Discussion:Real Estate Development
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Discussion Forum Index --> Tax Questions --> Real Estate Development
| 21 March 2006 | |
| Hello ....
I'm stuck preparing a return for an individual. I've spent about 4 hours on the phone with IRS trying to get an answer. I'm hoping you can point me in the right direction. This person is an individual who has a full-time job but this past year has started to become involved in real estate development in order to get a post-retirement business going. He materially participates in the business and plans to continue over the next several years. He buys undeveloped land and spends time and money adding improvements. It may be as simple as adding wells or sewer lines, bringing electricity to the propery, or could include adding structures to the land - buildings, barns, houses. Last year he bought and sold two properties. I want to treat this as Schedule C activity in order to deduct his reasonable and necessary expenses, including some depreciation on large tools and vehicles. He does have a substantial gain this year and he knows he will have to pay quite a bit in taxes. My questions are these: Can he use a schedule C and factor in the property bought and sold as inventory? If this is the case, is the contract labor and materials used to construct the buildings and make improvements included in the cost of good? Would this be better treated generally as a capital gain transaction? If that's the case, can I deduct tools and equipment as an investment expense on the Schedule A? Any thoughts or ideas on exactly how to treat this would be appreciated. Thanks for your help. Charles Davidson | |
| 21 March 2006 | |
| Real property is not inventory. What is inventory is the Section 263(A) adjustment. Sounds like you have an activity that is specifically classified as ordinary income, so Schedule C would be appropriate. The Section 263(A) calculation is going to drive you nuts. That's where most of your expenses are going to end up. | |
| 21 March 2006 | |
| Hmm. I disagree with Dennis as to it not being inventory. We typically hold work in progress/jobs as 'inventory' for lack of some other term. So whatever costs are accumulated against that property go there, and when sold, are relieved and booked to COS.
I might note that there are ways of converting the development profits in some part to capital gains, by creating another entity (of which he is not the 100% owner of) to do the construction work. So he sells the developed property to a construction company to do the rest of the work. The sale of the developed property can qualify for cap. gains. Now ducking, to find out what I don't know... | |
| 21 March 2006 | |
| Just to clarify, the IRS pointed me in the direction of classifying the property as inventory, so I would tend to go along with JR1. I'm not familiar with Section 263(A) adjustments, so I am going to go look those up now.
Thanks for the information. Any other ideas from anyone out there. | |
| 21 March 2006 | |
| If you classify real property as inventory (and the net effect is the same one way or the other) you are committing to ordinary income treatment on the whole parcel. Sometimes it is wise to preserve the option of selling undeveloped half at capital gains rates. | |
| 21 March 2006 | |
| Dennis, I don't think you can pull that off when you're the same guy/biz doing both. IRS won't accept the separation, from what I understand. This is a highly technical area, and I have one client who's doing one, and the tax attorneys who do have expertise in it set up separate entities with unrelated shareholders, etc. And timing has a lot to do with it as well...from what I've learned, anyway. | |
| 21 March 2006 | |
| Big difference between what your client is doing and a Schedule C,
and you're quite right about the same business doing both. What you want to preserve is the option to cease one business and do another. | |
