partnership interests determined, in part, whether the entity or aggregate
theory would prevail in the sale of a partnership interest.26 In these cases, the courts
reasoned that because partners did not have a separate or exclusive right to the
partnership assets, but rather a common interest in all the assets, a partner’s sale of
their partnership interest should be treated as the sale of a capital asset as opposed to
the sale of their interest in the partnership assets.27

        Notably, the courts that addressed the treatment of the sale of a partnership
interest in the pre-1954 cases did not deal with facts that showed the sale of a
partnership interest was something other than the sale of a capital asset.28 In other
words, the courts were not given the opportunity to consider whether capital gain or
ordinary income treatment would apply when a taxpayer was engaged in the business
of holding partnership interests for sale to customers. Given the facts of the pre-1954
cases and Congress’s intent to codify a line of cases that held that the entity approach
should determine the consequences of the sale of a partnership interest, Congress
intended to give capital asset treatment only to the sale of partnership interests that are
in fact held as capital assets.

      Further, Congress’s statement that § 741 retained merely the general rule of
present law that the sale of a partnership interest is treated as the sale of a capital asset
leaves open the possibility for ordinary treatment on the sale of a partnership interest
when the facts and circumstances are appropriate.



23 S. Rept. 1622, 83d Cong., 2d Sess. (1954) (emphasis added).
24 GCM 26379, 1950-1 C.B. 58.
25 See, e.g., Kessler v. United States 124 F.2d 152, 153 (3rd Cir. 1941); Commissioner v. Shapiro 125
F.2d 532, 533 (6th Cir. 1942); Long v. Commissioner, 173 F.2d 471, 471-72 (5th Cir. 1949) (finding that a
partner’s sale of a partnership interest is a sale of a capital asset, rather than his share of each asset
owned in the partnership).
26 See, e.g., Kessler supra; Commissioner v. Lehman, 165 F.2d 383, 384 (2nd Cir. 1948).
27 See, e.g., Shapiro supra; Commissioner v. Smith, 173 F.2d 470, 470 (5th Cir. 1949); Thornley v.
Commissioner, 147 F.2d 416, 422; Lehman, 165 F.2d at 385-386.
28 See, e.g., Kessler supra (advertising agency partnership); Shapiro, supra (partnership engaged in the
business of manufacturing and selling cosmetics and medicines); Thornley, 147 F.2d at 416-17 (3rd Cir.
1944) (advertising agency partnership); Stilgenbaur v. United States, 115 F.2d 283, 285 (9th Cir. 1940)
(general produce partnership); Lehman supra (brokerage business partnership); Smith supra (oil-field
retailer partnership); Long supra (drilling partnership).


         Here, because the substance of the sales of the SCE LLC interests by the
Taxpayer (and the Managed LLCs) were necessary steps in the SCE transactions
(facilitated using LLC interests) in the ordinary course of Taxpayer’s trade or business of
selling SCE LLC interests, § 1221(a)(1) applies to determine the character of the gain
on such sales. We are not challenging the entity approach of partnership taken by
§ 741 (i.e., that the sale of a partnership interest is treated as the sale of a single asset,
like corporate stock). The application of § 1221 under the present set of facts
harmonizes §§ 1221 and 741 such that capital gain treatment does not apply when a
taxpayer’s gain or loss arises from the everyday operation of a trade or business. Thus,
§ 741 does not foreclose treating the gain on the sale of the SCE LLC interests as
ordinary income in situations when, as here, the SCE LLC interests were pre-arranged
products frequently created and sold to customers (investors).

ISSUE 2

Sections 751(a)(2) and (d)(1)

       Section 751 is the exception to the general rule under § 741, which provides
capital gain treatment for the sale of a partnership interest. Section 751(a) provides that
on the sale or exchange of an interest in a partnership, the amount of any money, or the
fair market value of any property, received by a transferor partner in exchange for all or
a part of his interest in the partnership attributable to (1) unrealized receivables of the
partnership, or (2) inventory items of the partnership, shall be considered as an amount
realized from the sale or exchange of property other than a capital asset.

       Section 751(d) provides that for purposes of this subchapter, the term inventory
items means: (1) property of the partnership of the kind described in § 1221(a)(1); (2)
any other property of the partnership which, on sale or exchange by the partnership,
would be considered property other than a capital asset and other than property
described in § 1231; and (3) any other property held by the partnership which, if held by
the selling partner, would be considered property of the type described in § 751(d)(1)
and § 751(d)(2).

