1099 requirements

[OldJack]

The answer is they must file Form 1065 as a partnership. A joint venture where extensive services are performed (the remodeling of a house) is a business, not an investment.

Gees Bees... there you go again! You don't want to file form 1065 when there is a true partnership operation and now you want to call a joint real estate ownership investment as a partnership business when there is no business.

The 2 guys are only joint owners as investors in real estate. If they each pay their own share of expenses there is no partnership, even if they do it with a joint bank account.

Sale is as an investor on 1040 Sch-D.

An Individual deducting labor paid on anything other than 1040 Sch-C, Sch-E, or Sch-F does not have to file a 1099Misc as that is the only forms where the individual is in business requiring such reporting.

[Brad Imsdahl]

TheTaxBook, 2006 edition, page 20-2 says, "An unincorporated organization with two or more members is a partnership by default for federal tax purposes if its members carry on a trade, business, or financial operation and divide profits."

It then lists two exceptions:

1) Co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.

2) A joint undertaking merely to share expenses is not a partnership.

In this case, none of the above exceptions apply, as they are providing a service (the renovation of an old house), and they are sharing profits.

[outwest]

And the tax courts says..

This is a tax court decision that spells out the factors... Think them through, weight them and make your judgement.

Note: the court applied these factors in total. Just because one factor supports one position (such as #4 frequency) does not the case make.

Second note: though this is a 1954 case, I found it as a cite in support of a 2002 case. It's stood the test of time and many tax code changes.

Maddux Construction Co. v. Commissioner, 54 T.C. 1278

Subchapter P, secs. 1201 et seq., I.R.C. 1954, provides for special treatment of gains received on the sale of capital assets. Section 1221(1) excludes from the definition of a capital asset "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." In Malat v. Riddell, 383 U.S. 569, 572 (1966), the Supreme Court concluded with respect to this statutory provision:

The purpose of the statutory provision with which we deal is to differentiate between the "profits and losses arising from the everyday operation of a business" on the one hand * * * [citation omitted] and "the realization of appreciation in value accrued over a substantial period of time" on the other. * * * [citation omitted.] A literal reading of the statute is consistent with this legislative purpose. We hold that, as used in section 1221(1), "primarily" means "of first importance" or "principally."


Our task here is to determine whether petitioners held the property involved "primarily" for sale to customers in the ordinary course of its business as that phrase is interpreted by the Supreme Court in the above quotation.

This question is purely a factual question, the burden of proof being upon petitioner. Several factors have been enumerated by the courts for the determination of the question, some of which are: (1) The purpose for which the property was initially acquired; (2) the purpose for which the property was subsequently held; (3) the extent to which improvements, if any, were made to the property by the taxpayer; (4) the frequency, number, and continuity of sales; (5) the extent and nature of the transactions involved; (6) the ordinary business of the taxpayer; (7) the extent of advertising, promotion, or other active efforts used in soliciting buyers for the sale of the property; (8) the listing of property with brokers; and (9) the purpose for which the property was held at the time of sale. See James G. Hoover, 32 T.C. 618 (1959); Ralph J. Oace, 39 T.C. 743 (1963). None of the above factors are conclusive standing alone, but rather all of the factors taken as a whole govern. W. T. Thrift, Sr., 15 T.C. 366 (1950).

[OldJack]

TheTaxBook, 2006 edition, page 20-2 says, "An unincorporated organization with two or more members is a partnership by default for federal tax purposes if its members carry on a trade, business, or financial operation and divide profits."

It then lists two exceptions:

1) Co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants.

2) A joint undertaking merely to share expenses is not a partnership.

In this case, none of the above exceptions apply, as they are providing a service (the renovation of an old house), and they are sharing profits.

I disagree with your conclusion that they are providing a service. Improving property is not a service and sharing profits only means they have a joint ownership. There is no tenants or anyone in the original post mentioned for them to provide services. The exceptions you list are exactly the reason they are not subject to the "in business as a partnership" rules.

