Cassius Clay operates a bituminous coal home heating and delivery service in Dau

Question

Cassius Clay operates a bituminous coal home heating and delivery service in Dauphin and Center counties. He must have a supply of bituminous coal on hand so customers may get the coal they need to heat their homes. As a convenience to his customers, and to prevent high bills over the winter and low bills in the summer, he allows them to buy coal in advance at set prices and to pay for the coal ratably over a calendar year. To ensure himself a steady, reliable, and affordable supply of coal and to protect against price fluctuations, Cassius Clay enters into certain futures contracts to buy coal at a future date and at a set price. Clay clearly indicates beforehand that the futures contract in which he enters to buy coal is simply to secure a supply of coal and to protect him from losses on the futures contracts with his customers to sell coal, and that he does not intend to profit from the contract itself.

Assume that Cassius Clay realizes a loss on the futures contract in which he entered to buy coal. That is, the price per his contract to buy coal is higher than the actual spot market price of coal the day he acquires a new supply of coal. How should Cassius Clay classify the loss—as ordinary or as capital?

Be sure to demonstrate your research skills in writing a memo to the file. You must cite the relevant code section(s) (including section 1221) and at least two (2) Supreme Court cases (hint: the two key cases are dated 1955 and 1988). You must also address the general principle of classifying assets—as capital or as operating—and the exceptions thereto.

As a reminder, the memo to the file should contain a brief statement of the facts, a statement of the issue(s), your conclusion(s) and recommendations, and an analysis which will include the sources (eg, Code, Regs, court cases) you used in reaching your conclusion(s). Be sure the sources are cited appropriately.

Explanation / Answer

Clearly, the business suffered an ordinary loss. Section 1221 gives an account of what can respectively be ordinary losses and capital losses.

Under IRC 1221 :

1. In general , the term capital asset means property held by tax payer (whether included in business or not) but does not include,

A. Stock in trade of the tax payer or property held as inventory or which is meant for resale to customers in the ordinary course of business or trade of the tax payer.

B. Any asset for which the tax payer claims depreciation or allowances u/s 16.

C. Copyright,literary, musical or artistic composition or similar property held by

i. The tax payer whose personal efforts created them

ii. in case of a letter, memorandum, a tax payer payer for whom such property was created.

iii.a tax payer in whose hands the gains of such properties are calculated.

D. Accounts or notes receivable acquired in the ordinary course of trade through sale of properties mention in paragraph A.

E. A publication of US government held by

i. A tax payer who so received such publication.

ii. A tax payer in whose hands such gains are calculated for sale of such publications.

F. Any commodity derivative financial inattentive held by a commodities dealer.

G. Any hedging transaction clearly as such before the close of the day in which it was acquired, private or entered into..

H.supplies of a type used in the ordinary course of business by the tax payer.

The two important cases relating to this are :

1. Arkansas Best v Commissioner 485 U.S. 212(1988)

2. Corn products refining co. Vs commissioner, 350 U.S. 46(1955)

Keeping in mind the stated points it is quite evident that the transaction was not.entered into with an investment motive rather it was in itself for the purpose of hedging against the risk of loss in the ordinary course of business. Therefore the loss incurred is an ordinary loss within the purview of section 1221.

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