15 T.C. 69">*70 The Commissioner has determined deficiencies in the income tax liability of the petitioners for the fiscal year 1944 as follows:

The only issue for decision is whether gains realized from the sales of 14 houses are taxable as ordinary income under section 22 (a) of the Internal Revenue Code, or as long term capital gains within the meaning of section 117 (j).

The petitioners concede that other determinations have been made correctly by the respondent.

The petitioners, Lucille McGah and Carole O'Shea, are the wives of the petitioners, E. W. McGah and John P. O'Shea, respectively.

The income tax return of each of the petitioners for 1944 was filed with the collector for the first district of California.

FINDINGS OF FACT.

The facts which have been stipulated are found as facts and are incorporated herein by this reference.

Petitioners, E. W. McGah and John P. O'Shea, had been engaged for1950 U.S. Tax Ct. LEXIS 123">*126 several years prior to 1944 in a number of business enterprises including the building of houses for sale. During 1944, McGah and O'Shea were members of various partnerships which conducted business under the following names: Brennan & McGah & O'Shea; San Leandro Homes Co.; Leekins, McGah & O'Shea; Superior Tile Co.; Superior Tile & Linoleum.

McGah and O'Shea owned 25 per cent, each, interests in Brennan & McGah & O'Shea which was engaged in the business of constructing and selling houses, and which constructed and sold 121 houses during 1944. The issue which is presented in this proceeding does not relate to any of the transactions of Brennan & McGah & O'Shea.

The partnership of San Leandro Homes Co. was created on August 31, 1942, by McGah and O'Shea who were equal partners. It was organized for the purpose of constructing 169 houses to provide housing for persons engaged in national defense activities, i. e., to build "defense housing," on tract No. 68 in San Leandro, Alameda 15 T.C. 69">*71 County. McGah and O'Shea contributed $ 13,500 in cash to the working capital of San Leandro Homes Co., which will be referred to hereinafter as "San Leandro." The working capital of San Leandro, 1950 U.S. Tax Ct. LEXIS 123">*127 for the chief part of its operations, was borrowed from Central Bank of Oakland, California, under F. H. A. loans. San Leandro acquired title to 169 lots in tract No. 68 in the City of San Leandro, assuming obligations of the sellers of the lots to Central Bank in the sum of $ 88,725. On September 17, 1942, San Leandro's application to the Office of Production Management, Division of Priorities, dated August 2, 1942, for preference ratings on 169 dwelling units in a proposed defense housing project in the City of San Leandro was approved, effective as of September 17, 1942, and expiring January 17, 1943. The application was for preference ratings on materials entering into the construction of defense housing. In order to finance the construction of 169 houses, San Leandro borrowed funds from Central Bank under Title VI of the National Housing Act. The loans, which were made pursuant to liberal appraisals of Federal Housing Administration (F. H. A.) were sufficient to cover both the cost of the lots and the costs of constructing the proposed 169 houses, i. e., the loans were "one hundred per cent loans." San Leandro borrowed at least $ 676,000 or $ 4,000 for the construction of1950 U.S. Tax Ct. LEXIS 123">*128 each one of the entire group of 169 houses. The plan of the project called for completion of construction of all of the houses in three months, and each house was to be identical in floor plan and cubic feet area. The last units were completed by February 1, 1943. On that date the 169 houses were completed and ready for occupancy.

Originally, in August of 1942, McGah and O'Shea contemplated renting all of the houses, provided all could be rented at the rate of $ 50 per month rent. They applied to O. P. M. (Office of Production Management) for allocation of housing units to be built under preference ratings on materials which could be rented for $ 50 per month, but they were told by the officials in charge that some of the houses would have to be made available at a monthly rental of $ 39.99, and they agreed, therefore, that 69 units would be made available at that rental, and 100 units would be made available at a monthly rental of $ 50; the approval of the application for preference ratings was given upon that understanding; and it was set forth in the application. However, there was an oral understanding with officials that this allocation might be changed if and when other1950 U.S. Tax Ct. LEXIS 123">*129 directives and allowances were made officially, so that McGah and O'Shea had some hope that, eventually, all of the 169 units could be rented for $ 50 per month.

The application for preference ratings, as approved, did not contain any prohibition against or restrictions or limitations upon selling any or all of the houses. San Leandro was free to elect to sell houses, or 15 T.C. 69">*72 to rent them. In August of 1942, McGah and O'Shea intended to rent the houses. They knew, however, as construction progressed that if they should elect to sell any of the houses, the sales price of each house would be $ 5,000, or $ 5,100, or close to those prices. They knew, also, in the beginning, that the carrying or financial charges for the interest and mortgage payments would amount to about $ 33 per month for each house; that maintenance charges and other expenses would amount to around six or seven dollars per month for each house; and that, consequently, it would not be profitable to rent houses for $ 39.99 per month. They considered that the monthly rental would have to be $ 50 per month if San Leandro were to profitably hold the houses for rental.

