Tag Archives: Phelan

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:
http://www.ustaxcourt.gov/InOpHistoric/FargoMemo.Goeke.TCM.WPD.pdf

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

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
jwagner@williamsparker.com
941-536-2037

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
jwagner@williamsparker.com
941-536-2037

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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