Occasional Realty Sale: Capital Gain or Ordinary Income?

Some taxpayers think that gains from sales of real estate automatically result in capital gain treatment, versus recognition of ordinary income.  A typical profile is the situation of an individual with spare cash to “invest” who partners with a contractor in a “spec” building project.  The “investor” commonly views such a venture no differently from the purchase of a stock, intending/hoping for an increase in value, and the eventual realization of a gain upon sale.

The question of whether any gain realized in the real estate situation is ordinary or capital will generally depend on all of the surrounding facts and circumstances, and many unhappy taxpayers have left the courthouse after a determination of ordinary income treatment, which typically means the taxpayer’s gain will be taxed at a considerably higher tax rate.

Before venturing forth in a deal of this nature, taxpayers should acquaint themselves (with the assistance of a tax pro) with the broad benchmarks which the courts have used in analyzing whether gain is capital or ordinary in nature, including:

  • The nature of the property acquisition
  • The frequency and continuity of sales
  • The nature and extent of the taxpayer’s actions (including participation in decisions associated with the venture)
  • Activity of the seller about the property
  • Extent and substantiality of the transaction

See the recent decision in Cordell D. Pool, et al v. Commissioner ,  TC Memo 2014-3 for more on this from a recent case dealing with a longstanding issue.