In our newsletter last October (Vol. 9, No. 2), we reported on a case from the Northern District of California holding that a taxpayer realized ordinary income on the sale of real property because he had originally acquired the property with the intent to develop it, and when he sold it many years later, he had done nothing to show that he had abandoned his original plan to develop the property. Real property held primarily for sale is not a capital asset, so a sale gives rise to ordinary income taxed at a higher rate than capital gain income.
The Tax Court recently reached a similar conclusion on clearer facts in the case of Victor Fargo v. Commissioner (May 25, 2015). The taxpayer purchased the property in question in 1988 for $2.7 million with the intent to develop a 72-unit apartment complex and retail space. While the apartments were never developed, the taxpayer did incur costs of more than $1.8 million in his attempts to develop the property through 2001. These costs principally related to architecture, engineering, appraisal, permit and licensing fees. The taxpayer sold the property in 2002 for $14.5 million plus a contingent amount determined by the buyer’s sales of homes.
In what seems to be a clearer case than the one decided last fall by the District Court, the taxpayer continually attempted to develop the property during his period of ownership. The fact that no significant development occurred is not relevant. It was easy for the Tax Court to hold that at the time of sale, the taxpayer was holding the property for development, with the result that the taxpayer’s gain was taxed as ordinary income.