Achieving Capital Gains Treatment on Predevelopment Real Property Appreciation

Real estate values are going up, so property owners are choosing to develop their own projects instead of selling to someone else. When they sell the units, they have to pay taxes on the profit they make. But if they plan carefully, they can save money on taxes by treating the profit as a capital gain instead of regular income. This can be done by holding back some units to rent out, or by selling the property to another company owned by the owner before developing it. This article explains how this works and how it can save money on taxes. The difference between a dealer and a holder of a capital asset for real estate depends on the reasons for owning the property and the actions taken to sell it. Factors such as the length of ownership, sales efforts, and advertising are considered. There is no clear rule, but the more often and deliberately a person sells real estate, the more likely they will be considered a dealer. A real estate dealer is someone who sells real estate as a business, while someone who holds onto real estate for investment or receives rental income is not considered a dealer. If you sell something like property to a family member or a partnership you control, the IRS might treat the profit as regular income instead of investment income. However, there are some exceptions to this rule, like if the property is sold to a different type of business or if it’s not eligible for depreciation. Can the characteristics of someone who sells real estate affect the tax treatment of a property sale? Generally, the characteristics of an individual owner in a business are not attributed to the business itself for tax purposes. However, there are some cases where the IRS has connected the activities of a joint venture with the original owner and the buyer of a property. In one case, a court ruled that a property sale was not a capital gain for the owner because they were in the business of selling real estate, listed the property in inventory, and invested in developing the property. It’s possible to structure a sale in a way that separates the owner as a capital asset holder and a development affiliate as a “dealer,” which could lead to capital gains treatment for the owner. In simple terms, in the Bramblett case, a group of people owned some land through a partnership. They then formed a corporation and had the partnership sell the land to the corporation. The corporation didn’t pay the partnership back for the land right away and eventually sold the land to other people. The IRS said that the activities of the corporation should be counted as part of the partnership, and the Tax Court agreed. The court ruled that a partnership could report its land sale as a capital gain because the corporation buying the land wasn’t just working for the partnership. The court said the sale was legit, the price was fair, and the corporation had a good reason for buying the land. The same rule was used in another case involving a similar situation. In simple terms, if a company sells property to a related company, it’s better to pay with cash instead of using seller financing. This can help avoid tax issues. Also, if a developer sells property to a related leasing or investment company, the investment company can get tax benefits when it sells the property later. This means the developer can create a separate company to buy the property and get a better tax rate when selling it later. To make sure that profits from selling real estate get taxed as capital gains, it’s important to plan carefully. The investment entity should avoid any mention of developing or selling property in its documents, and should try to sell all its property in one go. They should also be organized well before the development entity is formed. When the investment entity sells to the development entity, the terms of the sale should be fair and documented, and the purchase should be supported by an appraisal. It’s also a good idea for the investment entity to make a cash payment and secure the rest of the purchase money with a mortgage. Lastly, the sale should follow all the usual formalities. When purchasing real estate, it’s important not to pre-sell any parts of it before buying it. Also, the selling price shouldn’t be based on how much the property could be sold for later. The buyer should make sure to pay for the property on time and have enough money to pay for it. The buyer and seller should keep their finances separate and not have the same ownership structure. If the seller is a partnership, the buyer should be an S corporation to avoid certain tax laws. In conclusion, there are many complex rules to consider, but it’s important to plan carefully when buying and selling real estate to get the best tax benefits. This is about how the law treats the sale of real estate for tax purposes. It talks about different court cases and criteria for deciding if someone is a real estate dealer or just an investor. It also explains the “single sale” theory and how it affects tax treatment. Thomas O. Wells and Franklin H. Caplan are lawyers in Miami who specialize in different areas of law. They have received advanced degrees in law and provide expert legal advice to their clients. They are also involved in the Tax Section, which focuses on tax laws and regulations.

Source: https://www.floridabar.org/the-florida-bar-journal/achieving-capital-gains-treatment-on-predevelopment-real-property-appreciation/