Property Deemed Held for Development and Was Not a Capital Asset

An often contentious issue for taxpayers who have real estate is determining if a piece of property does or does not represent a capital asset when it is sold.  The case of Boree v. Commissioner, 118 AFTR 2d ¶ 2016­5207, CA11, No.14-15149 posed just such an issue.

There is no question that Mr. Boree initially acquired the land in 2002 with the intent to develop the land and sell the property as over 100 lots.  Such a plan will cause the lots to be treated as property held for sale in the ordinary course of business.

The law initially defines all assets held by a taxpayer as capital assets (IRC §1221(a)), but then proceeds to give a list of property excluded from that definition.  Of interest in this case is IRC §1221(a)(1) which excludes:

(1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;

The IRS and Mr. Boree agree that had his plan gone forward the property would have clearly been of the type described in that section and, therefore, not treated as a capital asset.  Any gain or loss from the sale of the property would considered an ordinary, rather than capital, gain or loss.

But the situation changed.  In 2004 the County began imposing a number of restrictions and conditions on land in the area that made the planned development no longer economically feasible.  Rather, Mr. Boree concluded that a higher density development would be needed to justify the additional costs that the County now would impose, a type of development Mr. Boree did not himself wish to undertake.

Mr. Boree looked to “upzone” the property to make it appealing to other developers and obtained zoning changes that allowed a higher density development to be undertaken.  However, the County also later imposed additional conditions that would have made development even more expensive, and outside of what Mr. Boree wished to undertake.

He discovered another developer was planning a large scale project on property adjacent to his property.  He negotiated a sale of all remaining lots (he had sold only a few over the years before this point) to the other developer.  In 2007 the sale closed with a selling price of just over $9,600,000.  The gain of $8,578,636 was reported as a long-term capital gain on Mr. Boree’s tax return.

The IRS cried foul at this point, arguing that the property retained its status as property was excluded from capital asset treatment.  Mr. Boree argued that the County’s actions had changed the nature of the property from that held for sale to customers to property held for investment since the actions rendered the initial plan no longer feasible.

The Tax Court found for the IRS, noting the principal purpose for holding the land was development and eventual sale to customers.  The taxpayer appealed that decision, which lead to this decision of the Eleventh Circuit.

The Eleventh Circuit sustained the Tax Court’s decision.  First, it rejected Mr. Boree’s contention that only his intention at the instant of the sale mattered, noting:

[I]n Suburban Realty Co. , the Fifth Circuit rejected the notion that “the decisive question is the purpose for which (the property) 'primarily' was held when sold.” 615 F.2d at 182 (emphasis added). Rather, the court reasoned, “At the very moment of sale, the property is certainly being held 'for sale.' The appropriate question certainly must be the taxpayer's primary holding purpose at some point before he decided to make the sale in dispute.” Id. The court thus analyzed the taxpaying entity's purpose in holding the property over multiple years prior to its sale, finding that although the company originally acquired the property as an investment, it engaged in such frequent sales through a ten-year period that its primary purpose changed to “for sale” at some point during that time. Id. at 183-85. While the Borees would have us focus instead on this Court's statement in the subsequent case of Sanders v. United States that “it was the taxpayer's intent at the time of the sales that is relevant for an inquiry as to whether capital gains treatment is justified,” 740 F.2d at 889, Sanders is not at all inconsistent with Suburban Realty Co. The Sanders court also analyzed the taxpayer's activities over multiple years in sustaining the Tax Court's decision that the taxpayer's income was ordinary income, finding that although the taxpayer's original purpose was not to establish a real estate business, by the time he earned the profits at issue in the years 1974 and 1975, he had been engaging in the business of subdividing land, making improvements, and selling lots for several years. Id . Thus the “sales” the Sanders court referred to in the above-quoted statement were the taxpayer's “continuous and frequent sales of the lots over the period from 1972 to 1976.”Id . Far from diverging from Suburban Realty Co.'s direction to look at the circumstances leading up to the sale, the Sanders court actually did the same thing, in fact citing Suburban Realty Co . as its source. See id.

The Court also distinguished this case from the result that the taxpayer cited in the case of Ridgewood Land v. Commissioner, noting:

For instance, they rely on Ridgewood Land Co. v. Commissioner, in which the taxpayer acquired property intending to develop and sell it in the ordinary course of business. 477 F.2d 135, 136 [31 AFTR 2d 73-970] (5th Cir. 1973) (per curiam). The State of Mississippi then authorized condemnation proceedings against the property for use in the construction of a highway. Id . Under threat of condemnation, the taxpayer sold the property to an adjacent landowner who was negotiating to sell the land to the state for inclusion in the highway project. Id. In a decision the court emphasized was based on the “the particular facts of the case,” the court found that the taxpayer's purpose in holding the property had changed from ordinary course of business to investment because any development of the land would have been futile due to the impending condemnation. Id . That case is distinguishable, however, because an exercise of the government's eminent domain power, unlike an ordinance mandating the paving of roads, deprives a landowner of all potential uses of his property except selling the property to the government. It was appropriate for the court to conclude in Ridgewood Land Co. that because the property was condemned, the taxpayer lost the opportunity to develop it, and therefore had no other purpose for holding the property aside from investment. The Baker County paving requirements, however, merely placed additional costs on developers interested in pursuing certain types of development. The restrictions did not foreclose all development of property in Baker County. Potential developers just had to be financially able to pave internal and connecting roads. As such, “adverse government action” cases like Ridgewood Land Co . are of no help to the Borees.

And, as the Court noted, the taxpayers continued to take steps to ready the property for development following the adverse decision of the County:

More importantly, even if we were to focus only on the Borees' intentions for the property after the land use restrictions were imposed in 2004 and 2005, their actions in the years 2004 through the sale in 2007 betray their true intent to continue to develop the property. When compliance with the moratoria threatened to render the original West Glen Estates development plan unprofitable, Mr. Boree did not passively hold the property in hopes that he could sell it to a buyer at an attractive price, but instead first sought to obtain exceptions to the paving requirements so that his subdivision could proceed. When that was unsuccessful, he hired a land-use attorney and applied to rezone the property for a more densely zoned residential and commercial development that would fund his costs of complying with the new county paving requirements. Indeed, Mr. Boree was successful in persuading the county board to create a new land use designation of “rural commercial,” never before used in the county, for part of the Planned Unit Development. The Borees assert that the fact that their preliminary maps of the Planned Unit Development had no roads leading to it reveals that it was a mere hypothetical and that they were only trying to “up-zone” the property to make it more attractive to a buyer in hopes of selling it in bulk, but they offer no explanation for the fact that they continued to pursue the Planned Unit Development strategy even after they entered into the sales agreement with Adrian in April 2006. Indeed, at the June 2006 meeting of the Baker County Board of Commissioners, Mr. Boree's attorney confirmed that the Planned Unit Development had been undertaken to justify the paving costs imposed by the county restrictions and that Glen Forest, “the development entity that originally owned all this land and sold off some of it,” was the same developer who owned the remaining acreage. Such evidence of strategic and thorough involvement in pursuit of developing the property indicates that the Borees were holding the property for sale in the ordinary course of business right up until they sold it to Adrian, and not merely as an investment property. Not only that, but the Borees continued to sell, or attempt to sell, some lots to individuals after the land use restrictions were first imposed in 2004, and they deducted (instead of capitalized) expenses related to the property in 2006 and 2007. Thus, the Tax Court's factual finding that the Borees “continued to pursue development activities after the board adopted the moratoriums and requirements' was not clearly erroneous.

The panel concluded that this property continued to be property other than a capital asset and the resulting gain was ordinary income.