Professor Richard Winchester’s Essay, A Simple Tax Case Complicated by Race, is a very enlightening and quick read. His Essay details a Tax Court decision about whether a sale of land by a real estate developer is eligible for favorable tax treatment. And while most law students who have taken a single individual income tax class would rightly tell us the answer is no, Professor Winchester takes us through an opinion that finds otherwise—because of race! First, a primer for my non-tax-geek readers.
For most of our modern income tax history, the gain applicable to the sale of capital assets like stock or real estate held by investors, has been eligible for a low, preferential tax rate. Sales of inventory, or property “primarily for sale to customers” on the other hand are taxed at the highest ordinary income tax rates available. Real estate developers therefore are selling property they hold for sale to customers and generally ineligible for the lower, preferential tax rate. Except, Tax Court Judge Withey did not get the memo. Why? Professor Winchester argues that it is because of race.
The decision, Pontchartrain Park Homes, Inc. v. CIR, holds that the gain from the sale of real estate by a developer is eligible for the lower preferential tax rate—because the developer was doing something extra risky: building a subdivision of homes for sale to prospective black homebuyers during Jim Crow.
The story of how the development came to be is alone a valuable contribution to the literature. In 1950, a white Baton-Rouge based builder, Hamilton Crawford, along with the white mayor of New Orleans, deLesseps Story Morrison (the name alone deserves its own movie), agreed to build two communities: one white (Gentilly Woods) and one black (Pontchartrain Park) separated by a ditch. (Plessy v. Ferguson allowing “separate but equal” was still good law.) The purpose of Pontchartrain Park was to ease the housing shortage faced by black Americans and potentially prevent protests. (P. 38.) Financing for both were provided by the Federal Housing Administration (FHA). During this time FHA insurance generally flowed to developments that excluded black Americans. In this case an exception was made because of pressure applied by Mayor deLesseps Story Morrison on the FHA.
In 1951, Hamilton Crawford and a business partner bought the land. (P. 40.) By 1954, he teamed up with two New Orleans philanthropists to build Pontchartrain Park through a new company aptly called Pontchartrain Park Homes, Inc. (PPHI). Within a year, PPHI purchased the land from Crawford and his business partner, and construction soon started. By 1957, PPHI had completed installing improvements on about half the land, but it still had 188 unsold homesites. It took a pause and accepted an unsolicited offer from the state to buy seventeen acres of undeveloped land to build a satellite campus of Southern University, a Historically Black College and University. PPHI turned a profit of $154,019 on the sale and the issue was whether that profit was subject to the lower, preferential tax rate that applies to capital gains. The taxpayer claimed the lower preferential tax rate on their tax return and the Internal Revenue Service (IRS) disagreed. Tax court Judge Withey found for the taxpayer as did the Fifth Circuit on appeal albeit with a different analysis.
The Tax Court according to Professor Winchester (and any law student who took the introductory course) “incorrectly observ[ed] that raw land is generally a capital asset in the hands of a real estate developer.” (P. 41.) Professor Winchester notes that Judge Withey’s language describing how PPHI served “a market, the potentialities of which were a virtually unknown and untested factor in its experience or that of its incorporators,” meant in Winchester’s words that PPHI’s “customer base of Black buyers made it unique.” (P. 41.)
Because the development was for black homebuyers—something unheard of in the Jim Crow South—PPHI was not like the ordinary real estate developer who had a history of selling real estate to these customers. Their customer base was white. The market for white homebuyers was well established. Not so for the black homebuying market. Judge Withey concluded that any raw land was an investment when acquired by PPHI, making it a capital asset from the beginning. (P. 42.)
As Professor Winchester points out though, the facts do not support that conclusion. PPHI’s charter looked like “that of any other real estate developer.” (P. 42.) And “the company always classified its undeveloped land as ‘inventory’ in its books.” (P. 42.) The IRS naturally appealed and a three-judge panel of the U. S. Court of Appeals for the Fifth Circuit issued a per curiam opinion rejecting the Tax Court’s theory that the land was not primarily held for sale to customers when the company acquired it, but because PPHI’s purpose was changed substantially after acquisition, the Fifth Circuit concluded that it “was no longer held primarily for sale to customers” by the time the actual unsolicited offer to sell was received. The appellate court expressly rejected the Tax Court’s analysis that the land was an investment from the very beginning. (P. 43.)
Professor Winchester notes the role that race played in the Tax Court opinion. He argues that race made Tax Court Judge Withey interpret the law against precedent and in favor of the white developer’s company that was developing homes for sale to black Americans. Professor Winchester in effect describes the “market risk” discussed in the opinion as a dog whistle for race and notes how the Judge’s assumptions about black homeowners were the ultimate driving factor in his opinion. I might add that the Judge may have also seen PPHI as a sympathetic taxpayer, trying “to do the right thing” and therefore deserving of the capital gain tax break—a tax break that recent Treasury Department research shows is disproportionately received by white Americans.1
Professor Winchester points to current research that shows a tendency for Americans to associate “homeownership with whiteness.” (P. 44.) (Perhaps Judge Withey associated eligibility for the low, preferential rate with whiteness as well.) Professor Winchester discusses research that the FHA’s bias against insuring homes owned by black Americans is replicated in today’s market even though that bias has long been made illegal under the 1968 Fair Housing Act. “[H]omes located in racially integrated areas receiv[e] substantially lower bank appraisals than the ones for comparable homes in all-white areas.” (P. 44.) As Professor Winchester points out, that has real substantive economic impact.
In case you think this case is old and cold, Professor Winchester notes how Judge Withey’s decision was cited in a 2018 IRS brief, where the government argued the sale by PPHI was of raw land treated as a capital asset because “the company was in the business of selling improved lots, as opposed to raw land.” Of course, as he notes, this comports with the Tax Court opinion but not the Fifth Circuit’s decision. As Professor Winchester observes, “Withey’s rationale in PPHI’s case has retained some persuasive power, despite the Fifth Circuit’s admonition.” (P. 46.)
Professor Winchester urges all judges to be aware of and sensitive to any implicit racial bias that might cloud their thinking. Otherwise, there may be more simple cases…“complicated by race.” (P. 47.)
- See Julie-Anne Cronin et al., Tax Expenditures by Race and Hispanic Ethnicity: An Application of the U.S. Treasury Department’s Race and Hispanic Ethnicity Imputation (U.S. Dep’t of Treasury, Off. of Tax Analysis, Working Paper No. 122, 2023) (“White families are 67 percent of all families but receive…92 percent of the benefits of preferential rates for certain capital gains and qualified dividends….”) Id. at 28.
