The sale of real property by a taxpayer most frequently gives rise to capital gain income, which is subject to income tax at preferential rates if the taxpayer had a more than one-year holding period in the property sold. However, if the real property sold is considered to be held primarily for sale to customers in the ordinary course of a trade or business, any gain realized is subject to the higher income tax rates imposed on ordinary income. In the recent Tax Court case of Si Boo LLC (TC Memo 2015-19), the taxpayer was in the business of buying tax lien certificates at public auctions. The main source of profit from this activity arose because most people whose property had become subject to a tax lien certificate will redeem the certificate before they lose title to the property. The applicable state law required that they pay a substantial penalty to the holder of the tax lien certificate in order to redeem their property. These penalties provided a substantial return on the investments made by the taxpayer in purchasing the tax lien certificates.

On a number of occasions, however, the owner of the property did not redeem it within the statutory period. In those cases, the taxpayer was able to obtain a tax deed and thereby become the owner of the property. Once it acquired ownership, the taxpayer routinely sold the property. In one of the years that was at issue in the case, the taxpayer sold 175 parcels of real property it had obtained through its ownership of tax lien certificates on those properties. On these facts, the Tax Court had little trouble deciding that the real property sold had been held primarily for sale in the ordinary course of the taxpayer’s business. The taxpayer’s only real argument was that its 175 sales were relatively small compared to the more than 6,500 tax lien certificates the taxpayer had acquired. The court did not believe this to be a relevant factor and focused solely on the fact that 175 sales in a year were more than sufficient to indicate that the taxpayer was engaged in the business of selling real property.

The court had two more pieces of bad news for this taxpayer and its members. First, because the sales were dealer dispositions, they did not qualify for installment sale reporting under IRC Section 453. Second, because the gains from the sale of real property arose in the course of a business, the members of the taxpayer had to pay self-employment taxes on their profits, in addition to income taxes.