Tag Archives: Land bank

For Want of a Nail? How Long-Term Capital Gain Eligibility Can Turn on a Single Piece of Paper

An old proverb teaches that the absence of a horseshoe nail can cause the downfall of a kingdom. A recent Tax Court cases suggest a real estate owner’s eligibility for long-term capital gain can turn on something just as trivial:  a single piece of paper.

The Sugar Land case involved real estate businesspersons who, though various entities, held some land for investment purposes and other land for development purposes. During 2008, they decided to abandon development plans for raw land they originally intended to develop. In 2008, they executed an owner resolution expressing their change of intent. Their land holding company subsequently sold most of the property to an unrelated homebuilder in three transactions in 2011 and 2012. The company then sold substantially all the remaining property to related entities in four transactions spanning 2012 through 2016. The related entities developed that land for resale.

The IRS asserted that the 2012 sales should have generated ordinary income instead of long-term capital gain. Despite several factors militating against capital gain eligibility—including nearby development activity by related entities–the Tax Court found that the sales qualified as long-term capital gain. The court identified the 2008 owner resolution as the critical factor showing their intent.

The Sugar Land opinion is a bookend to the Fargo case we discussed in 2015. In Fargo, the Tax Court held that a taxpayer who held land without developing it for over a decade recognized ordinary income on its sale. The court reasoned that the long holding period did not overcome the absence of an owner resolution or other documentation evidencing the abandonment of the owner’s original development plan. The taxpayer could not recognize long-term capital gain.

Lesson learned? Silly or not, documenting the non-development intent for holding raw land can make a big difference in the income tax bill when the property is sold. If you want long-term capital gain, take a few minutes to make sure the owners execute a contemporaneous resolution or governing documents expressing the intent to hold the property for investment, not development. Otherwise you might tell a tale of losing your own financial kingdom, for want of just one piece of paper.

Helpful Resources:

E. John Wagner, II

Real Estate Investor Forced to Recognize Ordinary Business Income Instead of Capital Gain, Despite Holding Property Without Physical Improvement For Over a Decade

Sometimes it’s what you say, not what you do, that matters. A taxpayer learned that the hard way in a recent United States Tax Court decision.

There are numerous court decisions in which a taxpayer acquired property, incurred “soft costs” to entitle the property for future development, and then recognized capital gain (not higher-tax ordinary income) on the sale of the property. In these cases, the taxpayer did not physically improve the property, and the taxpayer by resolution, agreement, prior tax reporting, or other independent means expressed an intent to sell the property before physical improvement occurred. Amongst other factors, the combination of an expressed non-development intent with the actual lack of physical improvement was sufficient to preserve capital gain treatment, and to prevent the taxpayer’s activities from becoming a more active “business” subject to higher ordinary income tax rates. This sometimes has been true even when the taxpayer sells the property to another company with common ownership, which then develops the property.

The recent Tax Court decision emphasizes that the expression of intent is essential to preserving capital gain qualification, even if property is never developed or improved. In the case, the taxpayer originally intended to develop the property. The taxpayer incurred soft costs to prepare the property for development, but then held the property for over a decade without physically improving it. The taxpayer rented and occupied the property as office space, uses usually considered capital gain-qualifying activities. The Tax Court nevertheless held that the absence of evidence the taxpayer abandoned its initial development intent was sufficient to distinguish the case from others in which taxpayers engaged in the same activities, but specifically expressed non-development investment intent to third parties.

While the decision seems harsh, it is a reminder that the characterization of a taxpayer’s activities in partnership or operating agreements, resolutions, business coding on tax returns, and other third-party pronouncements is essential to protecting capital gain qualification, even if a taxpayer never physically develops property.

Here is a link to the United States Tax Court decision in Fargo v. Commissioner:

E. John Wagner, II

Can Developers Recognize Long-Term Capital Gain By Selling Land They Don’t Own? Maybe, at Least in Florida, Georgia, and Alabama

Reversing the US Tax Court, the US Court of Appeals for the Eleventh Circuit recently held that a real estate developer recognized long-term capital gain when he sold contractual purchase rights in real estate, even though the developer previously intended to develop and resell the underlying real estate as condominiums. The Court found that contractual purchase rights could be a capital asset even though the real estate itself would have become ordinary income generating inventory property had the developer closed the purchase contract instead of selling it. As a result, the developer’s effective tax rate was probably reduced by approximately 20%.

The case bolsters some capital gain preservation tax strategies. It does not, however, provide a blank check to lock in capital gain tax rates by trading in contracts rather than land. A few warnings:

First, the circumstances of the sale deviated from the developer’s original plan. While the Court’s reasoning is not entirely clear, the Court observed that the developer did not originally intend to sell the contractual rights. Instead, the developer originally intended to close on the contract, purchase the real estate, and develop condominiums for resale. The tax result could be different if the developer planned all along to sell the purchase contract itself.

Second, the Eleventh Circuit is a federal appellate court immediately below the Supreme Court, with jurisdiction over Florida, Alabama, and Georgia. It is unlikely the Supreme Court will hear this case. While other federal courts with jurisdiction elsewhere might find the Eleventh Circuit’s decision persuasive, they could reach different conclusions. The Tax Court reached a different conclusion in the same case. The Eleventh Circuit’s conclusion is most helpful to taxpayers subject to the Eleventh Circuit’s appellate jurisdiction. Other taxpayers face greater risks relying on the Eleventh Circuit’s decision.

Here is a link to the Eleventh Circuit’s opinion in Long v. Commissioner:

Here is a link to the Tax Court’s decision in the same case, which the Eleventh Circuit reversed on this issue:

E. John Wagner, II

A Proposal to Better Protect Capital Gains for Real Estate Investors Before Development

We have discussed a structuring technique real estate investors use to protect the lower-federal-income-tax-rate-long-term-capital-gain treatment of real estate gains, before property is converted to an active development purpose that creates higher-tax-rate income. The structuring requires property transfers and the use of multiple business entities, which decreases transparency for the government and is difficult for taxpayers to implement.

A “check-the-box” tax election that allows taxpayers to achieve the same tax result would better serve the interests of all involved. I am co-author of a new Florida Tax Review article proposing such an election. Here is a link: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2439888

The following provides a broader overview of the structuring technique allowed under current law: Check the Box Bramblett – ABA Tax SEB Committee Presentation

E. John Wagner, II

Protect Capital Gains for Real Estate Investors Before Development

In January we noted a new Tax Court case, Pool v. Commissioner, addressing the boundaries of a structuring technique real estate investors use to protect the lower-federal-income-tax-rate-long-term-capital-gain treatment of real estate gains, before property is converted to an active development purpose that creates higher-tax-rate income. Tax Court Sets Boundaries For Predevelopment Capital Gains For Real Estate Developers

Here is a link to materials from the American Bar Association Tax Section meeting in Washington this month, discussing the case in more detail: Pool v Commr ABA SEB Committee Presentation (May 10 2014)

The following provides a broader overview of the structuring technique: Check the Box Bramblett – ABA Tax SEB Committee Presentation

E. John Wagner, II

Tax Court Sets Boundaries for Predevelopment Capital Gains for Real Estate Developers

A recent Tax Court case, Pool v. Commissioner, is the first court opinion in many years describing the limits of a popular capital gain tax planning technique used by real estate investors and developers.
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