## Facts

- Five consolidated federal tax refund suits were brought in the United States Court of Claims by Castlewood, Inc. and several related individual taxpayers in the Swift family.
- In 1961, Thomas E. Swift, a real-estate developer, purchased land in Georgia for $60,000; by 1968 his adjusted basis in the land was about $8,500.
- In 1968, Swift formed Castlewood, Inc. to subdivide, develop, and sell lots in a planned subdivision (Castlewood Subdivision) and transferred the land to Castlewood for use in that project.
- At the time of the transfer, the land’s fair market value was about $250,000.
- In exchange for the land, Castlewood issued Swift five promissory notes, each in the face amount of $50,000 (total $250,000), bearing 4% interest, with annual maturities beginning in 1971 (installment obligations).
- Castlewood subdivided and developed the property and, from 1970 through 1973, sold 18 lots for total proceeds of about $240,000.
- Based on allocations of land and development costs, Castlewood reported the lot sales and reported profit of about $80,500.
- In 1976, the Commissioner of Internal Revenue issued deficiency determinations asserting that the 1968 transfer was not a sale but instead a capital contribution or a transfer governed by I.R.C. § 351, requiring Castlewood to take a carryover basis under I.R.C. § 362 (about $8,500), which would increase taxable gain on the lot sales.
- A second, related issue involved SJL, Inc., another Swift-controlled corporation that had elected Subchapter S treatment; the government asserted that SJL had excessive “passive investment income” under former I.R.C. § 1372(e)(5), terminating its S election and causing distributions to certain shareholders to be treated as dividends.
- The Court of Claims decided the consolidated matters on stipulated facts and addressed these two questions.

## Issues

1. Whether Swift’s transfer of land to Castlewood in exchange for Castlewood’s installment promissory notes was a taxable sale (giving Castlewood a cost basis equal to the note amount) or instead a § 351 transfer or capital contribution (giving Castlewood a carryover basis under § 362).
2. Whether more than 20% of SJL’s gross receipts constituted “passive investment income” under former § 1372(e)(5), terminating SJL’s Subchapter S status and recharacterizing shareholder distributions as dividends.

## Decision

- The court held that the transfer of the Georgia land to Castlewood in exchange for installment obligations was a sale, not a transaction governed by § 351 and not a capital contribution.
- Because the transaction was a sale, Castlewood’s basis in the land was its cost—reflected by the $250,000 face amount of the promissory notes—rather than Swift’s carryover basis.
- The court held that SJL’s Subchapter S election was not terminated under former § 1372(e)(5) on the government’s passive-income theory, so the related shareholder distributions were not treated as dividends on that ground.
- The court resolved the consolidated refund claims consistently with these holdings.

## Legal Principles

- The tax characterization of a property transfer to a controlled corporation depends on the substance of the consideration and the relationship created; genuine indebtedness can support sale treatment even when the transferor controls the corporation.
- Section 351 nonrecognition applies to transfers to a controlled corporation solely in exchange for stock or qualifying securities; an exchange for bona fide installment obligations may fall outside § 351.
- When a corporation acquires property by purchase, its basis generally is cost (the purchase price), rather than a carryover basis under § 362.
- Under former § 1372(e)(5), an S corporation’s election may terminate if passive investment income exceeds the statutory percentage of gross receipts (and other statutory conditions are met); receipts must be properly classified before applying the percentage test.

## Conclusion

In *Bradshaw v. United States*, the Court of Claims held that Swift’s 1968 land transfer to his controlled corporation, Castlewood, in exchange for fixed, interest-bearing installment notes was a sale, giving Castlewood a $250,000 cost basis for computing gain on later lot sales, and the court also rejected the government’s attempt to terminate SJL’s Subchapter S election under the passive-investment-income limitation, preventing dividend treatment of the challenged distributions.


Bradshaw v. United States, 683 F.2d 365 (1982)