10B — February 12 - 25, 2016 — New Jersey — M id A tlantic
Real Estate Journal
www.marejournal.com
C entral N ew J ersey
Applying properly structured land-banking strategy mitigates risk Withum answers the question of capital gain vs. ordinary income for real estate transactions
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capital gains rate. “Taxpayers who operate in the real estate industry are constantly faced with the risk that development and sales activities will convert capital gain from the appreciation of real estate to ordinary income in the eyes of the IRS,” said Bartolf. “Rather than accept- ing uncertainty, taxpayers may find that a properly structured land banking transaction will be beneficial in mitigating the risk.” In order for a sale to result in capital gains, the underly- ing asset must be a capital as- set. Defined by exclusion, the Internal Revenue Code (the
Code) states an asset is not a capital asset if it is “held by the taxpayer primarily for the sale to customers in the ordinary course of his trade or business [§1221(a)(1)].” Therefore, a taxpayer who holds property for sale to customers in the ordinary course of business is considered a “dealer.” The property is treated as inventory and any gain resulting from the sale of the property is ordinary income, subject to a top federal rate of 43.4%. Conversely, if the taxpayer does not hold the property for sale to customers in the ordinary course of business, the property is a capital asset
(provided no other exclusions from capital asset treatment apply), and any resulting gain is taxed at the more favorable capital gain rates, which under current law tops out at 23.8%. “Whether real estate is held by a taxpayer for sale in the ordinary course of business or not is among the more contro- versial and heavily litigated is- sues in the tax law,” explained Bartolf. “It’s imperative that taxpayers and their advisors understand the rules and struc- ture the transactions properly.” To remedy this challenge, land banking can be an attrac- tive option. When structured properly, it can save substan-
tial tax dollars. According to Bartolf, “Land banking seeks to separate the appreciation of real property held for invest- ment (capital gain) from the increased value associated with developing the property for re- sale (ordinary income).” Tax courts and the IRS rec- ognize these transactions as valid in the proper circum- stances. Criteria include the involvement of an S corporation development entity as well as an independent business purpose for the transaction, which should mirror that of two unrelated parties operat- ing in the normal course of business. Activities associated with conducting the transaction in a manner that is ordinary and customary also include an independent appraisal, a down payment and loan terms in line with the current marketplace. “Land banking does mitigate risk,” added Bartolf, who as- sists clients with compliance and tax-return preparation. His specialty areas include the real estate, manufacturing/distribu- tion and consumer products industries. “Ultimately, the burden of proof is the taxpay- er’s and the final decision rests with the IRS and tax courts.” n TRENTON, NJ — The City of Trenton was awarded a Com- munity Impact Award for its East State Street Brownfields Revitalization Project. The Revitalization Project involved the transformation of three former industrial sites, several dilapidated and abandoned row houses, and a small park that was transformed into a brand new park and 20 new homes. The dilapidated row homes and obsolete park were rede- veloped into 20 new, afford- able singe-family homes— now known as East Trenton Homes—at a cost of $4.3 mil- lion. V. J. Scozzari & Sons, Inc. served as the general contractor Project partners for this ef- fort included: Architects Mi- chael Graves and THINK- FORM ’s Russell DiNardo , Better Community Housing of Trenton, Inc. ; USEPA ; NJ Department of Commu- nity Affairs ; NJDEP ; Mercer County; Brownfield Redevel- opment Solutions, Inc. ; and members of the East Trenton Collaborative. n Trenton awarded a Community Impact Award
RINCETON, NJ – Capital gain or ordi- nary income, that is
the question for taxpayers who operate in the real es- tate industry, according to Scott Bar- tolf , CPA, a Toms River- b a s e d t a x
MAREJ 8.26.14_Copy of Layout 1 12/18/2015 4:11 PM Page 1
Scott Bartolf
manager with the audit, tax and advisory firm Withum , headquartered in Princeton. The tax preparation specialist notes the difference can be sub- stantial, given the top ordinary income rate is nearly double the
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