A tax strategy for real estate sales.

• Author: DeLuca, Allison

The U.S. real estate market has always attracted the attention of investors and developers worldwide and even more so recently because of a number of factors including increased financing channels (such as crowdfunding), more opportunities for foreign investors through special programs (such as the EB-5 program), and instability in emerging foreign markets. Properly planning for a real estate transaction is imperative to lowering tax expenses and increasing returns for investors. To plan effectively, however, many factors warrant consideration--e.g., intent, structuring, and ownership of an entity--a proper combination of which will provide the best opportunity for success.

Background

The owner's intent for the property determines the character of gain that will be recognized when it is sold. The gain could be taxed at ordinary or capital gain tax rates. A gain on the sale of property held primarily for sale to customers in the ordinary course of business is subject to ordinary gain treatment. In this case, the term "primarily" means "of first importance" or "principally." Increased tax rates on ordinary income in recent years have made it more critical to plan a transaction properly to obtain capital gain treatment on a sale.

Upon the sale of a capital asset held for more than 12 months, the gain generally qualifies to be taxed at the preferential long-term capital gain rate. A capital asset, as defined by Sec. 1221(a), is "property held by the taxpayer (whether or not connected with his trade or business)" but, as clarified by Sec. 1221(a)(1), it does not include property held by the taxpayer primarily for sale to customers in the ordinary course of his or her trade or business.

Determining the Type of Asset Sold

Often, the distinction between a capital asset and an asset sold in the regular course of business is ambiguous. The determination is made based on the facts for a particular asset. The Tax Court analyzes several factors, including the following, to determine whether property is a capital asset or an asset held primarily for sale to customers in the ordinary course of business:

1. The nature and purpose for which the asset was initially acquired and the duration of ownership;

2. The purpose for which the property was subsequently held;

3. The extent to which the taxpayer made any improvements to the property;

4. The number, extent, continuity, and substantiality of the sales;

5. The extent and nature of the transactions involved;

6. ...