Table Of Contents
In this episode, Brandon Hall & Thomas Castelli discuss key tax court cases on the dealer status for real estate flippers and developers.
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Full Transcript:
This podcast has been transcribed using AI, please excuse spelling, grammatical, and other errors.
Thomas Castelli 0:00
You're now listening to the real estate CPA podcast.
Brandon Hall 0:04
Your source for all things real estate, accounting and tax. Here we reveal our secrets that can save you 1000s in taxes, streamline your accounting process and help grow your business. Stay tuned to hear insightful interviews with industry experts, successful real estate investors and current clients on what strategies they use to grow their business, and how they steer clear of Uncle Sam. Hey, everyone, welcome to episode two of our flipping series and how to avoid dealer status. Today, Tom and I are going to be going through a handful of tax court cases we're not gonna be able to hit every single factor. So again, we we learned last episode, there's three main factors and then there's nine sub factors that determine what primarily held for sale means. And today, we're gonna be looking at tax court cases that kind of dig into that a little bit more, to hopefully give you real life examples of people that win. And people that lose whenever they battle it out in tax court, Tom is going to kick us off with two tax court cases. Take it away. All right,
Thomas Castelli 1:06
so the first one is going to be surburban Realty co first United States. And this happened back in 1980. So what happened was there was a corporation. So suburban Realty, they were a corporation, they held large volumes of land. And basically over a 33 year period, they sold 240 parcels of land. Now, there's important to note that the corporation was not engaged in any solicitation advertisement or development of the activities. And they did not actually act as a broker in these transactions. But despite all this, this usually indicate capital gains treatment. But the court decided that because of the continuous sales activity over the 33 year period, and the number of sales, again, it's 240, sales, over 33 years, they decided that that factor was a compelling case that basically said that this was going to be a dealer, because they are in the ordinary course of business of selling properties. And again, this is falling under the frequency of sales, which is one of the nine factors that kind of indicates whether or not a property is held primarily for resale. So that's again, suburban Realty versus United States held over a 33 year period, they sold 240 properties. And that alone, pretty much it was enough to make the tax court say that they were a dealer, and it was not eligible for capital gains tax treatment.
Brandon Hall 2:34
Because remember from last episode, if we do just a quick recap, the three main factors that are going to result in ordinary income treatment is if you are engaged in a trade or business, your property is held primarily for sale, and the property and sales ordinary for that business. So what we're breaking down here are the nine additional factors that explain what primarily for sale means. And so Tom's going through like, like he just said, the frequency number and continuity of sales. That's the one that place that the tax court has seemingly placed the most emphasis on, though not one of the nine factors is controlling. This one is the one that is again, seemingly most important. It's the Tom's next tax court case, dives even further into this factor, the frequency number and continuity of the sales.
Thomas Castelli 3:20
Yeah, and then there's so in this other tax court case, and Bono versus Commissioner, also in 1980, it was determined that this particular taxpayer was involved in zoning and subdivision of land, something that a normal developer would do, developer flipper would do. But basically, because they only sold all their land in one single transaction. The court deemed that because it wasn't frequent enough, the sales weren't frequent, they did not improve the land. And simply because they engaged in the subdivision activity didn't make them specifically a dealer. So this one kind of kind of the opposite, right. So the other in the other case, suburban Realty, there were over three, three year period, there was 240 sales. And this one, this was a just a very large one time transaction. And because of that, because there wasn't very frequent task where basically determined that they weren't in the business of selling property, and therefore they got capital gains treatment on this,
Brandon Hall 4:20
which is interesting and telling to because if you if you go review the facts of that tax court case, you can learn how to start the development of some of this land, you can do the subdivision, but if you structure your facts appropriately, you can still achieve capital gain treatment on the eventual sale rather than being tagged as dealer. So that's definitely a good one to to take a look at and what was that want to get Tom?
Thomas Castelli 4:46
That one was blown overs? Commissioner that's 74 TC 187 1980.
Brandon Hall 4:52
Nice. So I'm going to take one that is related to the factor of solicitation, advertising and sales. So Again, this is not one of the top factors but it is something that the IRS likes take a look at whenever they are auditing you. It'll it'll help demonstrate what your intent truly was with the property. Obviously, if you are trying to aggressively sell the property, it's harder to say that you are trying to actually hold it for investment. Because your your facts would point the other way in buying Harn Realty co versus United States 1976 tax court case, the tax court denied capital gain treatment. So the taxpayer lost the IRS one. And the taxpayer was arguing that the original intent was to hold the property for investment. There were some negative factors like some small minor development items that kind of actually in line with what Tom was previously talking about on the tax court case that he just mentioned. But the court spent a lot of time analyzing the tax payers, solicitation and advertising efforts. So the court noted the amount of signage that was used for marketing as an important factor in concluding that the taxpayer was a dealer and not actually an investor. Additionally, the court noted that the use of an independent broker to solicit sales does not shield the taxpayer from being treated as a dealer. So it actually worked against the taxpayer, you hired a broker to go and try to sell the property. What are you really trying to do with the property. So this taxpayer ended up losing because of primarily their solicitation efforts, they were trying to market the property, even though they said that their intent was to hold it, their objective facts, the objective evidence that the tax court places more emphasis on than whatever you claim your intent to be, you know, if you're sitting there trying to advertise your property for sale, then you might not actually be holding it for investment. And just to add a little more color to this, you know, if somebody buys a property does some minor pre development work on it, and then a deal falls into your lap, then it's gonna go the other way, you're gonna be able to say, Hey, I was not actively soliciting buyers, I wasn't advertising this property, this deal just fell into my lap. And we're actually going to go over a case here in a few minutes, where that exact same thing happened in the taxpayer one. So just be careful of any sort of advertising or solicitation activities that you engage in doesn't mean that you can't sell the property, it just means that you know, somebody has to come find you, and give you the deal versus you finding them and trying to get them to buy the deal from you.
