If a developer sells land in a real estate development, the normal tax rule is that he will recognize ordinary income, not capital gains. If a change in economics means the development effort should be abandoned, often it will be advantageous to recognize capital gains when the excess land is sold. A recent Tax Court shows how this can be done. Sugar Land Ranch Development, LLC v. Commissioner, T.C. Memo. 2018-21 (Feb. 22, 2018) (“Sugar Land”).
Sugar Land started a residential development near Houston, Texas. Starting in 1998, Sugar Land cleaned up the property and made land improvements necessary to subdivide the parcel into residential lots. Sugar Land sold a few lots in the years leading up to 2008. Because of the subprime mortgage crisis in 2008, the Sugar Land partners adopted a written policy that the residential development would halt and that the remaining land would be held for investment until the market recovered and the land could be sold. For the next four years, the Sugar Land managers ceased marketing, ceased making any improvements, and ceased listing the property with brokers. In 2011, an unrelated buyer approached Sugar Land and purchased the unsold land in bulk.
The IRS challenged the capital gain treatment because the property originally had been acquired for real estate development. However, the Tax Court upheld the capital gains treatment because found that the parcel had been converted to investment property prior to its sale. The Sugar Land partners did nothing to market the property for many years and sold the land in bulk to an unrelated person. The Tax Court was convinced that the infrequent sales activity was evidence that the partners had converted the development into investment property eligible for capital gains treatment.
Caution – This planning idea is not recommended if the land will be sold at a loss. In that event, ordinary loss treatment often is more advantageous.
Strassburger McKenna Gutnick & Gefsky can help you with your income tax planning. Please contact John Kelly, firstname.lastname@example.org or Dave Pollack, email@example.com at (412) 281-5423 for help with tax matters.
This post is provided for informational purposes only. Nothing in this post creates an attorney client relationship. Many of the rules discussed above have complicated exceptions. Please consult with your tax advisor before you implement any tax planning idea.