Pounds and Elrod were real estate
salesmen who contracted to sell some property belonging to Gilson. They
made a deal where if they sold the property, they would receive a
commission of 25% of the sale (12.5% for each of Pounds and Elrod).
Elrod urgently needed some
money, so he sold his half of the commission to Pounds for $2.5k.
Pounds eventually sold the
property, and Gilson paid the entire commission ($14k) to Pounds.
When Pounds filed his taxes,
he claimed the first 12.5% commission as ordinary income. However, he claimed that the 12.5% he bought
from Elrod was a capital gain.
The IRS disagreed.
Pounds argued that the 12.5%
was a receivable that he had held
for more than a year. It did not derive from Pounds' work, so it is a capital
gain.
The IRS argued that there
was no sale or exchange. When
Gilson paid the 25% commission, there was no sale exchange of any
property interest because Gilson didn't receive anything, he was just
discharging an obligation.
26 U.S.C. §1222 says that in order to be a capital gain
there must be a sale or exchange.
The Trial Court found for the
IRS. Pounds appealed.
The Appellate Court affirmed.
The Appellate Court found
that this was not a sale or exchange, therefore Pounds could not claim it
as a capital gain.
The Court found that in this
case, Pound's "asset" (the account receivable) disappeared
during the transaction, and therefore nothing was exchanged.
At the end of the day,
Gilson wasn't holding anything, so there wasn't an "asset"
that Pounds could point to and say "I exchanged that thing there."
Basically, this case said that
where a liability is satisfied, there in no sale or exchange, and
therefore it cannot be considered a capital gain under 26 U.S.C. §1222.
Compare to Kenan v.
Commissioner (114 F.2d 217 (1940)),
where Kenan's estate paid out some stock to satisfy an inheritance. But
at the end of the day, the asset Kenan's estate gave up (the stock) still
existed, so the asset was exchanged and they could consider it a capital
gain.
