Faced with determining the character of assets that do not fit any of the section 1221 exceptions to the definition of a capital asset yet do 2011 U.S. Tax Ct. LEXIS 14">*25 not appear to properly fit that of a capital asset, courts use the substitute for ordinary income doctrine to exclude certain property. See Lattera v. Commissioner, 437 F.3d 399">437 F.3d 399, 437 F.3d 399">402-403 (3d Cir. 2006), affg. T.C. Memo. 2004-216. Under this doctrine, "capital asset" does not include mere rights to receive ordinary income. Commissioner v. P.G. Lake, Inc., 356 U.S. 260">356 U.S. 260, 356 U.S. 260">265-266, 78 S. Ct. 691">78 S. Ct. 691, 2 L. Ed. 2d 743">2 L. Ed. 2d 743, 1958-1 C.B. 516 (1958).

The practical effect of the substitute for ordinary income doctrine is that the Supreme Court "has consistently construed 'capital asset' to exclude property representing income items or accretions to the value of a capital asset themselves 136 T.C. 341">*347 properly attributable to income." United States v. Midland-Ross Corp., 381 U.S. 54">381 U.S. 54, 381 U.S. 54">57, 85 S. Ct. 1308">85 S. Ct. 1308, 14 L. Ed. 2d 214">14 L. Ed. 2d 214 (1965). The doctrine has been applied by courts directly and indirectly to exclude a variety of assets from the breadth of section 1221. ^{72011 U.S. Tax Ct. LEXIS 14">*27} As we explained in Foy v. Commissioner, 84 T.C. 50">84 T.C. 50, 84 T.C. 50">66 (1985), the substitute for ordinary income doctrine is an important court-imposed limitation on the types of property that will qualify as a capital asset. ^{82011 U.S. Tax Ct. LEXIS 14">*28} It is now clear that the substitute for ordinary income doctrine is the only recognized judicial limit to the broad terms of section 1221. 2011 U.S. Tax Ct. LEXIS 14">*26 See 485 U.S. 212">Ark. Best Corp. v. Commissioner, supra at 217 n.5. Consequently, when determining whether property is a capital asset under section 1221, unless one of the eight exceptions or the substitute for ordinary income doctrine applies it is a capital asset.

Respondent asserts that the appropriate framework for determining the character of petitioners' gains is the analysis the Court employed in 112 T.C. 209">Gladden v. Commissioner, supra.⁹ The taxpayers in Gladden agreed to relinquish intangible water rights in exchange for cash. The Court applied contract analysis, specifically a six-factor test (Gladden factors), ¹⁰ to determine the character of the taxpayers' gain on the relinquishment of those rights. 112 T.C. 209">Id. at 221. Respondent argues the Gladden factors point to ordinary income treatment for the proceeds of the State tax credit sales.

We find that respondent's argument extends the Gladden analysis beyond its historical use and the purpose it serves. The Gladden factors arose from a judicial need to analyze the underlying nature of contract rights. This Court cannot conclude that a government-granted tax credit is a contract right. There is nothing in the Colorado statutes granting the tax credits 2011 U.S. Tax Ct. LEXIS 14">*30 that could be understood to create a contract. As the Supreme Court stated in Natl. R.R. Passenger Corp. v. Atchison, Topeka & Santa Fe R. Co., 470 U.S. 451">470 U.S. 451, 470 U.S. 451">465-466, 105 S. Ct. 1441">105 S. Ct. 1441, 84 L. Ed. 2d 432">84 L. Ed. 2d 432 (1985):

For many decades this Court has maintained that absent some clear indication that the legislature intends to bind itself contractually, the presumption is that "a law is not intended to create private contractual or vested rights but merely declares a policy to be pursued until the legislature shall ordain otherwise." This well-established presumption is grounded in the elementary proposition that the principal function of a legislature is not to make contracts, but to make laws that establish the policy of the state. Policies, unlike contracts, are inherently subject to revision and repeal, and to construe laws as contracts when the obligation is not clearly and unequivocally expressed would be to limit drastically the essential powers of a legislative body. Indeed, "'[t]he continued existence of a government would be of no great value, if by implications and presumptions, it was disarmed of the powers necessary to accomplish the ends of its creation.'" Thus, the party asserting the creation of a contract must 2011 U.S. Tax Ct. LEXIS 14">*31 overcome this well-founded presumption, and we proceed cautiously both in identifying a contract within the language of a regulatory statute and in defining the contours of any contractual obligation. [Citations omitted.]

