Discussion:1031 / LT Capital Gain for Hotel Developer?
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CowTownCPA (talk|edits) said: | 13 June 2007 |
| I have a hotel developer (LLC) with 18 properties in various stages of development. Four are operating and some are now just raw land or even just an option and franchise fee payment. His original intent was to hold and operate all of the properties. He then sold three in 2007. I believe his intent is changing to build and sell rather than build and hold. He explained to me his plan to sell some properties immediately upon completion and provide seller-financing to help the new owner create an operating history to take to a bank for permanent financing after one year. He also explained that he wants to report on a cash basis and plans to pay tax only on the amount of proceeds received proportionate to the overall gain. He believes that sums received after year one will be taxed as long-term capital gains. I've told him I see problems here.
1.) Am I correct that his plan to sell upon completion and then report the bulk payment in year two as a long-term capital gain will not pass IRS muster, even if he is a cash-basis taxpayer? 2.) Is he considered a dealer and subject to ordinary income? 2.) As long as he continues developing can we enter into a long series of 1031 exchanges? 3.) If he operates each property for one year can he then sell each one as a long-term capital gain? 4.) Could he lease the property for one year and then sell as a long-term capital gain? Any advice would be greatly appreciated. Thank you. | |
Sherman1031 (talk|edits) said: | 21 June 2007 |
| Investment property which is converted to development property loses its capital asset status. It becomes property which is being developed for resale and this is a business activity, not an investment activity. Profit from the development will be subject to ordinary income tax rates. If he wants to protect the capital gains status of the property he needs to think about creating a separate development corporation and sell the “dirt” to the development corporation and report the sale as a capital gain. Property being developed for resale is not qualifying 1031 property.
Let the development corporation develop the property for resale. Answering your questions #3&4: In this case, the property has been developed for investment or as an operating asset of the business. This will qualify for long term capital gains as well as for a possible 1031 exchange. | |
| 21 June 2007 | |
| Often a builder will rent out spec houses that haven't sold, just to pay the construction loan interest. When the economy improves, they will clean, paint, put in new carpet, and sell the house. This still qualifies as inventory/trade income and not as investment, because the intent of the builder/developer was not to hold as a rental, but to sell, all along.
I realize that the OP refers to a hotel developer. My point is to be careful. I liked Sherman's idea to sell the holding property to a separate entity which operates hotels or leases them to an operator. That company's intention is to hold the property as an investment. | |
| 21 June 2007 | |
| Hotel property 1031 issuee - You will have a mix of real and personal property. Be sure to keep it separate when you do separate 1031's for each kind of property. | |
