Couple’s Real Estate Profits Taxed as Ordinary Income

Generally, gains from the sale of real estate are taxed as capital gains. However, taxpayers who buy and sell property in their trade or business have their gains taxed as ordinary income. In a recent case, a couple who made thousands of dollars in real estate transactions over 3 years reported their gains as capital gains, but the IRS argued that they should have been reported as ordinary income.

The husband, a mortgage broker who made about $40,000 from his job, and his wife, who had no outside income, purchased and sold a number of properties within a short period of time. They derived proceeds from the sales in 3 years of $834,000, $604,500, and $473,000.

Whether the gains are taxed as capital gains or ordinary income depends on whether the taxpayers are in fact in a trade or business. The Tax Court lists the following nine factors used to make this determination:

1. The taxpayer’s purpose in acquiring the property
2. The purpose for which the property was subsequently held
3. The taxpayer’s everyday business and the relationship of the income from the property to the total income
4. The frequency, continuity, and substantiality of sales of property
5. The extent of developing and improving the property to increase the sales revenue
6. The extent to which the taxpayer used advertising, promotion, or other activities to increase sales
7. The use of a business office for the sale of property
8. The character and degree of supervision or control the taxpayer exercised over any representative selling the property
9. The time and effort the taxpayer habitually devoted to the sales

Applying these factors to the case, the Tax Court concluded that the couple had ordinary income from the sale of property held primarily for sale to customers in the ordinary course of business. The real estate activities were the couple’s main source of income. All the properties were held short term and not for long-term investment.

Source: Wendell V. Garrison et ux. v. Commissioner; T.C. Memo. 2010-261