136 T.C. 341">*349 Here there is no clear indication that the Colorado legislature intended to bind itself contractually. The presumption that Colorado's State tax credit has not created any private contractual rights has not been overcome.

State tax credits, as respondent concedes, are not contract rights. Respondent has asserted no reason, nor can we think of one, to expand the applicability of the Gladden analysis to the State tax credits at issue.

Respondent also asserts that petitioners' gains from the sales of their State tax credits are ordinary because they are merely a substitute for ordinary income. First, respondent asserts that petitioners' proceeds from selling the State tax credits are merely a substitute for a refund from Colorado that would have been ordinary income. Respondent's argument assumes that a refundable credit would not be excluded from income. ^{112011 U.S. Tax Ct. LEXIS 14">*33} Consequently, respondent's position is that the 2011 U.S. Tax Ct. LEXIS 14">*32 proceeds petitioners received from the sales of their credits are a substitute for the up to $50,000 tax refund that a Colorado taxpayer could receive in a year the State incurs a budget surplus. ¹² Yet respondent also concedes that there was no opportunity for a refund from the State either during 2004 (the year petitioners sold their credits) or in 2006 through 2010. ¹³

Petitioners sold $110,000 and gave away $10,000 of their $260,000 of State tax credits, leaving them with $140,000 of State tax credits to use. There is no evidence and respondent does not assert that petitioners sold credits they could have 136 T.C. 341">*350 otherwise used to receive a refund. Therefore, petitioners' proceeds from the sale of their credits are not a substitute for a tax refund.

Second, respondent maintains that to the extent a taxpayer could use a credit to reduce a State tax liability but instead sells that credit, that taxpayer has the economic equivalent of ordinary income. Respondent appears to reason that if an individual taxpayer who sells credits itemizes deductions (ignoring phase-outs), that taxpayer's section 164 Federal income tax deduction is greater than it would have been had that taxpayer retained and used the credits. Therefore, 2011 U.S. Tax Ct. LEXIS 14">*34 the taxpayer who sells credits has more Federal income tax deductions and owes less Federal income tax. Assuming arguendo that petitioners sold credits that they could some day have used to offset a State tax liability and that they could have deducted that liability for Federal tax purposes were it not offset, respondent's argument still fails. A reduction in a tax liability is not an accession to wealth. Consequently, a taxpayer who has more section 164 deductions has not received any income. ¹⁴

Having addressed respondent's arguments and finding them unpersuasive, we turn to whether there is any reason the substitute for ordinary income doctrine is applicable to the sales of petitioners' State tax credits. The parties and this Court agree that the receipt of a State tax credit is not an accession to wealth that results in income under section 61. 2011 U.S. Tax Ct. LEXIS 14">*35 See Browning v. Commissioner, 109 T.C. 303">109 T.C. 303, 109 T.C. 303">324-325 (1997); Rev. Rul. 79-315, 1979-2 C.B 27. We know of no authority, and respondent has not cited any, for the proposition that a State income tax credit results in ordinary income upon its later sale. ¹⁵ On the contrary, courts and the Commissioner's rulings frequently treat government-granted rights as capital assets. ^{162011 U.S. Tax Ct. LEXIS 14">*36}

136 T.C. 341">*351 It is also apparent that the transferred State tax credits never represented a right to receive income from the state. Instead, they merely represented the right to reduce a taxpayer's State tax liability. It is without question that a government's decision to tax one taxpayer at a lower rate than another taxpayer is not income to the taxpayer who pays lower taxes. A lesser tax detriment to a taxpayer is not an accession to wealth and therefore does not give rise to income. ^{172011 U.S. Tax Ct. LEXIS 14">*37}

It follows that the taxpayer who is able to claim a deduction or credit has no more income by virtue of having that right than the taxpayer who is unable to make such a claim. ¹⁸ Had petitioners used all of their credits to offset their State tax liability, rather than selling them, it appears that respondent would agree there would 2011 U.S. Tax Ct. LEXIS 14">*38 have been no income to petitioners. ¹⁹Using a tax credit to offset a tax liability is not an accession to wealth.

