How Do You Actually Own Real Estate?

1. As a Developer or Investor?

2. As a Capital Asset or Inventory?

Depending on the answer – Uncle Sam may have some questions for you.

An investor holds property for a period of time (typically longer than a year).

A dealer develops property or purchases property with the intent to make improvements and sell.

The fundamental issue is whether the property is a capital asset or inventory.

• Capital Assets are assets held as an investment or for productive use in a business.
• Inventory is fundamentally different from capital assets in that it is held for the purpose of resale to customers in the ordinary course of business.

Whether real estate is a capital asset eligible for 1031 depends on the nature of the owner’s business and the owner’s activities with respect to the property.

A real estate developer marketing subdivided lots and spec homes for sale would most likely qualify as a dealer selling inventory. The same entity or party holding separate land for investment without subdivision or major development would most likely be classified as an investor.¹

The following seven points can help determine if you fall into the dealer category:

1. The nature and purpose of the acquisition of the property and the duration of the ownership.
2. The extent and nature of the taxpayer's efforts to sell the property.
3. The number, extent, continuity and substantiality of the sales.
4. The extent of subdividing, developing and improving the property that was completed to increase sales.
5. The use of a business office and advertising for the sale of the property.
6. The character and degree of supervision or control exercised by the taxpayer over any representative selling the property.
7. The time and effort the taxpayer devotes to the sale of the property.²

The Intent is the key factor. Time is less important.

• Investors typically purchase and hold real estate for its appreciation and income over a period of time, typically years.
• A dealer sells real estate to customers in the ordinary course of its trade or business, typically in as little time as possible.

Dealers typically include real estate developers, subdividers, home builders, and flippers. The primary factor in characterizing a taxpayer as a dealer is whether the real estate is sold in the “ordinary course of a trade or business.”

The term “capital asset” explicitly excludes property held by the taxpayer primarily for sale to customers in the ordinary course of their trade or business (inventory).³

Knowing precisely which category you and your business fall under can help and prevent potential tax implications and headaches.

¹ Publication 544 (2023), Sales and Other Dispositions of Assets | Internal Revenue Service (irs.gov)

² Golub, Todd. D., Lipton, Richard M. Preserving Capital Gains in Real Estate Transactions. 2008. College of William & Mary Law School.

³ https://www.fletchertilton.com/1C2194/assets/files/News/Real Estate Investor or Dealer.pdf

Please Note: We encourage and recommend all taxpayers to seek guidance from a qualified Tax Professional. CYNA 1031 Advisors is not qualified to render tax advice.

If you need a referral to a Tax Professional or if there's anything we can do to help, please contact us.