[Brad Imsdahl]

I disagree with your conclusion that they are providing a service. Improving property is not a service and sharing profits only means they have a joint ownership. There is no tenants or anyone in the original post mentioned for them to provide services. The exceptions you list are exactly the reason they are not subject to the "in business as a partnership" rules.

Improving property is a service. Can you provide a court citation that says it is not?

You are mixing two separate and distinct rules. The first rule (as mentioned on page 2 of Pub 541) says if they are merely sharing expenses, they are not a partnership, unless they provide services. Since they are sharing profits, this exception to the partnership rules cannot apply.

The only exception to the partnership rules that can apply is the Exclusion From Partnership Treatment rules, discussed on page 20-3 in TheTaxBook.

Under those rules, two partners sharing profits can elect out of partnership treatment if:
1) They do not engage in the active conduct of a trade or business.
2) The own the property as co-owners.
3) They reserve the right to separately dispose of their shares of the property

It is doubtful they can pass the first test above.

They can pass test two.

It is doubtful they can pass test three as it is impractical to separately dispose of a house.

The exclusion from partnership treatment rules, therefore, generally apply to investing clubs, where members buy and sell stocks through a joint undertaking, with the ability to separately dispose of their shares at anytime. The exclusion from partnership treatment rules was not designed to allow construction contractors to opt out of partnership treatment.

[ChEAr$]

Nope!

If a guy or gal can buy a property, renovate it with contract labor (not having to issue
1099s by the way since it's not trade or business), I see no reason why two guys/gals
can't do the same. Does the fact that we have more than one invididual automatically
make it a trade or business as in "partnership"?

Nope. joint venture each reporting half the sale price and half the expenditures.

Holiday ChEAr$,
Harlan Lunsford, EA n LA

[OldJack]

Improving property is a service. Can you provide a court citation that says it is not?

Nonsense! An investor improving his owned property is not a service to anyone but maybe himself and that is not a business. Where is your citation?

[OldJack]

The only exception to the partnership rules that can apply is the Exclusion From Partnership Treatment rules, discussed on page 20-3 in TheTaxBook.

Under those rules, two partners sharing profits can elect out of partnership treatment if:
1) They do not engage in the active conduct of a trade or business.
2) The own the property as co-owners.
3) They reserve the right to separately dispose of their shares of the property

It is doubtful they can pass the first test above.

They can pass test two.

It is doubtful they can pass test three as it is impractical to separately dispose of a house.

Here is the Code that defines a partnership:

PART III - DEFINITIONS

-HEAD-
Sec. 761. Terms defined

-STATUTE-
(a) Partnership
For purposes of this subtitle, the term "partnership" includes a
syndicate, group, pool, joint venture, or other unincorporated
organization through or by means of which any business, financial
operation, or venture is carried on, and which is not, within the
meaning of this title, a corporation or a trust or estate. Under
regulations the Secretary may, at the election of all the members
of an unincorporated organization, exclude such organization from
the application of all or part of this subchapter, if it is availed
of -
(1) for investment purposes only and not for the active conduct
of a business,
(2) for the joint production, extraction, or use of property,
but not for the purpose of selling services or property produced
or extracted, or
(3) by dealers in securities for a short period for the purpose
of underwriting, selling, or distributing a particular issue of
securities,

Code Item 1. The 2 guys are excluded from being a partnership under item (1) as they are individual investors not actively conduction a business by improving their share of the asset.

Code Item 2. They are not selling services or property while improving the property.

Code Item 3. Not applicable in this case.

Note that they only have to meet the test for any one item as the word "or" is used rather than the word "and".

if the income of the members of the organization may be adequately determined without the computation of partnership taxable income.

It would be nice if you could provide citations other than those of yourself.

[Jesse]

Nonsense! An investor improving his owned property is not a service to anyone but maybe himself and that is not a business. Where is your citation?

If I buy land and build a spec home is that also investment property subject to capital gain treatment?

[Brad Imsdahl]

Here is the Code that defines a partnership:


Code Item 1. The 2 guys are excluded from being a partnership under item (1) as they are individual investors not actively conduction a business by improving their share of the asset.

Code Item 2. They are not selling services or property while improving the property.

