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B. Treatment of the RHI Sale
Analyzing the Hursts’ disposition of their interest in the
smaller HVAC company, RHI, turns out to be more complicated than
analyzing the redemption of their HMI stock. The notice of defi-
ciency was clear in stating that the Commissioner was disallowing
the Hursts’ treatment of the HMI redemption as a sale because
that sale was to a “related party.” And both the Hursts and the
Commissioner understood this to mean that the disposition of Mr.
Hurst’s HMI stock implicated section 302(b)(3). That’s the way
both parties approached trial preparation and then tried the
case. But the notice of deficiency cited no authority in disal-
lowing capital gains treatment for the Hursts’ sale of their RHI
stock, simply including it as a disallowed subitem within the
overall disallowance of Mr. Hurst’s treatment of his HMI stock
sale. The Commissioner’s answer did assert that “both petition-
ers retained prohibited interests, within the meaning of I.R.C.
� 302(c)(2)(A), in the corporation referred to by petitioners as
‘RH, Inc.’” And though the answer makes no more specific allega-
tion about Mr. Hurst’s alleged “prohibited interest” in RHI, it
does specifically allege that Mrs. Hurst had “an employment con-
tract with that corporation, which is a prohibited interest.”
The issue did not get much attention at trial, because the
stipulated evidence showed that the answer simply got it wrong--
Mrs. Hurst’s employment contract was with HMI, not RHI. And
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