As the houses were nearing completion, McGah1950 U.S. Tax Ct. LEXIS 123">*130 called upon officials in F. H. A. to request their approval of charging more than $ 39.99 for the 69 houses which it had been specified should be made available at that rental, but the request was denied. At that time McGah learned that San Leandro was not restricted in any respect in the matter of its electing to sell the houses rather than to rent them, that San Leandro was privileged to sell any of the houses it desired, and could sell all of them.

There was an active market for houses, and there would have been no problem in selling them.

When McGah and O'Shea learned at the end of 1942, or in the beginning of 1943, that they could not get more than $ 39.99 rental for 69 of the houses, they decided then to sell a group of 74 houses which, by location, made a group. San Leandro sold 74 houses during its first fiscal year which ended October 31, 1943, without ever letting them be rented, including the 69 which could have been rented for only $ 39.99 per month. The net profit from these sales was $ 82,691.20. The "realized profit" upon an installment sales method of reporting the gain was $ 53,820.13, and that amount was reported as ordinary income for the fiscal year ending 1950 U.S. Tax Ct. LEXIS 123">*131 in 1943.

San Leandro, from and after March 15, 1943, rented the remaining 95 houses but did not take leases on any of them. Rather, they were rented on oral month-to-month tenancies to defense workers for $ 50 rental per month. San Leandro maintained a rental office and paid an agent $ 10 for each house rented. From March 15, 1943, until August 14, 1944, the 95 houses were occupied by 156 different tenants.

About the middle of 1944, McGah and O'Shea discussed the financial position of San Leandro with officers of Central Bank. San Leandro wished to borrow more funds for the purpose of building more houses. At that time, San Leandro owed the bank in excess of $ 350,000. The bank officials "suggested" that it would be advisable for the partnership to liquidate some of its properties in order to reduce 15 T.C. 69">*73 the indebtedness to the bank. The advice of the bank was not actually in the nature of a "suggestion." It was in the form more or less of a demand. McGah and O'Shea then decided that San Leandro should sell houses. The demand for houses was large and very active in 1944. It was not necessary to advertise the houses for sale. As tenants gave up tenancy and moved out, 1950 U.S. Tax Ct. LEXIS 123">*132 houses were sold. Two brokers handled sales and were paid commissions. During the fiscal year ended October 31, 1944, 14 houses were sold; during the fiscal year ended October 31, 1945, 31 houses were sold; during the fiscal year ended October 31, 1946, 12 houses were sold, plus an additional house purchased and rented during the same year; during the fiscal year ended October 31, 1947, 3 houses were sold, and 35 of the original 169 houses (or 95 houses) remained on hand and were rented. During the period from about March 15, 1943, until October 31, 1947, 134 houses out of 169 were sold.

The sales of houses during the fiscal year ended October 31, 1944, were made on and after August 1, 1944 through October 18, 1944, and during the months of August, September, and October. Selling prices ranged from $ 5,500 to $ 6,000. Eight houses were sold for $ 5,500 each; one was sold for $ 5,750; and five were sold for $ 6,000 each. The cost of each house was $ 3,858.59. The net profits from the sales ranged from $ 1,768.69 to $ 2,281.61, per house sold. The net profit from the sales of 14 houses amounted to $ 27,936.51, of which $ 17,176.20 was the "realized profit" under installment payments. 1950 U.S. Tax Ct. LEXIS 123">*133 The sales of the houses in 1944 were continuous and frequent during the 3-month period of the sales. The net profit from rents during the fiscal year ending in 1944 amounted to $ 4,306.63. It amounted to $ 2,449.40 in the fiscal year ending in 1945. There was no profit from rents in the fiscal year ending in 1946, but a loss of $ 1,209.67 was sustained. And the profit from rents was $ 629.57 in the fiscal year ending in 1947.

With respect to the application for further loans which San Leandro made to Central Bank in the middle of 1944, the loan was obtained eventually, and more houses were built and were sold by San Leandro. A few were retained.

The parties have stipulated that McGah and O'Shea have held, at all times, their respective interests in the partnership, San Leandro Homes Co., as community property with their wives.

In the partnership return of income, Form 1065, which San Leandro Homes Co. filed for its fiscal years ending on October 31 of 1943 and 1944, the business of the partnership was stated to be "Building Houses."