Petitioners never possessed a right to income from the 2011 U.S. Tax Ct. LEXIS 14">*39 receipt of the credits. They did not sell a right either to 136 T.C. 341">*352 earned income or to earn income. Consequently, the sale proceeds are not a substitute for rights to ordinary income. ²⁰

The State tax credits petitioners sold do not represent a right to income; therefore, the substitute for ordinary income doctrine is inapplicable. None of the categories of property in section 1221 that Congress specifically excepted from the term capital asset is applicable to the State tax credits. Accordingly, we hold the State tax credits petitioners sold are capital assets.

Section 1012 sets forth the foundational principle that the basis of property for tax purposes shall be the cost of the property. Cost, in turn, is defined by regulation as the amount paid for the property in cash or other property. Sec. 1.1012-1(a), Income Tax Regs.

Petitioners argue that they have a cost basis 2011 U.S. Tax Ct. LEXIS 14">*40 in their State tax credits. On their tax return they claimed a cost basis in the credits based upon an allocation of $11,574.74 of professional fees they incurred in connection with establishing and donating the conservation easement. ²¹ In their cross-motion for partial summary judgment petitioners appear also to argue some portion of their basis in their land should be allocable to the State tax credits. ²² We find neither position tenable.

The first position assumes the expenses petitioners incurred to donate the conservation easement are properly allocable in their entirety to petitioners' State tax credits. However, individual taxpayers may deduct ordinary and necessary expenses incurred "in connection with the determination, collection, or refund of any tax" as an itemized deduction. Secs. 211 and 212. Appraisal fees and other ordinary and necessary expenses to determine a taxpayer's tax liability as the result of a charitable contribution may be 136 T.C. 341">*353 deductible under section 212(3). 2011 U.S. Tax Ct. LEXIS 14">*41 See Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">950-951 (1985); Robson v. Commissioner, T.C. Memo. 1997-176, affd. without published opinion 172 F.3d 876">172 F.3d 876 (9th Cir. 1999); Biagiotti v. Commissioner, T.C. Memo. 1986-460. Expenses incurred to determine any State tax, including State income tax credits, are also expenses that may fall within the ambit of section 212(3). Sec. 1.212-1(l), Income Tax Regs.

Section 212 aside, petitioners' argument also glosses over section 1012. Under section 1012, cost basis generally is what a taxpayer paid to acquire an asset. See Solitron Devices, Inc. v. Commissioner, 80 T.C. 1">80 T.C. 1, 80 T.C. 1">16-17 (1983), affd. without published opinion 744 F.2d 95">744 F.2d 95 (11th Cir. 1984). Petitioners paid transaction fees to establish a conservation easement that they donated to an unrelated third party. Petitioners did not acquire the State tax credits by purchase. ^{232011 U.S. Tax Ct. LEXIS 14">*42} It was the State's unilateral decision to grant petitioners the State tax credits as a consequence of their compliance with certain State statutes. Accordingly, petitioners easement costs are not allocable as cost basis to their State tax credits.

Petitioners appear to take a second position in their motion without fully articulating that position. Petitioners cite Fasken v. Commissioner, 71 T.C. 650">71 T.C. 650 (1979), for the proposition that where a taxpayer sells a portion of property any gain or loss is calculated separately for each part sold and the adjusted basis of the entire property is allocated to the portion sold. In Fasken the Court decided whether the consideration the taxpayers received for easement grants should be applied against their basis in all their land or applied to the portion of the basis allocable to the acreage upon which the easements were granted. 71 T.C. 650">Id. at 655-660. Unlike the taxpayers in 71 T.C. 650">Fasken, petitioners did not sell an easement; they made a charitable contribution. Petitioners assert that the rationale of Fasken should apply to their State tax credits. They appear to contend, like the taxpayers in Fasken, that their State tax credits are a portion of their land and that the basis in their land is allocable 2011 U.S. Tax Ct. LEXIS 14">*43 to their credits.

