U.S. v. Winthrop & Ordinary Income 

May 18, 2018

In the past, we’ve discussed how capital gain treatment of a given transaction (or series of transactions) depends on a variety of factors. In cases where there is uncertainty regarding the treatment of a transaction, courts will perform an independent analysis based on the particular facts of the case, but they will also give weight to established principles. Receiving capital gain treatment is a very important issue because capital gains are typically taxed at rates considerably lower than those which apply to ordinary income.   The case of U.S. v. Winthrop (1969) is a very important case that business owners would do well to be aware of because it gives detailed information about how to stay within the bounds of the capital gain classification. 

Buram Capital Gains Pillars

In the Fifth Circuit Court of Appeals case of Byram v. U.S. (1983), we were introduced to capital gains “pillars”.  They influence the analysis courts conduct when determining whether a given transaction qualifies for capital gain treatment. In that case, the court ruled in favor of the taxpayer and granted capital gain treatment to a series of real estate sales made over the course of several years.

We’ll see, however, in the Winthrop case, that not all taxpayers are are as fortunate as the taxpayer in Byram; sometimes courts find that what appears to be a capital gain is, in fact, ordinary income.  Ordinary income is essentially any income from a sale in the ordinary course of operating a business. Capital gains, by contrast, follow from the sale of a capital asset.  Further, as we’ve discussed, whether a given piece of property qualifies as a capital asset depends on how the asset is acquired and held.  

Facts of U.S. v. Winthrop

The taxpayer in this case, Winthrop, inherited numerous pieces of land over the course of several decades. He inherited his first piece of real estate in 1932.  Thereafter, he started to develop that piece of real estate in 1936. Winthrop sold his first piece of real estate later that same year in 1936. He continued to sell real estate consistently up until his death in 1963. Ultimately, a dispute arose as to the character of his sales activity.  The suit was to settle the issue. 

Importantly, Winthrop dedicated an extremely large amount of effort developing his properties and making them attractive to potential buyers. He did not create a business office from which he conducted sales activities.  Still, the sums generated from real estate sales constituted the majority of his income over the course of many years. Furthermore, he even listed real estate as his primary occupation on official documents in the years before his death.

Totality of Circumstances

In his disputes with the Internal Revenue Service, Winthrop cited a number of cases which collectively seemed to provide strong support for his argument that his income should be afforded capital gains treatment. The primary question before the Court then, was whether Winthrop’s actions, when considered together, fell within the accepted bounds of the capital gain classification. 

Procedural History 

The Fifth Circuit Court of Appeals overturned the initial ruling of the trial court.  It decided that Winthrop’s sales activity generated ordinary income. The U.S. v. Winthrop case should give readers a sense of the difficulty which is often involved when performing capital gains analyses: that is, since there was no factual dispute between the two courts,  the only dispute involved the proper legal treatment of the established facts. And in this case the lower, trial court ruling did not stand.  That should give us a sense of how unpredictable the outcomes of these analyses can be depending on the situation. 

The U.S. v. Winthrop Analysis 

The appellate court’s finding of ordinary income hinged on several key factors: Mr. Winthrop developed and sold the properties consistently over a long period of time; the funds derived from the sales made up the majority of his income for many years; he openly stated that the sale of real estate was his primary occupation; and, perhaps most importantly, selling the properties for profit was the primary purpose underlying his ownership. There was no question that Winthrop held the properties primarily for sale. The only real issue was whether the sales were in the “ordinary course of business”. This issue, in turn, was whether he was operating a trade or business. It’s clear that Mr. Winthrop had a reasonably strong case, which explains his initial victory at the trial court level, but the Fifth Circuit determined that he was, in fact, engaged in a legitimate business considering that selling the real estate for profit was the sole purpose of his ownership throughout the whole period in question.  

Rely on Our NYC Tax Attorneys

Again, cases such as U.S. v. Winthrop are exceedingly helpful as they help to show the difficult line which separates ordinary income and capital gains. If Winthrop had a few other factors in his favor, he may might have had a different outcome. The attorneys at Mackay, Caswell & Callahan, P.C. spend time laboring over tough cases such as these so you won’t be saddled with this task. We work hard to ensure that our clients receive the very best expertise possible. If you’re curious about whether your current activities could lead to a capital gain classification, or if you have any other tax issue, be sure to reach out to a premier New York City tax attorney and we will assist you in double quick time. 

Image credit: KMR Photography 


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