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Tax News
Failed Related Party Real Estate Installment Sale in Cordell D. Pool v. Com’r
January 09, 2014
Cases
Real estate investors desire capital gains treatment.  Actually receiving such capital gains treatment, however, proves to be difficult particularly when development activities are afoot. The Cordell D. Pool case (T.C. Memo. 2014-3) that came out yesterday presents a cautionary tale to opportunistic private real estate funds that have their hands entrenched in development activities, whether through related, or third-party developers.  The facts of the case involve a relatively typical related party installment sale transaction whereby the putative investor purchases land and then sells it to a related developer with the hope of converting what otherwise would be ordinary income into capital gains. Similar transactions have had mixed success in the past and have been previously blessed by the Tax Court in Phelan v. Commissioner, T.C. Memo. 2004-206. This time around, however, the Tax Court sided with the Commissioner. There are numerous lessons in this case, but I will focus on the ones that are most striking:

Lesson one – If you truly intend to hold the property as an investment before you sell it to the developer, do not list the principal activity code on the Form 1065 of the entity that holds the property as “development.”

Lesson two – When you file affidavits with the county subdivision agency, do not list the entity that holds the property for investment as a developer.

Lesson three – Do not have the investor entity holding the property enter into, or represent that it has entered into, buy-sell agreements for multiple lots with individual owners.

Lesson four – when you sell the property to the developer do not make up some exuberant value that has no basis in reality, or even worse, it is tied to the value you paid for the property, plus the projected cost of development. Have a third party appraisal and use a realistic value.

To me, all of these are common sense points, but the details often get lost in the implementation of a particular tax planning.  The tax planning in Cordell preached one thing but the facts spoke of another, which ultimately led to the negative result for the taxpayer. If there is an overarching lesson here, it is the lesson of meticulous attention to implementation detail when it comes down to deals that have a heavy tax component that lives or dies by a facts and circumstances analysis. On a more upbeat note, the Tax Court did not collapse the investor and developer entity because of their common ownership but re-affirmed its holding in Phelan in that regard.
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Tags: 1221(a), real estate fund and installment sale, real estate funds capital gains, related party installment sale