136 T.C. 341">*354 Colorado's grant of State tax credits creates cognizable property rights in those credits for the recipients of those credits. Cf. United States v. Griffin, 324 F.3d 330">324 F.3d 330, 324 F.3d 330">353-355 (5th Cir. 2003); Barrington Cove Ltd. Pship. v. R.I. Hous. & Mortg. Fin. Corp., 246 F.3d 1">246 F.3d 1, 246 F.3d 1">5 (1st Cir. 2001) (finding a developer did not have a cognizable property interest in Federal income tax credits for purposes of a substantive due process claim where the developer had no entitlement to credits and held only a "unilateral expectation" and desire for the credits). Upon petitioners' receipt of the credits, their expectation matured and they then possessed ownership rights in their State tax credits. However, these credits are not a right petitioners possessed in their land. Instead, their rights in the credits, although achieved because of the property, arose on account of the grant from the State. Unlike the easement granted in 71 T.C. 650">Fasken v. Commissioner, supra, the State tax credits are not a property right in land that would necessitate the allocation of basis in the land to the credits. Therefore, Fasken does not control the tax treatment of petitioners' charitable contribution.

Moreover, 2011 U.S. Tax Ct. LEXIS 14">*44 there are rules for determining a donor's basis in the context of a conservation easement. The donor's entire basis in the property is allocated to the conservation easement according to the ratio that the fair market value of the easement bears to the total pre-easement fair market value of the property. Sec. 170(e)(2); Hughes v. Commissioner, T.C. Memo. 2009-94; sec. 1.170A-14(h)(3)(iii), Income Tax Regs. The donor reduces its basis in the retained property by the amount of basis allocated to the conservation easement. Sec. 170(e)(2); Hughes v. Commissioner, supra; sec. 1.170A-14(h)(3)(iii), Income Tax Regs. These rules do not permit an allocation based upon the value of a State tax credit, only on the value of the easement. Therefore, it would be inconsistent with these rules to allocate the donor's land basis to the value of a State tax credit.

There is nothing in the Code or the Commissioner's regulations that justifies allocating petitioners' basis in their land to the State tax credits. Therefore, we conclude petitioners do not have any basis in their State tax credits.

On their tax return petitioners reported a short-term capital gain from the sale of their State 2011 U.S. Tax Ct. LEXIS 14">*45 tax credits. In their cross-motion for partial summary judgment petitioners claim the sale of their State tax credits resulted in long-term capital gain. ²⁴The sale of capital assets held for more than 1 year will result in long-term capital gain or loss. Sec. 1222. Petitioners assert that they held the land upon which they donated the charitable conservation easement for more than 1 year and that their holding period in the land is attributable to their holding period in the State tax credits.

Assuming, without deciding, that petitioners have a holding period in their land that was greater than 1 year, their argument still fails. Petitioners' reasoning, citing 71 T.C. 650">Fasken v. Commissioner, supra, appears to be that their holding period in their land and State tax credits are one in the same because they are both part of the bundle of their real property rights.

As we explained supra pp. 23-24, a Colorado taxpayer had no property rights in a conservation easement contribution State tax credit until the donation was complete and the credits were 2011 U.S. Tax Ct. LEXIS 14">*46 granted. The credits never were, nor did they become, part of petitioners' real property rights.

Instead, petitioners' holding period in their credits began at the time the credits were granted and ended when petitioners sold them. Since petitioners sold their State tax credits in the same month in which they received them, the capital gains from the sale of the credits are short term.

The State tax credits that petitioners sold are capital assets. Petitioners have no basis in their State tax credits. Additionally, petitioners held their credits for less than 1 year; therefore, the gains arising from their disposition are short-term capital gains.

136 T.C. 341">*356 To reflect the foregoing,

An appropriate order will be issued granting in part and denying in part respondent's motion for partial summary judgment and petitioners' cross-motion for partial summary judgment.