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Exclusive Listings by Lloyd
Wertheimer
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Commercial Real Estate
Westlake Village
Telephone
805.497.4557
FAX
805.496.3589
E-Mail Address
Lloyd@Westcord.com
Address
951 Westlake Blvd
Suite 101
Westlake Village, CA 91361 |
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Are you an
Investor or a Dealer in Real Estate?
Stock in trade and property held for resale are
specifically barred from §1031
qualification. Historically, there have been numerous cases that
analyze whether a pattern of sales made by a taxpayer indicates that
the taxpayer is holding his or her real property as a dealer,
developer, or investor. In the event that the taxpayer’s history of
sales, subdividing or developing property has crossed the line from
being an investment activity and has entered into the territory of
the business of land development, then his attempted
1031 exchanges will fail to qualify.
In effect, the nature of his or her real estate holdings will have
morphed from investment property to inventory to be sold. Existing
owners or non-professional investors whose activities begin to
resemble those of traditional dealers in real estate can be at risk
of classification as developers if they begin to act like
developers. The following activities are some of the many that have
been considered by courts to determine whether the seller is
classified as a dealer or whether he is entitled to investor status:
(1) the original intent of the taxpayer when he purchased the
property; (2) the length of time that the property was held; (3)
whether the taxpayer has engaged in developer-dealer activities in
the past; (4) the use to which the property was placed while it was
held by the taxpayer; (5) whether a change of circumstances has
occurred with respect to the property or the taxpayer’s economic or
personal situation; (6) the extent of improvements on the property,
and the time that such improvements were implemented; (7) whether
the taxpayer has entered into a joint venture or similar agreement
with a developer-dealer; (8) whether the property was leased to a
tenant, and the length and terms of such lease; (9) whether the
replacement property is disposed of, divided, or the taxpayer
otherwise demonstrates that his or her intent in acquiring the
replacement property is for purposes other than investment or
business use.
The following table illustrates these principles:
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Evidence for
Dealer/Developer Treatment |
Evidence for Investor
Treatment |
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The taxpayer classifies the
investment on his books and records as
inventory, work or construction-in-progress, or
fails to claim depreciation on the property.
The property is developed, subdivided or sold
quickly after its acquisition.
The taxpayer has not had a change in
circumstances that would motivate an ordinary
person to dispose of or develop the property.
The taxpayer has made substantial improvements
to the property in expectation of subdividing
the property.
The taxpayer enters into a joint venture,
partnership, or similar agreement with a
developer or dealer that provides that the
developer share the profits with the taxpayer or
that the risk of success or failure is shared by
both parties.
The units are not rented during the term that
the property has been held, or the leases have
been in effect for a brief time period.
The replacement property is subdivided and sold
quickly, or the taxpayer indicates that he or
she purchased the replacement property with the
intent of selling the property as units.
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The taxpayer consistently
treats the property on his books, records and
income tax returns as investment or business use
property.
The property is held for a lengthy time, used by
the taxpayer as investment or business property,
or is inherited by the taxpayer.
The taxpayer’s circumstances have changed.
Unexpected financial pressures, being required
to move and being unable to manage the property,
death of the taxpayer or the property manager,
zoning or other changes not instituted by the
taxpayer, or the loss of a significant tenant
could all be considered relevant to the
taxpayer’s motive in conducting the exchange.
The property required little improvement in
order to subdivide and sell, the improvements
were made at a time the selling price is at fair
market value or is based its appraised value at
the time of purchase.
The taxpayer subdivides and develops the
property himself, hires an outside party to
construct improvements, or if the agreements
that control the development and sale of the
property, provide for paying the taxpayer a
fixed fee for each unit sold (not contingent on
profits from the venture or the sales price of
the units).
The units have been rented by its tenants for a
significant time period, or have been offered to
the existing tenants under a right of first
refusal or similar agreement.
The taxpayer maintains a continuity of interest
in the replacement property, holding it for a
substantial time period for investment or
business purposes, or purchases replacement
property that is of a nature not conducive to
subdivision or development |
Finally, the frequency of sales is
important. Too many conversions and sales makes an
investor look like a developer or dealer. Each of these
factors would likely be weighed by a court, if the
transaction is challenged by the Internal Revenue
Service. No one factor is determinative, but by the same
token, "passing" a certain number of these tests will
not guarantee the desired tax treatment. Any activities
that imply the property was not held with the intent of
investment or business use, such as resembling a
developer or dealer, make it more likely that the
property will not qualify for rollover-deferral
treatment under Code Section 1031. Care should be taken
that the taxpayer gives no indication, whether written
or oral, that he or she intended to buy the property and
later sell off individual units, no matter how far off
in the future such sales may occur.
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