Shortly before August 1, 1944, McGah and O'Shea decided that San Leandro should sell houses in order to obtain capital for further construction 1950 U.S. Tax Ct. LEXIS 123">*134 operations, and they abandoned the purpose of holding the 15 T.C. 69">*74 houses primarily for the production of rental income. They decided to sell houses as tenants occupying them under oral month-to-month tenancies vacated them. The business of San Leandro from before August 1, 1944, to the end of its fiscal year was the sale of houses. At the time houses were sold during the fiscal year ended on October 31, 1944, the houses were held primarily for sale to customers in the ordinary course of trade or business, and they were not held primarily for investment purposes.

OPINION.

The question in this proceeding is whether the gain from the sales of 14 houses in 1944 by the partnership, San Leandro, is taxable as ordinary income or as capital gain. The respondent has determined that the 14 houses were held for sale to customers in the ordinary course of trade or business within the meaning of sections 117 (a) and (j) of the Internal Revenue Code and that, consequently, the gain from the sales of the 14 dwelling units during the taxable year is taxable as ordinary income. The petitioners contend, on the other hand, that the 14 houses were held primarily for rental and that they were not1950 U.S. Tax Ct. LEXIS 123">*135 held primarily for sale to customers in the ordinary course of San Leandro's business, and that the gains, therefore, are taxable as capital gains. The petitioners rely upon Nelson A. Farry, 13 T.C. 8, and upon other cases which have been decided by this Court. Consideration has been given to all of the cases which have been cited.

The issue involved is one of fact, and the burden is on the petitioners to show that the properties in question were not held primarily for sale to customers in the ordinary course of trade or business. Greene v. Commissioner, 141 Fed. (2d) 645, certiorari denied, 323 U.S. 717">323 U.S. 717; Commissioner v. Boeing, 106 Fed. (2d) 305, certiorari denied, 308 U.S. 619">308 U.S. 619.

Although the petitioners E. W. McGah and John P. O'Shea are individuals, the issue relates to them only as members of the partnership, San Leandro Homes Co., and the issue to be decided involves one question, among others, as to what the business of San Leandro was in 1944, which is a fact question. The evidence shows that San Leandro was engaged in1950 U.S. Tax Ct. LEXIS 123">*136 the business of constructing small houses, that the capital contributed by the two partners was small, only $ 13,500, and that San Leandro obtained "100 per cent loans," under F. H. A. regulations from Central Bank to finance the purchase of lots and the construction of 169 houses. The record lacks facts about the terms of the loans, but shows that about $ 676,000 (169 x $ 4,000), at least, was borrowed, and that the "life" of the houses, for purposes of depreciation, was a little more than 16 years. Since ceilings were placed by housing authorities upon the rent which could be charged 15 T.C. 69">*75 for the houses, that fact must be taken into consideration along with the large indebtedness of San Leandro. An obvious question is how San Leandro expected to pay the loans obtained to build the houses, and how long would it take to work out the project from the viewpoint of the financing which was adopted. San Leandro was created with a very small amount of working capital. Against this background, the petitioners have made the contention that San Leandro's primary purpose was to build houses for investment purposes -- to make its earnings and profits from the rental of 169 small defense1950 U.S. Tax Ct. LEXIS 123">*137 workers' houses. Petitioners place strong emphasis upon the purpose of San Leandro at the time it filed with O. P. M. an application for preference ratings for construction materials, which was in August of 1942.

Assuming for purposes of argument only that two of the contentions of the petitioners are sound and are supported by the evidence, namely, that when the houses were completed in about February of 1943, its purpose was to hold 95 houses for investment purposes, to be rented and thereby to produce income in accordance with an investment purpose, and that a valid differentiation is to be made between San Leandro's purpose with respect to one group of 74 houses and another group of the remaining 95 houses, (and we question the soundness of this contention), the question is narrowed to whether 95 houses were held primarily for rental and investment purposes in the fiscal year of the partnership ending on October 31, 1944, which is the taxable year, or whether the houses were held primarily for sale to customers in the ordinary course of the business of San Leandro. Since 14 houses were sold in the taxable year, it may be proper to narrow the question further to the question 1950 U.S. Tax Ct. LEXIS 123">*138 stated above as it applies to only 14 houses. We consider the question in both aspects. Since the question is a question of fact, it is better first to discuss the evidence which is pertinent to the above question.

