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Dealer Or No Dealer
| Read comments | Add comment / Rate this Article | Article by: Timothy Halligan |
IRC §1031 provides, in part, that property held for investment may be Exchanged for like kind property to be held either for the productive use in a trade or business or for investment.
Real estate held for investment is a capital asset, IRC §1221 property. It is treated as a portfolio investment asset for tax purposes. It is property held by the taxpayer primarily for appreciation of value due to factors beyond the control of the taxpayer such as location, changes in supply and demand and the passage of time. If real estate held for investment is sold at a gain, the gain is taxed as a capital gain. If sold at a loss, the loss is a capital loss subject to the capital loss limitation rules. Expense deductions are limited to investment income. The Exchange of real estate held for investment qualifies for non recognition treatment under IRC §1031.
A typical type of real estate held for investment is raw land or lots. It may be in many different forms from a large tract of land to a small isolated building lot. It may be a compilation of lots within a prescribed area or subdivision or it may comprise the entire subdivision and all of its associated lots. The land or lots may be located in the city, suburbs or the country, with or without infrastructure. The fact that the land may have existing permits and approvals for any type, quality or quantity of improvements will not alter its classification as land held for investment in the hands of the taxpayer. The intent of the taxpayer to sell the land, in whole or in part, or to develop the land at some time in the future does not change the characterization of the land for tax purposes as property held for investment.
Some examples of land held for investment which qualify for an Exchange are:
1. An individual isolated lot, parcel or tract of land held by the taxpayer for investment for a period of more than one year qualifies under §1031 for non-recognition treatment if given or received in an Exchange for other real property held either for investment or for the productive use in a trade or business.
2. The land or lot adjacent to the taxpayers personal residence which has been held by the taxpayer for more than one year for the incremental increase in value and treated for tax purposes as land held for investment if Exchanged for other real property to be held either
for investment or for the productive use in a trade or business also qualifies for non recognition treatment under IRC
§ 1031.
3. The lot or lots in the subdivision of lots which have been held by the taxpayer for more than one year and which have been treated for tax purposes as land held for investment.
4. The subdivided tract of land which has been held by the taxpayer for more than one year and is to be sold in a single transaction to the same buyer.
5. In Buono case the taxpayer acquired a large tract of land with the intent of subdividing into residential lots and sell. The land was sold several years later in three separate transactions, a condemnation by the state for improvements to the adjacent highway, a sale of a small portion of the acreage to the town and the remainder of the land which had been subdivided by the taxpayer into multiple one half acre building lots. This is a landmark case of dealer vs. investor. Gain on sale was determined to be capital not ordinary by virtue of the following: 1) Land was held for investment not for sale to customers in the ordinary course of business; 2) Land was subdivided solely for the purpose of making it more marketable; 3) Taxpayer was not engaged in frequent and substantial sales activity. The property would have qualified for non-recognition treatment under IRC §1031 if the taxpayer had elected to acquire qualifying replacement property in an Exchange.
6. In Gartrell vs United States, the court determined that sale proceeds were taxable as capital gain in a case where the property was subdivided, improved by the addition of gravel roads and sold as lots. Over a period of 17 years, the taxpayer sold 84 lots in 45 separate sales. All transactions were treated as the sale of a capital asset and would have qualified under IRC §1031 if Exchanged for real property to be held for investment of the use in a trade or business.
There are however, many situations where land or lots are not deemed to be real property held by the taxpayer for investment. Rather, the land held by the taxpayer is deemed to be held for personal use or for sale to customers in the ordinary course of a trade or business, ("Dealer Property"). Some examples of land or lots which are not held for investment and do not qualify under IRC §1031 are:
1. Land or other property which is acquired and subsequently sold pursuant to a prearranged plan or property which is acquired subject to a lease and option to buy.
2. The land or lots which are acquired with the intent to resell at a profit and which are sold within one year of acquisition.
3. The land or lot adjacent to the taxpayers personal residence which is used primarily by the taxpayer for personal purposes and which the taxpayer declares an interest deduction on Schedule "A" Form 1040 as personal residence interest. In several cases, the IRS concluded that as much as 65 acres of land adjacent to a taxpayer's residence was part of the taxpayer's residence and qualified under IRC §1034 for the residence rollover provisions. It is therefore presumed that the land in the hands of the taxpayer would not have qualified for Exchange treatment.
4. Land or lots which are or will be dealer property in the hands of the taxpayer. The characterization of the land or lots as dealer property involves an analysis of the extent to which the property is deemed to be held by the taxpayer primarily for sale to customers in the ordinary course of a trade or business. Dealer property does not qualify for Exchange treatment under §1031.
The determination of whether property in the hands of a taxpayer is dealer property or property held for investment is often very subjective and incapable of external verification. Dealer or nor dealer is an opinion based upon many factors, the contributions of which, may be weighted differently by the entity giving or making the opinion. Needless to say, if a taxpayer desires to treat land as non dealer property, property held for investment, then the taxpayer should make an effort to avoid activity which is characteristic of dealer property.
This information is not intended to replace qualified legal and/or tax advisors. Every taxpayer should review their specific transaction with their own legal and/or tax counsel.
| Comments on this article |
| Comments by Bill Timothy does a nice job if clarifying some important real estate tax issues. |
| Comments by Tamara Easy to comprehend and very informative! |
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