In several previous posts, we have emphasized the importance of educating oneself about the tax consequences of any given business transaction well before that transaction comes to life.  In many situations, such forethought gives a taxpayer the opportunity to weigh the costs and benefits of different courses of action and, as a result, to act thoughtfully in the events leading up to the transaction.  This will minimize any surprises resulting from a close look at the transaction by the IRS, and thus ensure that the taxpayer receives the economic result that he or she is expecting.

The Tax Court recently considered a case in which taxpayers apparently did not act pursuant to a carefully considered plan, and, as a result, were assessed a significant deficiency as well as an accuracy-related penalty.

 Boree v. Commissioner

 The Facts

In Boree v. Commissioner, husband and wife taxpayers (the “Taxpayers” or “Mr. and Mrs. B.”) and their partner, through an LLC, purchased almost two thousand acres of undeveloped land in Florida for approximately $3.2 million.  Between 2002 and 2006, the LLC sold several lots each year, representing over one-third of the property in the aggregate; most of the lots sold during that time comprised approximately ten acres, and were sold for between $3,000 and $6,000 each. 

In 2003 the LLC began building an unpaved road, and submitted to the county’s local board of commissioners (the “Board”) a conceptual map of a planned residential development consisting of one hundred lots.  It also applied for, and received, exemptions from certain county subdivision requirements that called for interior roads and the submission of plans to the Board prior to the sale of lots, and executed a declaration of covenants, conditions, and restrictions on the land that defined the LLC as the “developer.”

In 2004, the Board adopted one-year moratoriums relating to permits for the development of certain subdivisions and lots.

In 2005, the Taxpayers became the sole owners of the property when the LLC purchased their partner’s interest.  Also during that year, the LLC proposed to the Board that almost 1,000 acres of the property be rezoned as a planned development unit (“PUD”), and Mr. B. and his representative attended several Board meetings relating to that application.

In 2006, following the Board’s adoption of a requirement that developers pave certain public roads leading to subdivisions, the LLC entered into a purchase and sale agreement with Development Co., pursuant to which Development Co. obtained an option to purchase most of the remaining property.

In 2007, the LLC sold just over one thousand acres to Development Co. for $9.6 million.

 The Tax Returns    

On their Forms 1040, U.S. Individual Tax Return, relating to 2005, 2006, and 2007, the Taxpayers indicated on their Schedule C, Profit or Loss from Business, that Mr. B.’s principal business or profession was “Land Investor.”  For 2005 and 2006, the Taxpayers reported income from the LLC’s lot sales as ordinary income and deducted expenses relating to the property.

On their 2007 Form 1040, however, the Taxpayers listed Mr. B.’s occupation as “Real Estate Professional” and reported long-term capital gain relating to the transaction with Development Co.  Between 2005 and 2007, the LLC did not engage in any significant activity that was unrelated to the property.

 The IRS Disagrees

 In 2011, the Service sent Taxpayers a notice of deficiency relating to 2007, indicating that the gain relating to the transaction with Development Co. did not qualify for capital gains treatment.  In addition to finding a deficiency of $1,784,242, the Service determined that the Taxpayers were also liable for a section 6662(a) accuracy-related penalty.

The Tax Court Weighs In

 The Court stated that to determine whether or not an asset is “capital,” it considers, among other factors, “the number, extent, continuity and substantiality of sales… and the extent of subdividing, developing, and advertising.”  While no specific factor is controlling, the Court highlighted that the “frequency and substantiality of sales” is often the most important factor because “the presence of frequent sales ordinarily belies the contention that property is being held ‘for investment’ rather than ‘for sale.’”

The Court emphasized that the Taxpayers consistently treated the LLC as a real estate business, representing it as such to buyers of the property, the Board, and on their 2005, 2006, and 2007 returns, and spending significant time and money on zoning activities.  Additionally, the Court underscored the frequent and substantial sales of property between 2002 and 2006, and the fact that the Taxpayers deducted, rather than capitalized, expenses related to the real estate activities.  Each of these factors contributed to the Court’s conclusion that the transaction with Development Co. resulted in ordinary income to the Taxpayers.

Finally, the Court held that because the Taxpayers had understated their tax liability in 2007 by over $1,780,000—over 10% of the tax required to be shown on their return for that year—they were subject to the accuracy-related penalty under section 6662(a).


 As Boree demonstrates, a taxpayer that wishes to be taxed on a sale of real property as an investor, thereby receiving capital gains treatment on the sale, must be careful to, in fact, hold that property as an investor.  If Mr. B. had determined at the outset that it was a priority for him to avoid recognizing ordinary income on an eventual sale of his property, then he could have structured his actions accordingly to ensure that he was holding the property only as an investor.  Bear in mind, however, that it is quite possible that it was Mr. B.’s regular participation in and dedication to his investment that made the transaction with Development Co. as profitable as it was; a taxpayer in the same situation should carefully consider and compute the economic benefits of such participation against that of capital gains treatment in determining how best to hold his or her investment.