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Hi
I often get better answers here than at the IRS so before I call them, I'm wondering if anyone here knows much about house construction taxes.

Let's say someone is in business of buying land, building a house on it, and selling it. They have costs and income, a bottom line, and the profit ends up on Schedule C and there is income tax and SE tax. Just for example, let's say:
Land cost $20K
Construction cost $250K
Sale price $350K
Profit $80K

If they had the land for a year or two and it appreciated to, let's say $50K, can they not put the land on Schedule C as above but instead take it as a capital gain?
So the profit picture would look like this instead of the above:
$250K construction cost
$300K sale price (land sold "separately" for $50K)
Profit $50K.

Then take the land separately as $30K capital gain.

Can they do that? It's kind of like "pretending" they sold the land separately, isn't it? Seems a little fishy to me but I've been told by three contractors now that that's how they do it. Is it legitimate?

Thanks for any thoughts on this matter.
RB
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Nobody? : (
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RBMunkin: "I often get better answers here than at the IRS so before I call them, I'm wondering if anyone here knows much about house construction taxes.

Let's say someone is in business of buying land, building a house on it, and selling it. They have costs and income, a bottom line, and the profit ends up on Schedule C and there is income tax and SE tax. Just for example, let's say:
Land cost $20K
Construction cost $250K
Sale price $350K
Profit $80K

If they had the land for a year or two and it appreciated to, let's say $50K, can they not put the land on Schedule C as above but instead take it as a capital gain?
So the profit picture would look like this instead of the above:
$250K construction cost
$300K sale price (land sold "separately" for $50K)
Profit $50K.

Then take the land separately as $30K capital gain.

Can they do that? It's kind of like "pretending" they sold the land separately, isn't it? Seems a little fishy to me but I've been told by three contractors now that that's how they do it. Is it legitimate?"


First, asking this question on April 12 is probably not the best timing. The resident pros tend to get very busy (which makes them more selective about the posts to which they respond); also, allow for 1-2 weeks of decompression for the balance of April.

Second, I am not a tax pro, but an interested kibitzer and my $0.02 is that the this sound not legitimate to me because it appears to elevate form over substance.

--- land is simply inventory for someone in the business of buying land and building homes and IIRC, inventory does not get capital gains treatment.

--- your proposed scenario is ripe for allocation problems; why not place all the gain on the land?

--- once the improvements are built, it becomes much more difficult to sell the land separately because who wants to own improvements on land to which one does not have access or rights to use the improvements? And absent some very specific contractual provisions, title to the improvements would normally pass with the land and not separately.

I will be curious to read what the resident pros have to write, but you might want to give them a few weeks to respond.

Regards, JAFO

THIS POST IN NOT LEGAL ADVICE!
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Thanks for your "not legal advice" JAFO! I agree with you but will be interested in expert testimony. I can wait a bit. It's an amendment to 2007 return already filed so...
Thanks,
RB
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It's an amendment to 2007 return already filed so...

Short answer - No, it's not.

I'll let you make the inferences from there.

--Peter
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Don't know what "inference" you are talking about. I am talking about an amended return, form 1040X, for 2007.

RB
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Don't know what "inference" you are talking about. I am talking about an amended return, form 1040X, for 2007.

The inference is that this scheme is fraud. You cannot undo a fraudulent return by amending it. You may get to the right tax liability but the taxpayer can still be prosecuted for fraud.

Ira
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"The inference is that this scheme is fraud. You cannot undo a fraudulent return by amending it. You may get to the right tax liability but the taxpayer can still be prosecuted for fraud."

What's a fraud? First of all, the original return is completely straight, in no way a "fraud".
Secondly, the "scheme" we are discussing to possibly amend has not been determined to be wrong, let alone "fraud". Do you KNOW for a fact what I described is not legal? If so, you didn't discuss it at all. So I'm confused there.
I think at most it's a gray area, not fraud. I know two tax guys who say it's legit and one that says he doesn't think so.

So I'd like to hear more from you if you are sure it's no good. We don't want to do a wrong thing, that's why we are asking and trying to find out. So far we are getting contradictory info. I personally think it's not legit but I'm trying to keep an open mind until I research it further. It's hard to get absolute "yes" and "no" answers with a lot of tax issues.

In any case, the comment "cannot undo a fraudulent return" is not accurate since the return we are considering "undoing" is completely legit. Unless I'm misunderstanding what you are saying or referring to.

Thanks,
RB
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Peter,
I see you are a CPA so I'm hoping you can elaborate. What do you mean "no, it's not" when I mentioned amendment?

And also am I right in the first place that the land belongs with every other construction cost on Sch C and that there is no way to take the land as a capital gain? Are the construction guys I talked to wrong?

If you buy land and it appreciates and you just sell the land, that can be capital gains, right? But as soon as you build on it and sell than it's considered a business venture and thus not capital gainable?

Am I right here or is something else going on?

Thanks,
RB
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I see you are a CPA so I'm hoping you can elaborate. What do you mean "no, it's not" when I mentioned amendment?

And also am I right in the first place that the land belongs with every other construction cost on Sch C and that there is no way to take the land as a capital gain? Are the construction guys I talked to wrong?

If you buy land and it appreciates and you just sell the land, that can be capital gains, right? But as soon as you build on it and sell than it's considered a business venture and thus not capital gainable?

Am I right here or is something else going on?


You're almost right. The "almost" part is that someone in construction might have to treat undeveloped land as inventory and not capital gains property.

I believe that Peter, and I know that I, was reacting to the position being taken by the construction guys in your original post when referring to a fraudulent return. Sorry for the confusion.

Ira
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"You're almost right. The "almost" part is that someone in construction might have to treat undeveloped land as inventory and not capital gains property.

I believe that Peter, and I know that I, was reacting to the position being taken by the construction guys in your original post when referring to a fraudulent return. Sorry for the confusion."

Ok, thanks.
So if it's treated as inventory, I'm right that it would be expensed as COGS when it sells. So including it on Sch C in the year it sells, whether as an expense or as COGS would amount to the same profit and thus the same tax, right?

And if they treat the land as capital gains, that is fraud. Just to make double sure I know what you are saying.

I thought the IRS definition of fraud was intentional attempt to cheat. I guess intention is hard to prove though. They think they are doing it properly. But I guess a judge would have to decide if he believes them if they got audited and hauled into court.

Thanks,
RB
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And also am I right in the first place that the land belongs with every other construction cost on Sch C and that there is no way to take the land as a capital gain?

Yes.

Are the construction guys I talked to wrong?

Not necessarily.

If you do enough transactions - build enough houses - to justify the extra cost, you can arrange to hold the land in one entity and do the construction in another.

The entity holding the land is nothing more than a real estate speculator. That entity buys land, hoping to sell it to a builder at a later time. The entity doing the building waits until they are ready to build, then buys the land (or enters into a lease for the land).

Viola - the land-holding company gets a capital gain for the land. And the building company has ordinary income from their construction activities.

--Peter
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"If you do enough transactions - build enough houses - to justify the extra cost, you can arrange to hold the land in one entity and do the construction in another."

That's what I was wondering and was going to look into. Like the individual could buy the land and sell it to his S-corp, for instance?

As far as enough transactions to justify the cost, that could even just be one house a year maybe, eh? Since an S corp isn't expensive to set up and the minimum tax is only $800 (in California).

Sound good?
Thanks for your input.

Since he did not have the other entity last year I'm going to tell him not to do that "scheme" for 2007.

RB
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