Capital gain on development property.

• Author: Sartain, Bud

In Timothy J. Phelan, TC Memo 2004-206, the taxpayers segregated their real estate operations to achieve capital gain treatment on property ultimately held for development. Three entities were formed with identical ownership to engage in various aspects of the real estate business:

* Centre Development Co. of Colorado Springs, LLC (Centre) owned a shopping center.

* Jackson Creek Land Co. (JCLC), a limited liability company, invested in undeveloped property.

* Vision Development Corp. (Vision) developed and sold JCLC's property.

Facts

In 1994, JCLC acquired 1,050 acres of Regency Park (called Jackson Creek), a property located in an independent Colorado subdivision known as Triview (an independent quasi-governmental municipal corporation and political subdivision). In 1987,Triview agreed to construct water and sewer improvements and contracted with the town of Monument, CO, to construct roads and sanitation and other facilities. Monument annexed Regency Park and rezoned the property for residential and commercial development.

During 1996, JCLC authorized a geological study to evaluate development potential. In 1997, Elite Properties of America Corp. (Elite) negotiated with JCLC to acquire 102 acres, requiring the latter to cause Triview to maintain irrigation and landscaping and be responsible for any utility or roadway improvements that Monument imposed. Triview completed all development work.

In 1996, Triview defaulted On general obligation bonds it had issued in 1987. Centre paid $2.9 million for $4.8 million of the defaulted bonds; two utility companies purchased new Triview bonds for $1.5 million. Collateral for Centre's financing included the 1987 Triview bonds and Jackson Creek.

In 1997, Vision and JCLC borrowed $600,000 to finance infrastructure development on 184 acres. The loan was guaranteed by the taxpayer, Centre and a related construction entity.

Tax Court's Opinion

The issue was whether JCLC held Jackson Creek tot sale in the ordinary course of its business. The court addressed the following questions:

* Was JCLC engaged in a trade or business, and if so, what business?

* Was JCLC holding the property primarily for sale in that business?

* Were the sales contemplated by JCLC ordinary in the course of that business?

The...