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improvements and transfer his five lots The sole dispute before the Tax 4. The frequency, number, and continu-
to the LLC in exchange for dismissing Court concerned the character of Mus- ity of sales;
the lawsuit. selwhite’s reported $1,022,726 loss 5. The extent and substantiality of the
From 2008 to 2011, the LLC arising from his sale of the four lots. In transaction;
continued to own the condo and the its analysis, the court considered the 6. The nature and extent of the
original four lots but made no further reporting positions taken by the LLC taxpayer’s business;
improvements to the properties. Until on its prior-year returns with respect to 7. The extent of advertising or lack
2011, the LLC listed no inventory the four lots and the factors identified thereof; and
on Schedule L, Balance Sheets per by the Fourth Circuit, to which the ap- 8. The listing of the property for sale
Books, of its Form 1065, U.S. Return peal of Musselwhite’s case would lie, as directly or through a broker.
of Partnership Income, and listed the relevant to a determination of whether The courts have previously ruled
original four lots as “Investment property is inventory. that no one factor or group of factors is
— Real Estate.” However, on the determinative, and not all factors may be
2011 and 2102 returns, the lots were History of tax returns and relevant in a particular case — or factors
reported on the LLC’s Schedule L of reporting positions may have varying degrees of relevance
Form 1065 as “inventories.” In the court’s analysis of this issue, the depending on the facts of a particular
In June 2012, the lienholder of history of the LLC’s tax returns and case (S&H, Inc., 78 T.C. 234 (1982)).
the deed of trust covering the four reporting was considered significant, as Additionally, objective factors carry more
lots appraised the four original lots noted above. On the entity’s 2005 and weight than the taxpayer’s subjective
at $17,500 and began to pressure the subsequent filings of North Carolina statements of intent (see Guardian Indus.
LLC about them. To alleviate personal LLC annual reports, the principal Corp., 97 T.C. 308 (1991), aff’d without
debt exposure, Musselwhite and his business activity of the LLC was listed published opinion, 21 F.3d 427 (6th Cir.
business partner agreed to divide as real estate investment. Further, on 1994)).
up their jointly owned properties, its Form 1065 for the 2005 through The taxpayer here failed all the factors
including those held by the LLC. 2012 tax years, the entity reported its except for factors 7 and 8 regarding the
As part of this deal, Musselwhite principal business activity as real estate advertising and listing of the property
took a distribution from the LLC investment. The tax returns never for sale by a broker. The factors outlined
of the condo and the four lots. In showed gross sales (which would gen- below overwhelmingly, in aggregate,
2012, Musselwhite was able to sell erally indicate that the assets were held weighed against the taxpayer’s position
the condo and the lots, generating primarily for sale). Instead, when the that he should be able to take an ordi-
losses of approximately $137,780 and LLC had sales during those years, they nary rather than capital loss.
$1,022,726, respectively. were reflected on Schedule D. The tax Factors 1 and 2. The purpose for
On his return for 2012, return balance sheet (Schedule L) list- which the property was initially
Musselwhite treated the loss from the ed the condos and lots as investments acquired and subsequently held:
four lots as ordinary losses by reporting for 2005–2010. It was not until 2011 The first two factors did not support the
their sale on Schedule C, Profit or Loss that the lots first appeared as inventory taxpayer’s position that the four lots were
From Business, with the title “Activities on the balance sheet. inventory, the court held. He lacked real
Related to Real Estate.” This allowed estate development activity, the proper-
him to offset the loss against the Eight-factor analysis ties were classified on the balance sheet
considerable income he received from As the determination of whether an as an investment, and the sales of all pre-
his law practice. He included the loss asset is capital in nature relies on the viously owned properties were reported
from the sale of the condo as a capital facts and circumstances, the court also on Schedule D of the tax returns.
loss on Schedule D, Capital Gains and analyzed the facts of the case using the Factor 3. The extent of improve-
Losses. The IRS objected, finding that eight factors identified as relevant by the ments to the property: This factor
the loss from the sale of the four lots Fourth Circuit: also weighed against the taxpayer’s posi-
was a capital loss he could not offset 1. The purpose for which the property tion that the four lots were inventory.
against his legal practice income. was acquired; The last real estate development activity
The IRS issued Musselwhite a notice 2. The purpose for which the property was performed by the third party at the
of deficiency, and he subsequently was held; end of 2008. Once the property was
challenged the IRS’s determination in 3. Improvements, and their extent, acquired, the only activities that occurred
Tax Court. made to the property by the taxpayer; were annual maintenance and preparing

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