The question of whether real estate was or was not a capital asset in the hands of the taxpayer was the key issue in the case of Keefe v. Commissioner,[1] CA2, Case Nos. 18-2357, 18-2594, affirming TC Memo 2018-28. This issue comes up often with real estate, with taxpayers having a particular interest when they are unable to recover what they had invested in the property upon disposing of it.

Following a loss in the Tax Court, a case we had previously written about when originally decided in March of 2018 (Mansion Property Was Never Actually Used in a Rental Activity, Loss Was Capital), the taxpayers appealed the decision to the Second Circuit Court of Appeals

The question of whether real estate was or was not a capital asset in the hands of the taxpayer became an issue in the case of Keefe v. Commissioner, TC Memo 2018-28.  While the issue can arise with other assets, real estate investments are generally large enough that the question of whether a gain or loss on sale is capital, §1231 or ordinary is often a very significant issue, with high stakes involved.

In this case, the taxpayer was looking at a seven-figure loss on the sale of a historic waterfront mansion they had acquired to restore and attempt to rent in Newport, Rhode Island.  The restoration ended up taking much longer than anticipated and was far costlier.  Although they talked with a real estate agent about renting out the property to wealthy individuals who were expected to pay $75,000 a month for the property during peak season, it was never actually rented out.

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In the case of Sugar Land Ranch Development LLC et al. v. Commissioner, TC Memo 2018-21, the IRS challenged the taxpayer’s treatment of gain from the sale of land.  The taxpayer had treated the gain as capital gain from the sale of investment property.  But the IRS argued that the property was held for sale to customers in the ordinary course of business and that the gain should be treated as ordinary gain.

To qualify for capital gain treatment, the gain must arise from the sale of an asset that is a capital asset in the hands of the taxpayer.  What is a capital asset is defined, under the IRC, by what is not a capital asset.  All assets held by a taxpayer are capital assets unless one of the exclusions, found at IRC §1221(a), applies.

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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.

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Real estate held by a taxpayer could be either an asset held for investment, an asset used in a trade or business, an asset held for personal purposes or an asset held for sale to customers in the ordinary course of the taxpayer’s trade or business.   The nature of the property affects the tax treatment of any gain or loss incurred when the property is sold.

In the case of Evans v. Commissioner, TC Memo 2016-7, the determination of the reason Mr. Evans held the real estate would determine if he had an ordinary loss from the sale of a property or a capital loss. 

Taxpayers were again beaten back in an attempt to broadly define a “capital asset” and a “sale of a capital asset” in order to gain access to the preferential capital gain tax rates in the case of Patrick v. Commissioner, 142 TC No. 5, affirmed on appeal by the Seventh Circuit Court of Appeals, Case No. 14-2190.

In this case the taxpayers were looking to get capital gain treatment for an amount they received as a reward for, effectively, turning in the husband’s employer through a qui tam complaint filed under the False Claims Act.

In the case of Duffy v. United States, US Court of Federal Claims, 115 AFTR 2d ¶2015-438 the taxpayers were looking to either exclude $50,000 in a legal settlement from income or have it taxed as capital gains—and they succeeded in neither attempt.