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Sunday, December 11, 2005

Real Estate Investor vs. Developer - More "Development" Allowed?

Individuals and pass-through entities owning undeveloped real property desire to be characterized as "investors" for federal income tax purposes - that is, that their real property holdings are treated as capital assets that incur capital gain on sale. The alternative is usually developer/ordinary income treatment. Ordinary income rates can be twice as much as capital gain rates.

Under the Internal Revenue Code, undeveloped real property will lose its capital gain character if it is “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” For 60 years, the IRS and taxpayers have disputed what level of development activity a taxpayer can undertake without crossing the line from investor to developer.

A recent article by Ira Feldman, CPA posits that in recent years, a passive investor in undeveloped real property generally has to undertake more preliminary development-type activities to realize value from its investment, and that the IRS may be acknowledging this by allowing some level of development activity without the taxpayer being treated as a dealer. [PLAN NOW TO AVOID DEALER STATUS FOR 'INVESTMENT' REAL ESTATE, Practical Tax Strategies, Nov 2005, Practical Tax Strategies / Taxation for Accountants (WG&L)]

Mr. Feldman cites several recent Private Letter Rulings in which the IRS has allowed certain development activities without imposing dealer status, including:

-subdivision of parcels to smaller parcels
-multiple sales
-entry roadway built
-development agreement with town
-land planning
-preliminary engineering.

See PLR's 200510029, 200242041, 200530029.
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