## Facts

- F.C. and Frankie McDougal, Texas farmers, bred and raced horses and owned a racehorse, *Iron Card*.
- Gilbert and Jackie McClanahan were involved; Gilbert was a licensed public horse trainer who trained horses for a standard fee.
- The McDougals had a prior understanding with McClanahan that if he trained *Iron Card*, he would receive a one-half interest in the horse.
- On October 4, 1968, the McDougals transferred a one-half interest in *Iron Card* to McClanahan pursuant to that understanding.
- Before the transfer, the McDougals received multiple offers to purchase *Iron Card*, including a $60,000 offer, which they rejected.
- On November 1, 1968, the McDougals and McClanahan orally agreed to operate a joint venture regarding *Iron Card* to race it as long as feasible and later use it for breeding; profits would be split equally, but losses would be borne solely by the McDougals.
- The McDougals’ amended 1968 return treated the October 4 transfer as compensation, claiming a $30,000 business-expense deduction and reporting a long-term capital gain; they also asserted the joint venture’s basis in the horse.
- The Commissioner determined deficiencies for 1968 and 1969 for both couples and asserted that a joint venture existed as of October 4, 1968, with the horse contributed by the McDougals and services contributed by McClanahan, producing no gain to the McDougals at that time.

## Issues

1. Whether the October 4, 1968 transfer of a one-half interest in *Iron Card* to McClanahan was compensation for services or instead part of forming a joint venture in which McClanahan contributed services.
2. Whether the McDougals recognized taxable gain on transferring the one-half interest in appreciated property, and how that gain is measured.
3. How to determine the joint venture’s basis in *Iron Card* after the parties’ subsequent contribution of the horse to the venture.

## Decision

- The Tax Court held the McDougals transferred the one-half interest in *Iron Card* to McClanahan as compensation for services rendered.
- The court held the McDougals recognized gain to the extent the fair market value of the half interest transferred exceeded their adjusted basis in that half interest.
- For basis purposes, the court treated the events as a two-step sequence: (1) transfer of a half interest to McClanahan as compensation, followed by (2) contribution of the entire horse by both owners to the joint venture.
- The court’s deficiency determinations and additions to tax were resolved through computations consistent with these substantive holdings and the parties’ concessions.

## Legal Principles

- A transfer of an interest in appreciated property as compensation for services is a taxable disposition by the transferor; gain equals the property’s fair market value (as transferred) minus the transferor’s adjusted basis in the portion transferred.
- Property received as compensation is includible in the service provider’s income at fair market value, and that amount generally becomes the recipient’s basis in the property.
- When co-owners subsequently contribute property to a joint venture/partnership, the venture’s basis is determined by the bases each contributor has in the property at the time of contribution.
- The court may apply a step-transaction approach to reflect the economic substance of compensation followed by contribution to a venture, rather than treating the entire arrangement as a nonrecognition formation in services-for-interest form.

## Conclusion

The Tax Court characterized the half-interest transfer of *Iron Card* as compensation for training services, requiring the McDougals to recognize gain on the appreciation in the transferred portion, and it determined the joint venture’s basis by treating the transfer as occurring before the parties jointly contributed the horse to the venture.


McDougal v. Commissioner, 62 T.C. 720 (1974)