Tax News
Fargo and Girard Development v. Comm’r, T.C. Memo. 2015-96 – Yet Another Dealer v. Investor Travail
May 27, 2015
The Tax Court just released a consolidated case (T.C. Memo. 2015-96) whereby Victor Fargo and its related entity Girard Development took an issue with the IRS’ “dealer” characterization of a sale of certain property held by Girard. This case is a classic example of the unpredictability of the quint-essential real estate tax issue: is the taxpayer a dealer or investor in real estate? Every real estate fund would be familiar with the problem and hopefully is addressing it in its PPMs, but to summarize, if the property held by the fund is found to be held for resale to customers, the attendant result is ordinary income instead of capital gain at the time of sale. The companion issue is that the property could also cause UBTI to tax exempts.

Now, you would say, how by golly would an investment fund be found to be a dealer in property?  After all, an investment fund is an investor. It’s right there in the name!  Well, a real estate fund could enter in a partnership with a developer for one. Two, the fund could be buying and selling mortgages. Depending on the number of sales and multitude of other factors the activities could rise to the level of ordinary course of business. The issue is, as with many other facts and circumstances tests, that there is no bright line rule. In the case of real estate, a plethora of cases have distilled the law in this area to a eight factor test including:
• The length of time the property was held;
• The reason that the property was held;
• The nature and extent of any improvements;
• The extent of developing and subdividing the property, including advertising to increase sales; and so on.

No need to go into great detail about this case because it is a re-run of many other cases that raise the same issue. However, to those market participants for whom the issue is material, it is worth keeping the case in your research file and noting the factors that undid the taxpayer. The Tax Court mainly took an issue with the following: (1) the taxpayer never abandoned its development plans prior to the sale. This was evidenced by multiple efforts to obtain financing and expenses incurred for architectural, engineering, and appraisal fees, (2) the property was sold to an unrelated party but under the sale agreement Fargo was to develop it and Girard was to share in the development profits.

What is interesting, telling, and somewhat worrisome about this case is that a significant number of the factors the Court analyzed were in favor of the taxpayer. It is also interesting to note that the Court pointed out to the same facts in resolving two factors in favor of the Commissioner (i.e. “purpose at time of sale” and “purpose for which property was subsequently held”).  Lastly, the Court was not persuaded by the fact that the property was rented. So, this case was a bit of a toss-up and should offer a cautionary tale to market participants regarding the unpredictable outcome of this significant tax issue.  
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