Rev. Rul. 54-607

Advice is requested as to when the sales occurred of certain real property used in a trade or business under the facts set forth below, and whether the gain realized on the sale of such property by the taxpayer constituted capital gain.

Under the provisions of a sales agreement entered into in the latter part of 1952 the vendors, in consideration of x dollars, agreed to execute warranty deeds conveying certain real estate used in their business to the taxpayer. The vendors further agreed to furnish the taxpayer an abstract of title. The warranty deeds, abstracts, leases, permits, notes, obligations and bill of sale were to be placed in escrow, to be delivered to the taxpayer upon final payment of the purchase price. The vendors agreed to assume and pay all taxes for 1952 as in previous years. They also agreed to pay all normal and ordinary expenses of the property concerned, to and including December 31, 1952, but all taxes and operating expenses after that date were to be paid by the taxpayer. In accordance with the agreement the taxpayer operated the property for the vendors during the remainder of 1952 and took possession of the property on January 1, 1953, and continued the operation of the business. The warranty deed conveying the property to him is dated June 3, 1953, final payment of the purchase price having been made on May 4, 1953.

On April 12, 1953, the taxpayer entered into a so-called option agreement with the M Company for the sale of real and personal property. In consideration of x dollars the taxpayer granted to M the option to purchase certain property including the property under consideration. The agreement provided that M exercise its option by May 15, 1953. However, it was provided that M take immediate possession of all of the land, premises and personal property covered by the agreement and operate such property in the manner in which it saw fit. From the time of taking possession and pending acceptance of title, operating costs were to be paid by M. The M Company took possession of the property on or before April 12, 1953. The option was exercised on May 14, 1953 and payments were made in accordance with the agreement. The warranty deed conveying the property to M is dated July 17, 1953.

Real property being used in a trade or business is excluded from the definition of a capital asset under section 117(a) of the Code of 1939, and section 117(j) of the Code providing for capital gain treatment of the gain realized on the sale of such property under certain conditions is only applicable where the property has been held for more than 6 months.

In determining the holding period for capital gain and loss purposes, the date the property is acquired is excluded, and the date the property is disposed of is included. See I.T. 3287, C.B. 1939-1 (Part 1), 138 and I.T. 3705, C.B. 1945, 174.

With respect to real property which is the subject of an unconditional contract of sale, the holding period begins on the day following that on which title passes, or on the day following that on which delivery of possession is made and the burdens and privileges of ownership are assumed by the purchaser, whichever occurs first. The question is not always conclusively determined by the date of passage of title. See O.D. 751, C.B. 3, 116 (1920), and I.T. 1378, C.B. I-2, 26 (1922). A delivery of possession under a mere option agreement, however, is without significance until a contract of sale comes into being through exercise of the option, so that the holding period of the seller cannot end prior to that date.

In applying the above principles to the facts in this case, the taxpayer assumed the burdens and privileges of ownership of the property on January 1, 1953, and his holding period for such property began on the following day, January 2, 1953. The M Company, having been in possession, assumed the burdens and privileges of ownership by the exercise of its option to purchase on May 14, 1953, thereby ending the holding period of the taxpayer.

In view of the foregoing it is held that the gain realized by the taxpayer upon the sale of the property is not subject to capital gain treatment under section 117(j) of the Code but constitutes ordinary income.