If you suffer a loss on the disposition of real property, you want to be treated as a developer for income tax purposes - that is, to be treated as engaged in a trade or business. That way, you can get ordinary loss treatment and not a long termor short term capital - the ordinary loss will typically be available to offset more types of income than a capital loss.
So how many properties must one be dealing with and how much activity is needed to cross into developer territory? This question comes up a lot - it is a question of facts and circumstances. In a recent Tax Court case, ownership of 3 properties coupled with sporadic development activities was not enough for ordinary loss treatment.
More particularly, the taxpayer had a plan to purchase properties, tear them down, build single or multi-unit residences, and then sell them - alternatively he might rent them out. From 2003 through 2007, he bought one rental property and two tear-down properties. He developed one tear-down into a two-condominium building and sold it. Regarding the subject property he incurred costs to prepare the property for development, paying for architectural, electrical, and mechanical plans, permits, property taxes, and interest. He borrowed money to develop the property - ultimately he defaulted and lost the property in foreclosure.
The court did not find him to be a developer. Some of the court’s observations included:
1. The intent to develop is not enough.
2. Sales activity should be frequent and continuous - not sporadic.
3. Not enough properties involved here.
4. That the property was sold in foreclosure instead of to a regular buyer is a neutral fact.
5. The taxpayer’s primary source of income was elsewhere - the development activities would account only for an insubstantial portion of his income.
6. The taxpayer was lackadaisacal about keeping business records.
Reading the facts, I would have said that the taxpayer was in the trade or business of real estate development - too bad for the taxpayer I wasn’t the judge on his case.
Evans, TC Memo 2016-7