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Were real estate purchases investments or a business?
The Tax Court recently decided whether a couple who purchased more than 250 vacant lots and resold 42 of them were investors in real estate or were actively engaged in the business of buying and selling real estate.
Donald Flood was a day trader in the stock market. He and his wife, Patricia, operated a real estate venture, in which they purchased and sold vacant lots. The Floods did not generally subdivide the lots or construct buildings on them.
From 2001 through 2008, they purchased more than 250 lots. During 2004 and 2005, they sold a total of 42 lots at a combined gain in excess of $1 million.
The Floods reported their gains from the sale of the lots as long-term capital gains. The IRS contended that the Floods purchased and sold lots in the ordinary course of a trade or business and that the gains should be taxed as ordinary income.
The Tax Court examined nine factors and supported the conclusion that the Floods were not investors eligible for capital gains treatment. (Patricia and Donald Flood v. Commissioner, TC Memo 2012-243, Aug. 27, 2012)
Rather, they were engaged in the business of buying and selling lots. The factors the court looked at were:
1. The Floods’ purpose in acquiring the lots
2. The purpose for which the lots were subsequently held
3. The Floods’ everyday business and the relationship of the income from the sale of lots to the Floods’ total income
4. The frequency, continuity and substantiality of the lot sales
5. The extent to which the lots were developed or improved to increase sales revenue
6. The extent to which the Floods used advertising, promotion or other activities to increase sales
7. The use of a business office for lot sales
8. The character and degree of supervision the Floods exercised over any representative selling the lots
9. The time and effort devoted by the Floods to the sale of lots
With the exception of factors Nos. 5 and 7, the court concluded that the preponderance of the factors indicated that the Floods were engaged in the active business of buying and selling real estate. Their profits were not eligible for capital gains treatment.
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The technical information here is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.
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