## Facts

- Sol Diamond, a mortgage broker, and his wife filed joint returns; the transactions at issue were Diamond’s.
- The IRS determined deficiencies for 1961 and 1962; the Tax Court upheld (i) ordinary-income treatment of a compensatory venture interest (1962) and (ii) disallowance of certain claimed deductions (1961).
- In 1961, Philip Kargman sought financing for a $1,100,000 office-building purchase; Diamond agreed to arrange a loan in exchange for a 60% share of the venture’s profits and losses if successful.
- Diamond obtained a $1,100,000 mortgage; the parties agreed to a 24-year joint venture tied to the mortgage term, with profits/losses split 40% (Kargman) and 60% (Diamond), and sale proceeds first repaying Kargman’s cash contributions.
- The purchase closed in February 1962; Kargman contributed $78,195.33 cash beyond loan proceeds, meaning appreciation beyond that amount was needed before Diamond would have equity after repayment mechanics.
- Soon after, a new investor offered to enter the venture; Diamond agreed to exit by assigning his entire interest to Kargman for $40,000, and Kargman conveyed a 50% interest to the new investor.
- The Diamonds reported the $40,000 as short-term capital gain and reported no income when Diamond initially received the venture interest.
- For 1961, Diamond earned $145,186.37 in loan-arrangement commissions and paid $39,398.50 to officers of a lending institution; he claimed either exclusion as a conduit or deduction as ordinary and necessary business expenses.

## Issues

1. Whether Diamond’s receipt of a profit-and-loss-sharing venture interest for services was taxable as ordinary income upon receipt, and whether nonrecognition rules for partnership contributions prevented current taxation.
2. Whether Diamond could exclude from income, or deduct under I.R.C. § 162, payments made to lender officers from commissions he received.

## Decision

- The Seventh Circuit affirmed the Tax Court.
- Diamond realized ordinary income upon receipt of the venture interest because it was compensation for services and had an ascertainable fair market value.
- The fair market value at receipt was $40,000, supported by the near-immediate sale for that amount.
- Nonrecognition under I.R.C. § 721 did not apply to a compensatory receipt of a venture interest for services on these facts.
- The payments to lender officers were neither excludable under a conduit theory nor deductible as ordinary and necessary business expenses.

## Legal Principles

- Gross income under I.R.C. § 61 includes compensation for services in any form, including valuable property rights.
- A partnership or joint-venture interest transferred as compensation is includable in income upon receipt if it has a determinable fair market value.
- A near-immediate arm’s-length sale can be strong evidence of an interest’s fair market value at the time of receipt.
- I.R.C. § 721’s nonrecognition rule for contributions to a partnership does not shield a service provider’s compensatory receipt of an interest where the transfer is properly characterized as payment for services.
- A taxpayer bears the burden to prove either (i) amounts received were held for others under an agency or similar arrangement (conduit theory) or (ii) disputed payments qualify as “ordinary and necessary” business expenses under I.R.C. § 162.

## Conclusion

The court held that Diamond’s receipt of a profit-and-loss venture interest in exchange for arranging financing was taxable as ordinary income when received, valued at $40,000, and it upheld the denial of exclusion or deduction for payments Diamond made to lender officers because he failed to prove a conduit relationship or that the payments were ordinary and necessary business expenses.


Diamond v. Commissioner, 492 F.2d 286 (7th Cir. 1974)