       Section 751(a)(2) and (d)(1) collectively apply to characterize as ordinary income
the gain recognized from the sale of a partnership interest attributable to partnership
property of the kind described in § 1221(a)(1).29 In other words, ordinary treatment
would be appropriate when (i) a partnership asset is inventory to the partnership, or (ii)
when a partnership asset is held by the partnership primarily for sale to customers in the
ordinary course of the partnership’s trade or business.



29 Section 1221(a)(1) excludes from the definition of capital asset: stock in trade of the taxpayer or other
property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close
of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course
of his trade or business.


        Here, the facts presented do not support that the land was included in the
inventory30 of the SCE LLCs or held by the SCE LLCs primarily for sale to customers.
Additionally, there are no facts to support that the SCE LLCs were engaged in the trade
or business of selling land. Each SCE LLC donated the easement, and/or the land, to a
§ 501(c)(3) organization on behalf of the investors. Therefore, § 751(a)(2) and (d)(1)
collectively would not apply to characterize the gain recognized by Taxpayer (or the
Managed LLCs) as ordinary income.

       Section 751(a)(2) and (d)(1) would apply, however, to characterize the gain
recognized by Taxpayer (or the Managed LLCs) as ordinary income if additional facts
are presented to support their application. That is, the facts must support that the SCE
LLCs were engaged in the trade or business of selling land and that the land held by the
SCE LLCs was either inventory or held primarily for sale to customers by the SCE
LLCs.

Sections 751(a)(2) and (d)(3)

       Collectively, § 751(a)(2) and (d)(3) apply to characterize as ordinary the gain
recognized from the sale of a partnership interest attributable to partnership property,
which, if held by the selling partner, would be considered: (1) property of the kind
described in § 1221(a)(1) and (2) any other property considered to be other than a
capital asset and other than property described in § 1231. In other words, ordinary
treatment would be appropriate when a partnership asset, if held by the selling partner
is, property other than a capital asset to the selling partner; inventory to the selling
partner; or held by the selling partner primarily for sale to customers in the ordinary
course of the selling partner’s trade or business.

         Here, the facts presented do not support that Taxpayer (or the Managed LLCs)
was in the trade or business of selling land. Promotional materials for the SCE
transactions described Taxpayer as not acting as a real estate broker with respect to
the SCE transactions. Additionally, in at least one year Taxpayer stated that neither
Taxpayer, nor the Managed LLCs, sold land and was not engaged in the business of
selling land. Accordingly, the land in the SCE LLCs, if held by Taxpayer (or the
Managed LLCs), would have been a capital asset to Taxpayer (or the Managed LLCs)
because there is no indication that the land was inventory to the Taxpayer (or the
Managed LLCs) or held by Taxpayer (or the Managed LLCs) primarily for sale to
customers in the ordinary course of the Taxpayer’s (or the Managed LLCs’) trade or


30 Here and elsewhere in this document, potential characterization of real property as inventory is
included in the analysis for the sake of consistency with the statutory language in § 751. However, note
that the Tax Court has held that real property does not constitute merchandise within the meaning of
§ 471. See W.C. & A.N. Miller Development Company v. Commissioner, 81 T.C. 619 (1983). Accordingly,
ordinary income treatment would depend on a determination that the underlying real property constitutes
property held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer’s trade
or business.


business. Therefore, § 751(a)(2) and (d)(3) collectively would not apply to characterize
the gain recognized by Taxpayer (or the Managed LLCs) as ordinary income.

       Section 751(a)(2) and (d)(3) would apply, however, to characterize the gain
recognized by Taxpayer (or the Managed LLCs) on the sales of the SCE LLCs as
ordinary income if additional facts are presented to support their application. That is,
the facts must support that the Taxpayer (or the Managed LLCs) was engaged in the
business of selling land. In addition, the facts must support that the land held by the
SCE LLCs was (i) inventory to the Taxpayer (or the Managed LLCs); (ii) property other
than a capital asset to the Taxpayer (or the Managed LLCs); or (iii) property held by the
Taxpayer (or the Managed LLCs) primarily for sale to customers.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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       This writing may contain privileged information. Any unauthorized disclosure of
this writing may undermine our ability to protect the privileged information. If disclosure
is determined to be necessary, please contact this office for our views.

      Please call Alta Li of the Office of Associate Chief Counsel (Passthroughs &
Special Industries) at (202) 317-5279 if you have any further questions.