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.
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