Bulk Land Sale Generated Ordinary Income To Developer - Your Actions and Intentions Often Determine Your Tax Fate

One should always respect one's intentions when it comes to classifying for tax purposes transactions contemplated for business.  

In Boree, CA-11, September 12, 2016, the Eleventh Circuit Court of Appeals affirmed that the subject taxpayers were liable for tax on ordinary income with respect to the bulk sale of a parcel of land following its development rather than capital gain treatment for property held for investment purposes.  

In this case, the taxpayers were found to have acted as developers with respect to the land, and the income attributed to the land sale was to reflect that position, and as a result it was ruled that the taxpayers failed to act in accordance with their claimed intentions. Given the facts and circumstances, the taxpayers’ behavior with respect to the bulk sale (like that of their behavior with that of other parcels of land they sold to individuals) was in line with that of a developer, and, not an investor, and therefore, the sale, resulted in ordinary income.

Background

The taxpayers owned a real estate business. The taxpayers acquired nearly 1,900 acres of vacant real property. The taxpayers engaged in development activities with respect to the property, to include submitting development plans, deducting business expenses related to the property, and selling several lots to buyers between 2002 and 2006. In 2007, the taxpayers sold its remaining lots, nearly 1,100 acres, in a bulk sale to a development company.

For the 2007 tax year, the taxpayers sought capital gains treatment with respect to the bulk sale. The IRS determined that the sale resulted in ordinary income. The taxpayers were also assessed accuracy-related penalties. The Tax Court ruled in favor of the IRS, finding that the sale resulted in ordinary income, as the property was held for sale in the ordinary course of business.

Circuit Court’s analysis

The Eleventh Circuit affirmed the Tax Court’s decision, finding that income from the taxpayers’ bulk sale of property resulted in ordinary income. The taxpayer asserted that the later imposition of land use restrictions was so adverse that it led them to hold the property for investment and not for sale.  But the court said the restrictions did not act as a bar of all development of the property. The court's decision was also based upon the fact that the taxpayer's continually requested for exceptions from the subsequent land use restrictions so that they could continue with their proposed subdivision.

Additionally, the court found that the Tax Court appropriately determined that the taxpayers continued to sell, or make attempts to sell, lots to individuals after the land use restrictions were in place, and deducted, as opposed to capitalized, expenses related to the property. This activity suggested that the taxpayers engaged in development activities even after the restrictions were imposed. 

The Appeals court also found that the Tax Court’s determination that the sale of 600 acres, which equaled one-third of the property, amounted to "frequent and substantial" sales, regardless of the fact that the taxpayers sold fewer lots after the land restrictions were in place. The "frequency and substantial(ity)" of sales is a factor used to determine whether property is being held as a capital asset. Frequent sales tend to suggest that property is not held for investment.

Also, the court noted the taxpayers’ failure to distinguish the parcels of land that they intended to use for development purposes from those they intended to hold as investment property. In addition, the court found that the early maps and later plans for the property envisioned a project that included, and continued to include, the property in its entirety, further undermining the taxpayers’ contentions that their primary purpose with respect to the property changed. 

References: CCH Tax Bulletin 2016-2 ustc ¶50,406; TRC SALES: 15,104.15.