The petitioners knew when the 169 houses were completed, at the latest, which was in February of 1942, what each cost, what the interest and mortgage carrying charges were for each house, and what the ceilings on rents were. Although they contend that San Leandro went into the project of constructing 169 defense workers' houses as an investment rather than with a purpose of selling the houses, they admit that before any houses were rented, it was decided that 74 should be sold. The original purpose was changed, therefore, in about February or March of 1943 with respect to 74 houses, at least. During the trial of these proceedings, McGah admitted that he knew in February or March of 1943, that San Leandro was privileged to sell any or all of the houses, in so far as regulations of the housing authorities were concerned, and O'Shea testified that he and his partner did not know, at the time they applied for priorities ratings, in 15 T.C. 69">*76 1942, how long San Leandro would1950 U.S. Tax Ct. LEXIS 123">*139 be in "the business," and that it was impossible to guess. O'Shea testified also, that in the middle of 1944, Central Bank did more than "suggest" that houses should be sold in the then favorable market. He testified as follows: "I think the bank's remarks were a little more than a suggestion. It wasn't actually in the form of a suggestion. It was in the form more or less of a demand."

The evidence shows that from August of 1944 until October 31, 1947, 60 houses (out of 95) were sold. In 1944, 14 were sold in three months between August 1st and October 31st. The sales were continuous and frequent during that period. The record fails to disclose the dates of sales during the three subsequent years, but the number of sales in the succeeding year, 31, indicates that those sales were continuous and frequent.

The evidence shows, also, that San Leandro, at some time subsequent to the conference with officers of Central Bank in the middle of 1944, obtained a further loan from the bank with which it financed the building of more houses, which, for the most part, were sold, only a few of those houses being retained.

Upon all of the evidence, it must be concluded that at some time prior1950 U.S. Tax Ct. LEXIS 123">*140 to August 1, 1944, the members of the partnership, San Leandro Homes Co., changed their alleged original purpose with respect to the 95 houses held by the partnership from the purpose of holding them primarily to rent, for investment purposes, to holding them primarily for sale and to selling houses as they became vacant. None of the houses were leased. All were rented under a month-to-month arrangement which was made orally. It is concluded, also, that the evidence does not support the theory of the petitioners.

The general issue which is involved here has been before courts frequently. There are several tests which are to be applied to determine whether property is held primarily for investment purposes, or primarily for sale to customers in the ordinary course of business. We need not restate them, but refer to the extensive review of authorities in Boomhower v. United States, 74 Fed. Supp. 997 (D. C., N. D.Iowa, Dec. 23, 1947). One test of whether property is held primarily for investment purposes is lack of continuity of sales, either because of inactivity or infrequency of sales, so that sales which take place have the aspect of isolated1950 U.S. Tax Ct. LEXIS 123">*141 transactions. That test, applied to the facts of these proceedings fails, according to our understanding of the evidence in these proceedings. Furthermore, the contention that the 95 houses constituted investment properties in 1944, prior to the sales of 14 houses, is not convincing, in the light of the record. The Central Bank was not disposed to carry San Leandro for any extended period of time, according to the record before us. About one year after the project was completed, it demanded faster liquidation of the 15 T.C. 69">*77 original loan or loans, after 74 houses had been sold in 1943. And the partners, themselves, had no fixed purpose in 1944 of renting the properties for a long period of time, or of holding them for investment purposes, according to the testimony of one of the partners. How long they would "be in the business" was a matter of conjecture to them.

It has been held that an original status of property is not determinative of the question of whether it was, at the time of its sale, held for investment purposes or for sale to customers. See Carl Marks & Co., 12 T.C. 1196, 1202, where this Court said that the "crucial factor to consider1950 U.S. Tax Ct. LEXIS 123">*142 in determining the character of" the property in question is the purpose for which it was held during the period in question, i. e., in the taxable year. See, also, Richards v. Commissioner, 81 Fed. (2d) 369, affirming 30 B. T. A. 1131, and Oliver v. Commissioner, 138 Fed. (2d) 910. The question becomes concerned with whether an original purpose of holding property changed, and if so, when.

The fact that the houses were rented prior to sales does not establish that at the time of sale they were held primarily for investment to produce income. See Neils Schultz, 44 B. T. A. 146; Charles H. Black, Sr., 45 B. T. A. 204, and Walter G. Morley, 8 T.C. 904. In these proceedings, a decision had been made at some time prior to August 1, 1944, to sell houses as they became vacant, and this decision was carried out in 1944, and in succeeding years. The original purpose to rent houses had changed prior to the time sales were made.

