25 May Subdivided Lots – Understand Intent of Purchase to Characterize Gain
Under §1221(a)(1), property held by a taxpayer primarily for sale to customers in the ordinary course of a trade or business is excluded from the definition of a capital asset. Accordingly, if you by acreage to subdivide, develop and sell, the transaction would not meet the definition of a capital asset under §1221(a)(1) since his purpose was to sell the subdivided lots.
In Mathews v. Commissioner the Tax Court held that a taxpayer may hold land primarily for sale to customers in the ordinary course of a trade or business and hold other land as investment at the same time. In order to determine if land is held for investment or for sale to customers in the ordinary course of a trade or business, certain factors need to be considered. While no single factor or combination of factors is determinative, the Court has considered factors such as:
• The purpose for which the property was acquired.
• The purpose for which the property was held.
• The extent of improvements that were made to the property by the taxpayer.
• The frequency, number and continuity of sales by the taxpayer.
• The number, frequency and substantiality of sales.
• The nature and extent of the taxpayer’s business.
• The extent or lack of advertising to promote sales.
• The extent of listing property for sale directly or through brokers.
The Tax Court was persuaded that the taxpayer intended to use the lots for his multifamily rental activity and not for his building and selling activity. Therefore, the three lots in question were considered to be capital assets, which generated a short-term capital gain when sold. This gain was not subject to self-employment tax.
Pre-production costs of a property are required to be capitalized under §263A. Interest, however, is not required to be capitalized under §263A(f) until physical production begins. Physical production activities do not include planning and design activities. Therefore, the mortgage interest expense was not required to be capitalized pursuant to §263A(f).