Around 1980, the taxpayer and his wife divorced, and a citrus farm located outside Phoenix, Arizona which the taxpayer owned was transferred by him to a revocable living trust in which he and his wife had respective beneficial interests of 80% and 20%. In 1994 (at a time that the suburban development of Phoenix had reached the area of the farm), 20 acres of the farm ("Parcel 6") were transferred by the trust to a partnership between the taxpayer, his wife and a corporation (having a 1% interest). Parcel 6 was sold at a gain in 2000. Immediately before the closing of the sale, the property was distributed to the partners (thereby realizing gain under s. 98(2)), with the partners conveying to the purchaser.
There was no reviewable error by the Tax Court when it found that there had been a clear intention to convert Parcel 6 from a capital asset used in the production of farm income to an item of inventory (notwithstanding that Parcel 6 continued to be used for citrus production) on the drop-down of the parcel in 1994, so that the sale of the parcel six years later gave rise to a gain on income account based on its cost as had been established under s. 97(1).