2D — May 11 - 24, 2018 — NJAA Conference & Expo — M id A tlantic
Real Estate Journal
2018 NJAA C onference & E xpo
ne issue that has been heavily litigated in tax court is whether By Rebecca Makely, CPA, WithumSmith+Brown, Real Estate Services Group Member Ordinary vs Capital: How facts and circumstances play a crucial role in the taxability of the sale of land O outcome.
was that of Sugar Land Ranch Development, LLC (“SLRD”). In this case, the Court ruled that the tracts of land in ques- tion were held by SLRD as investments and, therefore, gains from the sales were treat- ed as capital gains. While there are many factors to consider in such cases, it appears that the factor relied upon most heavily in the court’s decision was the frequency and substantiality of sales of property. SLRD was established in 1998 with the principal pur- pose of acquiring contiguous tracts of land for development.
In 1998, SLRD purchased a former oil field that was under development by related par- ties. The original plan was to clean up the site and subdivide it into residential units. SLRD spent 10 years beginning clean up, building a levee, and also entered into a development agreement with the City of Sugarland. Late in 2008, how- ever, SLRD determined that the original development plan was not economically feasible given the crisis in the hous- ing market. The decision not to move ahead with develop- ment was formalized in an
official company document and member resolution. The land remained untouched until 2012, during which time no further attempts to develop or sell any portion of the land were made by SLRD. In 2011, SLRD was ap- proached by Taylor Morrison about purchasing 2 or 3 parcels collectively known as the TM parcels. In 2011, Taylor Mor- rison purchased TM-1 and, in 2012, he purchased TM-2 and TM-3. The 2012 contracts had consideration of one lump sum for the mostly undevel- oped parcels. In addition, the contract on TM-2 contained a provision under which SLRD would receive 2% of the fi- nal sale price of each future home, accrued upon sale of the home. SLRD would also receive $3,500 and $2,000 for each plat recorded on TM-2 and TM-3, respectively. Dur- ing 2012, the only payments made by Taylor Morrison to SLRD were the lump sum payments for the undeveloped land – there were no payments made on the 2% or per plat provisions. The Court concluded that the gains from the sales of TM-2 and TM-3 were capital gains as the parcels were held for invest- ment and not sold in the ordi- nary course of business. This decision was based on several key facts and circumstances presented. First, the evidence showed that, in 2008, SLRD ceased to hold its property for the primary purpose of devel- oping it for sale and, rather, held it as investment property. This was substantiated by the formal Company documents discussed previously. Second, SLRD did not develop or sell lots from this parcel of land or any other parcel beginning in 2008. The property in question was never subdivided for sale and the Company never spent any time marketing or seek- ing potential buyers. Third, subsequent to 2008, SLRD had infrequent sales, further supporting the conclusion that the sales in question were not within the ordinary course of SLRD’s business. Fourth, with the exception of land conveyed for public use, all of SLRD’s sales of undeveloped property subsequent to 2008 (in the area in question) were to either Taylor Morrison or related entities. The IRS attempted to make an argument that SLRD’s continued on page 6D
In order for a sale to result in a capital gain, the underlying asset must meet the definition of a capital asset. However, rather than providing a direct definition of a capital asset, the Internal Revenue Code defines the term by exclusion stating that an asset is not considered a capital asset if it is “held by the taxpayer primarily for the sale to customers in the ordi- nary course of the taxpayer’s trade or business.” (Section 1221(a)(1)). One such case recently set- tled in the Fifth Circuit court
gain from the sale of land qualifies for capital gain t reatment . While the re- sults of cases dealing with t h i s i s s u e have been
wide-ranging and sometimes contradictory, it is clear that the specific facts and circum- stances in each case play a crucial role in determining the
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