## Facts

- Fred and Rosalie Pellar decided to build a personal residence after failing to find a suitable existing home.
- Rosalie’s father, Sam Briskin, had substantial business connections with Ragnar Benson, Inc., a construction firm, and facilitated contact.
- The Pellars bought a lot and contracted with Ragnar Benson, Inc. to build the house for an agreed construction price of $40,000, later increased by requested extras.
- The contractor incurred major cost overruns due to miscalculations, errors, and rework; its total construction cost was about $101,936.52.
- The completed house (excluding land) had a fair market value of $70,000.
- Ragnar Benson, Inc. nonetheless honored the contract price (as adjusted for limited extras), absorbing the loss to preserve and advance business goodwill with Briskin.
- The IRS asserted a deficiency, treating the difference between the amount paid and either the contractor’s cost or the home’s fair market value as unreported taxable income to the Pellars for the year of completion.

## Issues

1. Whether taxpayers realize taxable income when they acquire a newly constructed personal residence for less than the contractor’s cost and less than the residence’s fair market value.
2. If any taxable income could arise, whether it would be measured by the excess of construction cost over price paid or only by the excess of fair market value over price paid.

## Decision

- The Tax Court held for the Pellars and disallowed the asserted deficiency.
- The court ruled that the Pellars realized no taxable income attributable to the excess of either (i) the contractor’s cost or (ii) the residence’s fair market value over the contract price paid.
- The contractor’s loss, incurred to maintain goodwill with a third party, did not convert the transaction into taxable income to the homebuyers.

## Legal Principles

- A bargain purchase, without more, does not create taxable income at the time of acquisition; the bargain is reflected in basis and becomes relevant upon later disposition.
- A below-market transfer may be taxable when the discount functions as compensation, a constructive dividend, or a gift, depending on relationship and intent.
- Business-motivated price concessions made to secure or preserve goodwill with a third party do not constitute taxable income to the purchaser absent facts showing compensatory intent, shareholder distribution, or donative intent toward the purchaser.
- Unrealized gain inherent in acquiring property below value is not taxed until realization through sale or other disposition.

## Conclusion

The Tax Court rejected the IRS’s attempt to tax the Pellars on the “bargain element” of their home construction contract, holding that acquiring a residence below construction cost or fair market value does not produce current taxable income absent a compensatory, dividend, or gift-type transfer.


Pellar v. Commissioner, 25 T.C. 299 (1955)