Recent Rulings in Real Estate Development

By Eric R. Elliott, CPA/ABV, MBA, Knoxville, TN

Editor: Frank J. O'Connell, Jr., CPA, Esq.

With the slowdown in the real estate market continuing, many taxpayers with investments in undeveloped real estate are attempting to find creative ways to realize the built-in profit on their existing holdings. This planning may involve a real estate developer’s attempting to sell a large tract of land originally scheduled for development or a real estate investor’s subdividing and developing property originally intended as a long-term investment. Based on this recent trend in the marketplace, practitioners should review with clients the attributes of a developer versus an investor of real estate holdings.


Sec. 1221(a)(1) defines a capital asset as property held by a taxpayer (whether or not connected with the taxpayer’s trade or business) that is not primarily for sale to customers in the ordinary course of his or her trade or business. If an asset does not meet this definition, it will potentially be subject to tax at more than double the current capital gain tax rates.

Several cases have attempted to clarify the “primarily held for sale” definition. In Fraley, TC Memo 1993-304, the Tax Court reaffirmed eight factors that should be considered when making the “purely factual determination” of whether or not land is primarily held for sale to customers in the ordinary course of a trade or business:

  1. The purpose for which the property was acquired;
  2. The purpose for which the property was held;
  3. The extent of improvements made to the property;
  4. The frequency of sales;
  5. The nature and substantiality of the transactions;
  6. The nature and extent of the taxpayer’s dealings in similar property;
  7. The extent of advertising to promote sales; and
  8. Whether the property was listed for sale, either directly or through brokers.

Note that the courts have concluded that the existence of any one factor or group of factors does not characterize property as primarily held for sale to customers. Instead, each situation must be considered based on its own facts and circumstances.

Recent Developments

Many real estate investors wonder whether they will jeopardize their investor status if they begin to promote, subdivide, or otherwise begin to take on certain traits of a developer. In Phelan, TC Memo 2004-206 (the most recent case on this issue), the taxpayer was involved in limited activities that might be deemed to be inconsistent with capital-asset status. The taxpayer was contractually obligated, at its sole expense, to make limited improvements to the land it ultimately sold. The taxpayer had owned the land for four years prior to the first of three sales of the property in question.

In Phelan, the court stated:

In determining whether property was held for sale in the ordinary course of business, the frequency and substantiality of sales is the most important factor to be considered…. Frequent and substantial sales of real property more likely indicate sales in the ordinary course of business, whereas infrequent sales for significant profits are more indicative of real property held as an investment.

In addition to the Phelan case, there also have been several recent letter rulings dealing with the attributes of investors and dealers. Although the recent rulings involve not-for-profit taxpayers, the IRS was required to review the same factors relating to the “primarily held for sale to customers” definition, to determine whether the not-for-profits were subject to the unrelated business income tax.

In Letter Ruling 200510029, the IRS concluded that, because the taxpayer hired a real estate consultant and its intent was to dispose of the property via nine sales over a reasonable period of time, the lots would not be considered as held primarily for sale to customers in the ordinary course of a trade or business. In Letter Ruling 200530029, a private foundation received a favorable ruling relating to its sale of land parcels. The parcels were to be subdivided into 20-acre lots; land planning with engineering studies was performed to determine how to maximize the land’s value. Even though some of the foundation’s activity leaned toward development, the IRS ruled in the taxpayer’s favor. In Letter Ruling 200242041, a private school that sub-divided surplus property in order to sell and maximize gain also received a favorable IRS ruling. In addition to the subdivision of the surplus property, the school needed to construct a roadway for access to the parcel. It was also required, under an agreement with the local township, to build the roadway, drainage, landscape, and trails.


In the midst of the current real estate slowdown, many investors are looking for innovative ways to accelerate and maximize the gain inherent in their real estate holdings. It is clear that a taxpayer may have attributes of a developer while still being considered an investor in real estate. Fortunately for these taxpayers, many of the recent rulings in this area have been favorable. However, it should be noted that the courts and the IRS continue to take a factual approach to each investor/developer situation.

There are no guarantees that these favorable rulings will continue. Practitioners should review the rulings and the attributes of “primarily available for sale” with all real estate investors eager to liquidate their holdings.


Frank J. O'Connell, Jr., CPA, Esq, Crowe Chizek, Oak Brook, IL.

Unless otherwise noted, contributors are independent members of Crowe Chizek.

If you would like additional information about these items, contact Mr. O’Connell at (630) 574-1619 or

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.