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Taxation
Pine
Creek farms, Ltd. V. Commissioner [§§1221 and 6662]
(losses on the
sale of futures were capital losses since taxpayer was not sufficiently engaged
in hog farming)
Facts.Taxpayer raised corn, soybeans, and cattle and used its corn and
soybean crops either to feed its cattle, which it raises and markets, or to sell
to two other corporations, which have a common shareholder with taxpayer. One
of these corporations raised piglets and sold them to the other corporation, which
raised them to maturity and sold them at market. Taxpayer also sold grain to the
other two corporations to feed the pigs. Prior to incorporating, the common shareholder
had a commodities hedging account, which was transferred to taxpayer. The other
two corporations did not have a commodities account; however, the common shareholder
claimed that he maintained one account for all three corporations to simplify
the record keeping and tax reporting. Taxpayer was involved in numerous futures
transactions for corn, soybeans, cattle, and hogs and deducted the hedging expenses
as an ordinary loss. The IRS disallowed the losses related to hog futures on grounds
that taxpayer was not engaged in the production of hogs.
Issues
Issue 1. Whether losses incurred by taxpayer on the sale of hog futures are
capital losses or ordinary losses.
Issue 2. Whether taxpayer is liable for the accuracy related penalty under
I.R.C. §6662(a).
Analysis and Holding
Issue 1. Under Treas. Reg. §1.1221-2(a) and (b), the term capital asset does
not include property that is part of a hedging transaction, which is defined as
a transaction that a taxpayer enters into in the normal course of the taxpayer’s
trade or business primarily to reduce risk of price changes or currency fluctuations
with respect to ordinary property that is held or to be held by the taxpayer.
In Myers v. Commissioner, 52 T.C.M. (CCH) 841 (1986), it was concluded that Myers
had little, if any, reason to hedge soybean and feeder cattle since he did not
produce soybeans or feeder cattle, and Myers’s hedging transactions were held
to be capital losses.
The court concluded that the taxpayer failed to prove a direct relationship
between its production of corn or soybeans, which were the basis of its business,
and the hog futures in which it dealt. Further, the court found that taxpayer
failed to establish that there was a close relationship, or any relationship,
between the price of corn or soybeans and the price of hog futures, and that the
hog futures transactions did not reduce the risk of price changes or currency
fluctuations regarding taxpayer’s ordinary property. Therefore, the Tax Court
held that the losses incurred by taxpayer on the sale of hog futures were capital
losses.
Issue 2. Finding that taxpayer reasonably relied on its accountant’s advice
in characterizing the losses as ordinary, the Tax Court held that taxpayer was
not liable for the accuracy-related penalty under I.R.C.§6662(a).
[Pine Creek Farms, Ltd., v. Commissioner, 82 T.C.M. (CCH) 181 (2001)]
© 2001 Copyrighted by the Board of Trustees of the University of Illinois
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