Who is the developer?

• Author: Stutman, Mark

If a taxpayer owns a tract of land and holds it for investment, any gain will be capital gain taxed at the lower capital gain rate.

If the taxpayer decides that he can make more money by subdividing the land and selling parcels or lots, the gain will be taxed at ordinary income rates. At that point, the development and sales activities mean the taxpayer is in the business of selling real estate rather than acting as an investor, i.e., he is a dealer.

A recent Fifth Circuit decision shows a taxpayer how he can have his cake and eat it too (Bramblett, 5th Cir., 1992, rev'g TC Memo 1990-296). In this case, a partnership was allowed to subdivide the land and obtain capital gains on most of the profit.

The taxpayer formed a corporation wholly owned by the partners of the partnership, selling the land to the corporation at its fair market value (FMV), and letting the corporation subdivide the land.

Thus, the gain on the taxpayer's sale of the land to the corporation was a capital gain; the gain on the sale of the lots by the corporation was ordinary income - but the corporation had a stepped-up basis equal to the land's FMV.

The IRS tried to attack this plan under at least three different arguments. First, it claimed the partnership was also in the business of selling land. Second, the Service argued that the corporation was an agent of the partnership so that the corporation's activities were attributable to the partnership...