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LTCG: Dealer vs. Investor

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    LTCG: Dealer vs. Investor

    One of my high income clients is a developer of residential property. He is 100% owner of S-corp.

    Corporation buys typically 30-40 acres of unimproved land, then develops with pavement, drainage and sewerage, and may build and sell 15 - 20 homes over the course of a couple years. Corporation always owns 3-4 such tracts which they have bought for future development, enough backlog of tracts to last 7-8 years.

    What if one of these tracts is sold while still in an unimproved state? Example: Bulldozer, Inc. buys 20 acres of Gullible Gulch in 2006. In 2009, the nearby town announces the relocation of a hospital close to this property, and rezones the Gulch to commercial status. Bulldozer develops residential property only and has no interest of getting into the commercial market.

    Bulldozer, Inc. then sells Gullible Gulch to a commercial developer, who is obviously now interested. Bulldozer's orginal basis is $50,000 and because of the rezoning, the buyer is willing to $250,000 for the property. Bulldozer's president says if he kept the property and built houses, he would scarcely clear a $200,000 profit on the houses, so he sells the Gulch in 2009.

    Question: Bulldozer (remember is an S corp, not a C corp) thinks the $200,000 gain qualifies for capital gains since the property turned out to be "investment" property. What about the denial of capital gains because Bulldozer might be treated as a "dealer" instead of "investor?" In grey areas, I tend to support my client, and think Capital gains would be appropriate.
    Last edited by Snaggletooth; 11-05-2009, 10:57 AM.

    #2
    Excellent question Snag, IMHO, and without any research this early in the morning I would say the property is still part of his inventory, and as such will result in ordinary income if sold.
    Dave, EA

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      #3
      Originally posted by dsi View Post
      Excellent question Snag, IMHO, and without any research this early in the morning I would say the property is still part of his inventory, and as such will result in ordinary income if sold.
      Agree that it was "held for resale" and results in ordinary income.

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        #4
        Improved

        Snag:

        The tract is in an improved state because the road, sewer, water, drainage, etc etc was run to each lot. This would clearly be ordinary income and not LTCG.

        If this guy was in MI (where I am) he would probably have 50 - 75 k into each lot and they would only be worth 15 - 25k. I am sure he would not want capital gain treatment in that case now would he.
        I would put a favorite quote in here, but it would get me banned from the board.

        Comment


          #5
          Just re-read

          So the entire property never had any improvements done to it? Is that what I understand? There may still be an issue with him being a dealer in real estate. Not sure if the commercial vs. residential would have anything to do with it or not, I am not sure.
          I would put a favorite quote in here, but it would get me banned from the board.

          Comment


            #6
            He is a dealer, and improvements notwithstanding, the Scorp cannot take LTCG treatment. It is ordinary income. It appears that the corp purchases the land, then subdivides into tracts, then offers for resale. See Sect. 12.374.
            Exception 12.374.01 would not apply in this case.
            Last edited by Burke; 11-09-2009, 05:16 PM.

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              #7
              Sova

              Thanks Matt - and always good when you help us out on the board.

              With regard to your comment on real estate where you live -- my brother lives in suburban Detroit and says $10,000 will buy you almost any residence in Detroit city limits. The Police are legendary and don't even answer 911 calls. Incredible! My last trip there two years ago there were absolutely no retail establishments whatsoever. The residents have to go to the suburbs just to fill up their car.

              Better things are ahead for Michigan - the people there are resilient and will do what they have to make things better. It might mean a clean sweep in Lansing though.

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