One of the most fascinating things about the field of tax law is the way in which it often compels us to carefully analyze many terms that are used casually in everyday conversation.

In typical conversation, terms such as “property,” “income,” “real estate” and “gain” are understood rapidly and there is generally no reason for any additional clarification. But in the field of law, these terms may have particular meanings depending on the context in which they are used. Their meanings may also be shaped by the opinions issued in cases, so it’s imperative we check cases thoroughly to determine the complete meaning of a given term. Many cases are considered landmark decisions simply because they contributed substantially to the full understanding of frequently used terminology.

The case of Helvering v. Bruun (1940) can accurately be described as a landmark opinion in this regard. In this case, the full scope of the term “taxable gain” came under scrutiny as the court attempted to determine whether the gain received by the party could be subject to tax. Though it’s factually simple compared to modern financial cases, Helvering v. Bruun added an important layer to our overall system of taxation as it helped clarify the bounds of what can and cannot be taxed. As this case shows, taxable gain need not occur only within the context of a typical business transaction. If a person has received a calculable form of value, this may constitute taxable gain. This is generally well known among lawyers and tax professionals today, but it was cases such as Helvering v. Bruun that paved the way for our current understanding.

Let’s look at the facts of this case and then discuss its reasoning. As will be shown, though, the applicability of this ruling has been overturned in its most narrow sense.

Facts of the case

The respondent (in this case, the landowner) developed a lease with a tenant that made it clear that any buildings, fixtures or other improvements added to the land would be surrendered to the landowner when the lease ended. The tenant tore down one of the existing buildings on the leased land and constructed a new building in its place. There was a sizable difference in material value between the old building and the new building: $51,434.25, or roughly $923,000 in 2018 dollars.

During the course of the lease, the tenant became unable to keep up with rent and taxes, and eventually the lease was ended prematurely. Consistent with the provisions of the lease agreement, the building added by the tenant was forfeited to the respondent, and subsequently the IRS claimed the respondent had a realized gain equal to the difference in value between the old building and the new building. This claim was disputed by the respondent, who argued that the receipt of the new building did not constitute “taxable gain” under the current construction of that term.

The court ultimately ruled in favor of the IRS and determined that the respondent had in fact received taxable gain. The court’s reasoning set a notable precedent for conceiving taxable gain, which informed other opinions in future cases.

Section 22(a) of the Revenue Act of 1932 provided the definition of “gross income” usable at the time of the litigation. The issue before the court was whether the gain received by the respondent should fall within the meaning of this term (gross income) as defined under the act.

Judicial reasoning

In his argument against the taxability of the gain, the respondent stressed the fact that the building was not “severable” or “transferable” from the land itself, and that transferability was a key element of taxable gain. Since the building could not be “transferred” from the land without losing its value, the respondent contended that any gain derived from the building was nontaxable. The respondent cited case law which held that transferability was an essential component of taxable gain in the receipt of stock dividends, but the court rejected this logic and stated that transferability was a key element only in those limited circumstances. The cases referenced in support of this argument were Eisner v. Macomber and United States v. Phellis.

The case of Eisner v. Macomber was apparently the most promising resource for the respondent, because in that scenario the taxpayer was found to have not been in receipt of taxable income. In the Eisner scenario, the taxpayer received a stock dividend — which was functionally equivalent to a “stock split” — in the form of new shares, which reflected his pre-existing proportional ownership interest in the company (in this case, Standard Oil). The company diverted newly acquired profits to its capital account and then issued stock certificates to shareholders to balance out this transfer of company profits. The taxpayer had not actually been placed in a financially superior position by way of this transaction, however, because the value of the individual shares owned by the taxpayer had declined to reflect the greater number of shares in circulation. In other words, the taxpayer had not profited from the transaction, but simply had the value of his shares diluted as a consequence of the dividend.

In the Eisner case, one of the main points discussed by the court in its ruling was that the new shares had no independent value apart from the capital. Although the taxpayer had received additional shares, the aggregate value of all the shares owned by the taxpayer remained the same; the gain received by the taxpayer was therefore not “severable” from the capital owned by the corporation, and had no value separate from the capital. This scenario was easily distinguishable from the situation in Helvering v. Bruun. Clearly, though the value conferred by the tenant was tied up with the land already owned by the respondent, the respondent was placed in a financially advantageous position by way of the improvement. Unlike the taxpayer in Eisner, the respondent in Helvering v. Bruun obviously received a form of economic gain which was easy to quantify.

In its reasoning in favor of the government, the court stated that taxable gain can be triggered whenever someone is placed in a financially superior position. A traditional business transaction involving the sale of an asset for cash is not the only context in which taxable gain can take place; taxable gain can occur whenever someone exchanges property, or is relieved of debt, or receives values or profits by some other means. The ruling in Helvering v. Bruun, as it applies to enhanced value received upon termination of a lease, was actually nullified by subsequent revisions to the Tax Code, but the general principles pertaining to taxable gain are still valid. In later years, the code was revised so that lessors could exclude the gain derived from repossession of an asset with enhanced value from their gross income, and so in this narrow instance a lessor would not realize this same type of gain today. Currently, Section 109 of the Tax Code governs this type of scenario involving lessors and improvements made to their property throughout the course of a lease and excludes such improvements from gross income.

Again, this scenario, as well as the general principles involved, may seem relatively simple in comparison with modern cases, but understanding the reasoning of cases such as these is always beneficial. Every practitioner should familiarize themselves with the facts, reasoning and ruling of this case because it demonstrates clearly how case law shapes the bounds of essential terminology. Even a seemingly straightforward term, such as taxable gain, can cause all sorts of complexity depending on the fact pattern. Though the ruling of Helvering v. Bruun may not apply in a narrow sense today, it’s still invaluable as a training tool and resource for current practitioners.

Jorgen Rex Olson

Jorgen Rex Olson

Jorgen Rex Olson writes for Mackay, Caswell & Callahan PC, a tax and business law firm in New York.