Selling real property can greatly impact your taxes if the profits aren’t classified properly.
The IRS examines whether your sale is investment income or part of your business. Investment income is taxed as capital gains and business income is taxed as ordinary income.
In the case of Flood, T.C. Memo. 2012-243, the court reviewed whether profits from Donald Flood’s sale of vacant lots should be taxed as capital gains or ordinary income. Flood, who was active in both stock trading and real estate, argued that land sales were for investment purposes and that capital gains treatment should apply.
However, the IRS reclassified the profits as ordinary business income, subject to higher tax rates and self-employment taxes. The Tax Court agreed with the IRS after applying nine criteria to determine the nature of the property sales:
- Purpose of acquiring the property
- Purpose for which the property was held
- Taxpayer’s everyday business and how the sales related to total income
- Frequency and volume of sales
- Extent of improvements made to the property
- Efforts to advertise or promote sales
- Use of a business office
- Control over representatives selling the property
- Time and effort devoted to selling the property
The court found that Flood's activities—purchasing 250 lots, using advertising, a real estate agent, and creating a sales website—indicated that he was in the business of selling real estate. This meant the profits were subject to ordinary income tax.
This case highlights the complexity of determining whether property sales are treated as capital gains or ordinary income. No single factor guarantees a specific outcome, and taxpayers should be cautious. If you’re active in real estate, assessing your actions carefully is crucial to avoid higher taxes.
Always consult a tax professional to understand how your property sales will be classified and taxed.
If you have questions about this topic or how other tax strategies can help you save taxes book a FREE Tax Advisory Call Today.