Did you know that “Qualified Taxpayers” can subdivide and actively sell real estate from a single tract held for investment without having the income taxed as ordinary income? Instead, all or most of the income can qualify for capital gains treatment. Internal Revenue Code 1237 provides that a taxpayer will not be a dealer merely because the taxpayer has (a) subdivided the tract into lots or (b) engaged in promoting, advertising, and selling activities, or used agents to sell such lots in the subdivision.
To be a “Qualified Taxpayer” you must meet all four of the conditions below
- No portion of the tract can ever have been held for sale in the ordinary course of the taxpayer’s business.
- No other real estate can have been held for sale to customers in the year of sale.
- No substantial improvements can have been made on the tract that materially increased the value of the lot sold. In addition, no substantial improvement may have been made by a lessee (but only if the improvement is recognized as income by the taxpayer) or by a governmental unit (but only if the improvement constitutes additional basis to the taxpayer). Certain improvements will not be considered substantial but you must meet certain conditions.
- The property must have been owned five years,unless it was inherited.
These provisions are complex and there are exceptions to the general rules. If you are considering selling subdivided property please give us a call.
Written by Howard M. Flitt