Code Item 3. Not applicable in this case.

Note that they only have to meet the test for any one item as the word "or" is used rather than the word "and".



It would be nice if you could provide citations other than those of yourself.

Apparently I don't have to provide any further citations, as you already have. How is buying a house, fixing it up, and then selling it for profit not an active conduct of a trade or business?

Gee, I guess I have been improperly treating all of my construction contractors as businesses all of these years. I never knew I could just through all of that fixing up activity on Schedule D and call it an investment.

[OldJack]

If I buy land and build a spec home is that also investment property subject to capital gain treatment?

If you are in a continuing activity/intent of building and selling property, then you are not an investor and you would be in a trade or business where capital gains treatment would not normally be available.

[OldJack]

How is buying a house, fixing it up, and then selling it for profit not an active conduct of a trade or business?

I buy a house with the intent to sell it, fix it up, live in it 2 years and then sell it. Why would you call that a trade or business when the code allows me to exclude my expected and intended profit? I am allowed to do that every 2 years and never pay income taxes on the profit even if I do it full time and tell all my friends that I am in the business of fixing up my residences for sale. Granted, if the person is continually engaging in property activity (other than his residence) there would be little doubt that he is in a trade or business. That was not the case posted in this thread.

Gee, I guess I have been improperly treating all of my construction contractors as businesses all of these years. I never knew I could just through all of that fixing up activity on Schedule D and call it an investment.

My position on this case was from the original post statements and not the facts of your construction contractors. Your position would imply that there is no such thing as an investor with regards to real estate. Maybe you should re-read the original post.

[Brad Imsdahl]

I buy a house with the intent to sell it, fix it up, live in it 2 years and then sell it. Why would you call that a trade or business when the code allows me to exclude my expected and intended profit? I am allowed to do that every 2 years and never pay income taxes on the profit even if I do it full time and tell all my friends that I am in the business of fixing up my residences for sale. Granted, if the person is continually engaging in property activity (other than his residence) there would be little doubt that he is in a trade or business. That was not the case posted in this thread.

The section 121 exclusion for the sale of a personal residence is a tax loophole…one every construction contractor should take advantage of. Section 121 is not the norm. It is the exception. You can’t compare that rule with other rules and try to make any sense out of it. Section 121 breaks every logical rule in the book. Why should I get to exclude $500,000 on the sale of my house, but if I sell my car for more than I paid for it, that is taxable?

My position on this case was from the original post statements and not the facts of your construction contractors. Your position would imply that there is no such thing as an investor with regards to real estate. Maybe you should re-read the original post.

I admit this is a grey area of the law. Where do you draw the line?

I draw the line where substantial improvements are made. If this were a case where two guys buy a house, clean up the yard, do some painting and other minor repairs, sell the place for profit without ever doing it again, then I would call it investment property.

Where I draw the line is when you are looking at substantial improvements. Professional construction contractors doing $50,000 worth of improvement work is beyond what I would call causal investing. Now you are talking the construction business, even if it is a one time deal.

The court cases that others have cited mention the extent to which improvements are made to real estate as being one factor to consider on the trade or business vs. investment rule. I think that is more important of a factor than counting the number of times you buy and sell a house. Anyone can say they are only going to do it just this one time….until next year when they find another deal they just can’t pass up.

[Jesse]

I guess if you bought 1 share of stock on the stock market with the expectation of making a profit you would have a problem of not having "investor" status and would therefore be a trader?

What if you started with $100,000, invest another $70,000 buying and selling daily and at the end of a six month period you have a gain of $80,0000, does this have any impact your status?

[ChEAr$]

Naw, you done good!

Apparently I don't have to provide any further citations, as you already have. How is buying a house, fixing it up, and then selling it for profit not an active conduct of a trade or business?

Gee, I guess I have been improperly treating all of my construction contractors as businesses all of these years. I never knew I could just through all of that fixing up activity on Schedule D and call it an investment.

Your construction contractors are in a trade or business so you done it right.

However a one time fix up does not a trade or business make.

Holiday ChEAr$,
Harlan Lunsford, EA n LA