The development of a tract of lots by building houses thereon requires capital. 1950 U.S. Tax Ct. LEXIS 123">*143 Ordinarily, where the primary purpose is for the investment of capital and the holding of property to produce income and for investment purposes, there is expectation of carrying on the venture for some longer period of time than is the case where gain is to be realized from a comparatively rapid turnover of capital. The petitioners assert that San Leandro, in the taxable year, was engaged in an investment operation. But the record shows that San Leandro lacked any substantial capital of its own, and it is a fact that it had borrowed practically all of the capital required to purchase the lots and build the houses. The evidence shows, also, that the annual net income from rental receipts was small in view of the large amount of San Leandro's indebtedness to the bank. The situation was such, as we construe the evidence in the record before us, that realization of any substantial gain depended upon making sales of the houses. And in the middle of 1944, the bank pressed San Leandro to sell its properties. We think the reasonable conclusion to be drawn from the evidence is that San Leandro was in the business of selling houses in 1944. It is concluded that San Leandro was in the1950 U.S. Tax Ct. LEXIS 123">*144 business of selling houses in 1944 within the meaning of sections 117 (a) and (j) of the Code. See Delsing v.United States, U. S. D. C., N. D., Texas, decided March 23, 1950; Larson v. Korth, 92 Fed. Supp. 705; Ehrman v. Commissioner, 15 T.C. 69">*78 120 Fed. (2d) 607, certiorari denied, 314 U.S. 668">314 U.S. 668; and James Lewis Caldwell McFaddin, 2 T.C. 395, modified on another point, 148 Fed. (2d) 570. Cf. McDaniel v.United States, U. S.D. C., N. D., Texas, decided March 23, 1950.

Petitioners rely upon Nelson A. Farry, supra, but the facts in that case showed clearly that property was held for investment purposes. That case is distinguishable from these proceedings upon the facts. In the Nelson A. Farry case, the taxpayer had made investments in rental properties over a period of several years. Other than some stock in a small local company, he had no other investments than his rental properties. From 1934 until 1940, he acquired or built 38 duplex apartments and negro rental houses. At1950 U.S. Tax Ct. LEXIS 123">*145 the end of 1941, he had increased his holdings to 45 different rental properties, comprising about 100 rental units. In the Farry case, the taxable years involved were 1944 and 1945. It was not until 1944 that the taxpayer considered selling any of his properties. In 1944 and 1945, he sold 46 parcels of property. We found the following facts: "It was pointed out to petitioner by his banker that interest on the notes which he could take in the sale of these rental properties would yield more than rents from the property. Petitioner concurred in this view," (p. 11). The facts were, in the Farry case, that the taxpayer had gradually accumulated rental properties for purposes of investment during a period of seven years, and had held various parcels as investment properties during periods of from four to ten years, respectively. This Court concluded that the petitioner had

* * * proved by overwhelming evidence that he purchased and held the rental properties primarily for investment purposes. The fact that in the taxable years he received satisfactory offers for some of them and sold them does not establish that he was holding them "primarily for sale to customers in1950 U.S. Tax Ct. LEXIS 123">*146 the ordinary course of his trade or business." The evidence shows that he was holding them for investment purposes and not for sale as a dealer in real estate.

In the instant proceedings, we are unable to conclude that the petitioners have proved that San Leandro was holding 95 houses in 1944, prior to the sales of 14 houses, primarily for investment purposes. The record indicates that in the middle of 1944, San Leandro desired to build more houses and approached Central Bank for a loan for that purpose. It was then indebted to the bank for over $ 350,000. The houses were a little over one year old. About one year and a half after the group of 95 houses were built, San Leandro began selling the houses in this group of 95 which the petitioners ask us to consider as a distinct group, separate and apart from the 74 houses which it sold in 1943. There is nothing in the record to indicate that the market for the sale of houses was more favorable in 1944 than it had been in 1943, so that the decision in 1944, prior to August 1st, to sell houses was not predicated upon a change in market conditions 15 T.C. 69">*79 as compared with prior years as was the situation in the Farry case. And1950 U.S. Tax Ct. LEXIS 123">*147 here, there is no convincing evidence that the purpose of San Leandro was to build houses primarly for investment purposes and that sales of houses were merely incident to carrying out that purpose, as was concluded in the Farry case. It appears in these proceedings that the business of San Leandro was building houses, that sales thereof were part of that business, and that it was only by selling houses than San Leandro could turn over its capital and build more houses. We consider the Farry case to be clearly distinguishable on the facts from these proceedings.

It is held that the 14 houses which San Leandro sold in its fiscal year ended October 31, 1944, constitued property held by San Leandro primarily for sale to customers in the ordinary course of its business, and that the gains realized from the sales of 14 houses are taxable as ordinary income. The respondent's determinations are sustained.

Decisions will be entered for the respondent.