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<p style="text-align: justify;"><strong>William M. McNeil, et ux. v. Commissioner, T.C.M 2011-109</strong></p>
<p style="text-align: justify;"><strong>Facts. </strong> William McNeil and Catherine McNeil were the only members of McNeil Ranch, LLC (the “McNeil Ranch”).  In 2003, McNeil Ranch sold a conservation easement in a bargain sale to the American Farmland Trust and to Ducks Unlimited.  The sale of the 2003 easements gave rise to a Colorado conservation easement credit of $260,000 to McNeil Ranch.  On December 18, 2003, McNeil Ranch sold $231,600 of its available $260,000 state conservation easement credit for $178,332 (“2003 transferred credit”).</p>
<p style="text-align: justify;">In 2005, McNeil Ranch sold an additional conservation easement in a bargain sale to Ducks Unlimited.  The sale of the 2005 easement gave rise to a Colorado conservation easement credit of $156,800.  On December 15, 2005, McNeil Ranch sold all of the $156,800 state conservation easement credit for $133,280 (“2005 transferred credit”).</p>
<p style="text-align: justify;">All of the income, deductions, and credits reported on McNeil Ranch’s 2003 and 2005 income tax returns flowed through the company to the McNeils’ joint 2003 and 2005 individual income tax returns.  The McNeils reported the net gain from the 2003 and 2005 transferred credits as long-term capital gain.</p>
<p style="text-align: justify;">On audit, the IRS determined that the sale of the conservation easement credits resulted in ordinary income and not capital gain because the credits were merely a substitute for ordinary income (i.e., a substitute for a refund from Colorado that would have been ordinary income).  The McNeils sought relief in Tax Court.</p>
<p style="text-align: justify;"><strong>Tax Court’s Decision. </strong> Relying on its previous decision in George H. Tempel, et ux. v. Commissioner, 136 T.C. No. 15 (2011) dealing with the same Colorado tax credit, the Tax Court held that the tax credits sold by McNeil Ranch were capital assets.  The Tax Court rejected the IRS’s contention that the credits should be treated as ordinary income, reasoning that under I.R.C. § 1221(a), a capital asset includes property held by the taxpayer (with exceptions for eight specifically excluded categories, none of which were state tax credits such as those at issue).</p>
<p style="text-align: justify;">The Tax Court also held that the McNeils’ holding period in their Colorado tax credits was insufficient to qualify for long-term capital gain treatment.  The holding period in their credits began at the time the credits were granted and ended when they were sold.  Therefore, the capital gains from the sale of the credits were short-term.</p>
<p style="text-align: justify;">As in Tempel, the Tax Court rejected the taxpayers’ contention that their holding periods in their land and state tax credits were one and the same because they were both part of the bundle of their real property rights.  The Tax Court reasoned that a taxpayer had no property rights in a conservation easement contribution state tax credit until the donation was complete and the credits were granted.  Accordingly, the credits never were, nor did they become, part of the taxpayers’ real property rights.</p>