Long VS. Short Cap Gain

Technical topics regarding tax preparation.
#1
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I have a client who purchased a piece of land and a home which he moved onto the land to sell. We have gone back and forth as to whether he is a dealer or an investor (Sch C vs Cap Gain). From what I have found I think we can marginally get into the investor category because he has only done this once and does not intend to do it again and he does have several other rental houses. This particular rental house would not be feasible in our area and after he crunched the numbers the interest and other expenses would not be covered with the rental payments he could get in the market.

Now however, he is selling the house. The actual land was purchased over a year before the sell and the house 13 months before the sale, but he did a LOT of construction, dug a basement, actually moved the house onto the land and finished less than a year before the sale (ie - it was NOT ready to be put into service as a rental). He is going to move his business (which is several businesses and personal tax returns) elsewhere if I go short term cap gain, but just wanted to get some others input to be comfortable that letting him go is the right decision. It would make at least a $40K tax difference.
 

#2
JR1  
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The case law ALL hinges on intent. So don't fear, sounds like you're ok with cap gains on this one.
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
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#3
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Yes - I believe I'm comfortable with the cap gain but can we call it a long term cap gain even though he was still doing significant construction on the house up to 6 months prior to the sale? He purchased the actual house and land just over a year before the sale, but he moved the house onto the property it now sits on (he has a house moving business) and did a significant amount of the construction/fixing up less than 12 months from the sale...
 

#4
JR1  
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Good one! Someone else can share thoughts on that....I wonder if you don't have two things: One long term and one short?
Go Blackhawks! Go Pack Go!
Remembering our son, Ben Jan 22, 1992 to Aug 26, 2011.
For FB'ers: https://www.facebook.com/groups/BenRoberts/
 

#5
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This is a good read, somewhat along your scenario. Obviously it is just an attorney's article and not authoritative, but it does reference some court cases and Rev/ Rulings you may want to explore further.

https://kurtzcpa.com/rental-holding-period/

From my understanding of this, I think you have to break down the gain into three parts:

1) Gain on sale of the land.
2) Gain on sale of the home and improvements made more than one year prior to the sale.
3) Possible gain on sale of improvements made within the year prior to the sale.

Is it possible that the entire gain can be allocated to the land and the original home, and that the costs incurred in the last year only helped to put those items together for a quick and easy sale?

BTW - I am far from an expert on this area and just found this information because I found your situation interesting.
 

#6
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if I go short term cap gain

Land is LT.

Original basis in house is LT.

Cost of construction is either all ST or some combination of ST/LT, depending on when the costs were incurred. See RR 75-524.
 

#7
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Make an election under 266 for 2020 to capitalize carrying costs during the development period, if you're taking the position that this is an investment and not a trade or business?

It's easy to forget if the sale isn't reported until next year on the 2021 return.
 

#8
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Assuming you're ok with investor status, my sense is that you should report the sale on Schedule D with a holding period beginning with acquisition of title and include the construction cost in the basis. I am aware of RR 75-524, but note that it applied for purposes of section 1231 and this is not a 1231 situation. I am not aware of the separate holding period idea outside of 1231.
Steve
 

#9
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So if you own raw land for over a year and build a rental house that you decide to sell instead of rent, you can get LTCG? (Assuming investor status.)

I realize that most of the gain would be on the land and not the newly constructed house but I thought the short-term holding period of the improvement would taint the entire transaction.
 

#10
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I think that's correct. I'm not aware of a rule bifurcating an asset for holding period purposes.
Steve
 

#11
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gatortaxguy wrote:I think that's correct. I'm not aware of a rule bifurcating an asset for holding period purposes.


Aren't we technically supposed to bifurcate? For example, rental property replaces a roof. The roof must be capitalized. Rental property is sold less than a year and a day after roof is put into service. Roof would technically be STCG or ordinary gain (if used in a trade or business).

Admittedly, FMV and cost basis of roof should be materially in parity, so there's not material gain there and the point would probably be moot in most situations.
 

#12
Nilodop  
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The operative language in 1231 is
held for more than 1 year
.
The operative language in 1222 is
held for more than 1 year
.
But gatortaxguy (apparently) believes that, because RR 75-524 says
for purposes of section 1231 of the Code.
, its bifurcation principle is not applicable to 1222.
That interpretation makes no sense.
 

#13
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I am saying there is only one asset. I'd be happy if someone shows me otherwise.
Steve
 

#14
Nilodop  
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How many assets were there in RR 75-524?
 

#15
dave829  
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gatortaxguy wrote:I am saying there is only one asset. I'd be happy if someone shows me otherwise.

This case shows otherwise: Paul, 206 F.2d 763 (3d Cir. 1953)

https://scholar.google.com/scholar_case?case=4132320753565885260&hl=en&as_sdt=6&as_vis=1&oi=scholarr
 

#16
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I stand corrected. Thank you!

I am also confused as to how far bifurcation goes. I know it doesn't apply to stock. But does it apply to a new roof, and if so, how is the allocation to be made?
Steve
 

#17
dave829  
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Russo, 68 T.C. 135 (1977) made such an allocation. In that case, a partnership owned land in Palo Alto and began constructing an office building there. After the building was completed, the partnership sold the property on 12/31/1971. To get capital gains treatment for the building, the partnership had to show that the building had been completed by 6/27/1971. It wasn’t. It was completed 7/3/1971. The court said that it could make an apportionment for the part of the building that was completed on 6/27/1971, and based on the evidence, it estimated that 60% had been completed by that date, so it allowed 60% of the gain to be LTCG.

https://scholar.google.com/scholar_case?case=95251865343824421&hl=en&as_sdt=6&as_vis=1&oi=scholarr
 

#18
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I can see a building under construction. But what about a roof?
Steve
 

#19
dave829  
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Same principle. A new roof is under construction until it is completed. Just a shorter construction period. If, for example, a new roof was put on the building and completed only 3 months before the sale of the property, then any gain attributable to the roof is not LTCG. But it's likely that there's no gain attributable to the roof anyway because the basis is high. ManVsTax pointed this out in #11 above.
 

#20
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Sounds pretty weird to me. Does anyone actually do that?
Steve
 

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