Thomas Castelli 7:34
Absolutely. Here's another tax court case is going to be more verse Commissioner 30, TC 1306. And this one's back in 1958. And this is gonna be an interesting case, because basically, over an 11 year period, this taxpayer sold 22, lots of land now this taxpayer acquired the land via gift. And then again, over a 11 year period, they went ahead and sold 22 Lots. And the question was whether or not it was going to be capital gains or dealer status. And basically, the tax court said, what was the intent? What was at the time of sale? What was the intent? Were they holding the property simply to get the best maximum sale price they could to maximize the return on their investment? Or were they holding it primarily for resale? And when the tax court determined was that they were simply holding it to maximize profit, which is in line with the intent of an investor, and they ended up granting capital gains tax treatment, and there are some other supporting facts there, including the fact that there was not an extensive development or sales activity during the 11 years? So this kind of falls under the intent category? What was your intent there? The taxpayers, they held it, they got as a gift. And they're pretty much just holding the property for investment purposes. It was land, and they were just looking to sell at the most advantageous price. So they weren't necessarily holding it for resale. It was investment property. And when basically when sales came in, and ALAP, and it was a fair opportunity, it seems that they sold the property at a tax court said that you know what, that's consistent with an investor level activity, and they granted capital gains tax treatment to this taxpayer.
Brandon Hall 9:13
Awesome. All right. So I'm going to take the last one municipal bond Corporation versus Commissioner 1967 tax court case, the tax court looked at the taxpayers business and determined that they were in the business of acquiring and holding real estate, both for investment and for sale in the ordinary course of its trade or business. So this made it a little bit interesting. So this is a corporation that had or that held property for long term investment and also flipped property essentially, or held property out for sale in its ordinary course of business. And one thing that I came here if it came out of this case or a different case, but the Tax Court ultimately over time has said that you look at this status, this ordinary versus capital treatment, on a property by property basis. So just because you're tagged As a dealer doesn't mean that you also can't have investment property. And that's something that actually happened in this tax court case. So in this case, the taxpayer contacted the town of Frisco, to purchase a 240 acre lot. They purchased the lot. And then they also once they perfected title and did some subdivision work, minor subdivision work, they contacted Frisco again, and tried to negotiate a long term lease. Now that went back and forth for some time. And then Frisco contacted the taxpayer and asked for Frisco, the town of Frisco contacted the taxpayer and asked if they could purchase a portion of the land. So the taxpayer wasn't really advertising for sale, they were trying to engage in a long term lease, and they were ultimately able to engage in a long term lease at extremely favorable terms to the taxpayer. So again, kind of like parlaying what Tom just said about maximizing profits, that's what an investor tries to do. Not to say that a business owner doesn't try to do the same thing. But that's what the tax court kind of looks at here. So this, this taxpayer was able to maximize the profits based on extremely favorable long term lease to the town of Frisco, their advertising efforts to sell the property were very minimal, the development efforts were minimal. So really, even though they were actively trying to engage Frisco in a long term lease and even sell some property to Frisco, ultimately the taxpayer one and was able to, to achieve capital gain treatment on the sale of property to Frisco based on all the other factors. So really interesting tax court cases, it can go either way, I highly recommend that you press rewind, you listen to the names of these tax court cases, throw them into Google, and go read the opinions yourself. And it's a little weird at first, but you can scroll down about I don't know what halfway 60% of the way down whatever PDF document you find. And you'll be able to start reading the summary the actual summary, from the tax court case, that will give you a lot of insight. It'll cross reference other cases, you can go check those out as well. But a really good way to learn, what is the IRS, what is the tax court going to be looking at, if my file gets pulled for a review for an audit, you want to make sure that you structure your facts and circumstances in such a way that point to investor rather than dealer status? Because, you know, again, just just saying that I have the intent of holding the property is not going to be enough. You have to look at your objective facts. And that's what the IRS and tax court are going to take into consideration.
Thomas Castelli 12:36
Absolutely. And you got to think about it too, you know about what a tax court case is, right? So you know, all these cases over the years, we had many years of spanning what we discuss here today, they were not tried by the same tax court judge or the same attorneys didn't represent every single taxpayer. So there are differences in the way that these facts and circumstances, facts and circumstances were positioned in front of the court that may lead them to these conclusions. But really what happens is once these conclusions do take place, and these are documented in the summaries of the tax court cases, these become precedents right precedents that the IRS and future tax court cases will be will be viewed through if that makes sense the lens that they were will be viewed through So by understanding some of these cats has court cases. And like Brent said, being to align your facts and circumstances with those that favored, say capital gains treatment versus dealer treatment, might be able to save you some money down the road. So just kind of a good way to look at what a tax court case means to you. It's really a precedent that's going to be relied upon by the IRS and attached courts to make their case. When if if and when you actually get to that point. Hey, everyone, thanks again for tuning in today's episode. Before you go, we do want to remind everybody about the tax smart real estate investor Facebook community with over 2500 members and counting. There are a ton of great conversations taking place right now between real estate investors of all levels. And with the binding tax changes in the pipeline. This is something you're not going to want to miss out on to join go to wwe.facebook.com/tax Warn investors or search for tax smart investors on Facebook to join today.
Brandon Hall 14:18
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