12A — August 25 - September 14, 2017 — M id A tlantic
Real Estate Journal
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By Andrew Cohen, Friedman LLP Dealer vs. Investor: What factors are considered and why it matters
question to ask is wheth- er the seller is a dealer or investor in real property. The ultimate resolution of t h e d e a l e r versus inves- W
both a dealer and investor in real property based on fac- tual circumstances. In taking the Ridgewood Land Co. case for example (as highlighted in Robinson: Federal Income Taxation of Real Estate Part V Paragraph 17.14), the tax- payer, a land developer, pur- chased a 500-acre tract of land for purposes of developing the land into residential homes for purchase by customers. The taxpayer was successful in de- veloping and selling 325 acres to a residential builder. It then purchased a nearby 80 acre parcel for the same purposes. Subsequently, the government authorized a condemnation of that land to use for fill dirt in a highway construction project. After the condemnation, the taxpayer decided that it could not develop the land and held it for investment. The taxpayer then sold the 80 acres to a con- tractor who was going to use the land in the highway project. The gain on the sale was taxed as capital gain since, at the time of sale, the taxpayer was an investor in the property. Conclusion The ultimate determina- tion as to whether a taxpayer is a dealer or investor in real property is based on all the facts and circumstances—and has serious tax implications. Therefore, it is imperative that the taxpayer document his/her intentions and actions surrounding the purchase and sale of the property. Should you have any ques- tions or need guidance on the tax implications of a purchase or sale of property, please con- tact a Friedman LLP profes- sional for assistance. Andrew Cohen, JD LL.M is a senior tax manager at Friedman LLP. n Cloud-based property man- agement/accounting software can be a game-changer for real estate organizations, but companies must be aware of all that it entails, as well as the processes and decisions affecting it. That awareness will set the management team up for a fast and accurate ROI calculation and, ultimately, a successful implementation. Ask the right questions and make the right decisions up front, and you will be in a great position to secure a cloud property management/ accounting system that fits your organization’s needs and budget. Michael Mullin is presi- dent at Integrated Busi- ness Systems. n
hen real property is sold for a gain or loss, an important
Andrew Cohen
tor question has significant tax implications given the current differences between the capital gain and ordinary income tax rates. Tax Advantages and Disadvantages of Dealer vs. Investor Classification For individual taxpayers, or- dinary income will be reported on Schedule C and subjected to self-employment tax and unincorporated business tax for New York City residents. For the sale of real property held in a partnership, Limited Liability Company or some other pass- through entity, the income allocated to the owners will be reported on Schedule E. Thus, taxpayers prefer to be considered investors in real property when selling real property at a gain and dealers in real property when the prop- erty is sold for a loss. Basic Factors in Determining Dealer vs. Investor Classification – Actions and Intent The determination of dealer versus investor hinges on many factors, but turns mainly on the intent and activities of the seller at the time of the sale. If the taxpayer purchases land with the intent to subdivide the property and sell plots to cus- tomers in the ordinary course of business, most likely that person is going to be consid- ered a dealer. However, if the individual holds the property for several years, without any land, financing costs, and all types of syndication fees (partial list). • Application Fraction – A portion of rental units that are qualified low-income units (lesser of square footage or number of units). • QualifiedBasis – Eligible Basis x Applicable Fraction. Another item to consider in terms of determining the Equity Price per credit is the depreciation deductions asso- ciated with the building held by the partnership. Typically, the passive investors will stay with the partnership until the end of the Federal compliance
The chart above illustrates the tax treatment of the sale of real property at a gain or a loss dependent on whether the taxpayer is considered a dealer or an investor.
effort to promote or develop the property, that individual would probably be considered an investor. Dealer vs. Investor According to the IRC The starting point for deter- mining whether a taxpayer is a dealer or investor in real prop- erty is Internal Revenue Code Section 1221 which defines what property is considered to be a capital asset, and is writ- ten in the negative. Section 1221(a)(1) states, in part, that property held by the taxpayer primarily for the sale to cus- tomers in the ordinary course of business is not a capital asset. Most taxpayers who sell depreciable property held for more than one year that is used in their trade or business can avoid ordinary income treat- ment by utilizing the provisions of Internal Revenue Code Sec- tion 1231. Generally, if the taxpayer’s net section 1231 gain exceeds the section 1231 losses, the net 1231 gain will be treated as long- term capital gain. If the 1231 property is sold for The LIHTC program has at- tracted several notable inves- tors for stimulating affordable housing projects throughout the country. However, this article does not go into detail with regards to the applica- tion process, or post certifi- cation process, which both require a certified financial statement audit in some part of the process. To further com- plicate things, the audit needs to be tailored to each state’s HFA requirements. There is no doubt this is a complex process with many moving parts. If you are
a loss, the loss will be consid- ered an ordinary loss (not a loss from the sale of a capital asset). Investors in real property, who hold property as an invest- ment and not for sale to custom- ers, can utilize these beneficial provisions. However, if the property owned by the taxpayer is treated as property held for sale to customers, the Section 1231 tax treatment will not apply pursuant to IRC 1231(b). If a taxpayer is considered to be a dealer in real property, the provisions of Section 1231 will not be applicable. This puts added importance on being labeled an investor rather than a dealer. How the Courts Distinguish Between Dealer vs. Investor When determining whether a taxpayer is acting as a dealer or an investor in real property, various courts, including the United States Tax Court in Frank H. Taylor & Son case have considered several factors. No one factor is dispositive and each factor should be weighed in the analysis. These include: thinking of entering the Low Income Housing Tax Credits program for a specific project and have any questions or con- cerns, please feel free reach out to Sax LLP’s Real Estate Industry Services Group to go over the intricacies of the program specific to your situ- ation. Michael Benguigui, CPA is a senior manager at Sax LLP and a member of the firm’s Real Estate Industry Ser- vices Group. He specializes in tax and accounting services for property owners, develop- ers and private equity inves- tors. Michael can be reached at mbenguigui@saxllp.com. n
• the purpose for which the property was acquired; • the purpose for which the property was held; • improvements, and the ex- tent of the improvements made to the property by the taxpayer; • the frequency, number and continuity of sales; • the extent and substantial- ity of the transactions; • the nature and extent of the taxpayer’s business; • the extent of advertising to promote sales, or the lack of advertising; and, • the listing of property for sale directly through brokers. • It is important to note that some of these factors are ap- plied to the particular property being sold and not to the tax- payer’s activities. The factors are analyzed separately for each property sold. Situations When a Taxpay- er Can be Considered Both a Dealer and Investor When making the analysis, a taxpayer can be considered After implementation, a property management/ac- counting system will incur maintenance costs. These are usually defined at purchase, whether in an on-premise or SaaS configuration. They should be estimated for the useful life of the software and included in the ongoing expense as incurred. The pro- jected expense of training new staff, or re-training existing staff when software upgrades are installed, should also be included as an ongoing cost of maximizing the investment. training and data conversion costs should also be identified, estimated and included as part of the implementation cost. 5. Ongoing Costs
By Michael Mullin, Integrated . . . continued from page 8A
period (15 years) before exit- ing the deal. continued from page 6A By Michael Benguigui, CPA, Sax LLP . . .
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