Discussion:Reporting gain on S-Corp spec house

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Discussion Forum Index --> Tax Questions --> Reporting gain on S-Corp spec house

TaxTalker (talk|edits) said:

7 January 2007
An S-Corp (100% single shareholder) enters into a "Joint Venture Agreement" with an individual to build a spec house. The S-Corp owned the land & title to the house (but the cost of constructing the house were borne by the other individual, as per the agreement).The house was built during 2006, put on the market for sale by owner first, then by a real estate agent. The house was not sold in 2006. (A) What expenses, if any, can the S-Corp deduct on its 2006 tax return? (B) When the house is sold, is S-Corp responsible for reporting the entire proceeds (assuming it is sold at a profit)? (C) Is the profit reported as a capital gain or ordinary income?

The joint venture agreement states that the parties (S-Corp and other individual) will share in the profits & losses according to their respective capital contributions. It doesn't mention capital gains. Should the S-Corp issue a 1099-S to the other individual (even though individual's name is not on the title) for his share of the gain when the house is sold? Thanks for your responses. Any tax guidance links would be appreciated.

JR1 (talk|edits) said:

January 7, 2007
A. None

B. It all depends. Whatever part of the sale is reported as sold by the title company is what the corp will show as sales. If it's more than its share, it would report the difference as COS to the other party. I don't see that this is 1099 reportable, unless the S effectively was the general contractor and the individuals mere subs.

As to cap gain or ordinary income...what else does the S do? If this is it...sounds like a big mistake was made in putting in the corp...I think it's ordinary income since it's the only thing the corp is doing. Had it been done personally...clearly cap gains unless there's an on-going activity.

Wait for others to log in on that last part.

FTF65 (talk|edits) said:

January 7, 2007
A: In general, the costs of developing real property must be capitalized in accordance with the uniform capitalization rules set forth in Sec. 263A and Reg. 1.263A-1. There are, however, some exceptions to the general rule including marketing expenses, state income taxes and fees paid for tax services which are deductible in the year incurred in accordance with your method of accounting (note: these are the most common exceptions to the general rule - see Reg. 1.263A-1(e)(3)(iii) for others.

B: The profit is reported by the JV which should file a partnership return. Each partner's share will be reported on schedule K-1 - so, no 1099 to the individual. Since the land was contributed to the JV by the S corporation, the S corporation's share of the gain is generally determined by the agreement. However, if the value of the land was greater than the S corporation's basis in the land at the time of contribution, this "built-in" gain must be allocated wholly to the S corporation before any other profit is allocated as provided under Sec. 704(c) . Since the agreement specifies that profits are in accordance with capital contributions - what does it say under the definition of "capital contributions"? Is an amount assigned to the individual that is contributing the services? If the individual is not assigned a capital contribution, he is being compensated in some other manner - is there a development fee? a guaranteed payment provision? (in the agreement, look for a section that discusses "fees."

C. This is a loaded question. To get the preferential capital gains rates you need three things: (1) a sale or exchange of (2) a capital asset that (3) has been held for more than 1 year. I am guessing that you will clear the first hurdle without issue. With respect to item (3), you do not mention when the land was acquired by the S corporation, so that piece cannot be determined; however, the holding period for a constructed asset is determined on a "brick-by-brick" basis and since you completed the construction in 2006, there is no way that you have satisfied the holding period requirement yet. Assuming that you will eventually get the required holding period, the final question is "do you have a capital asset?" This is the loaded part and must be examined in the context of Sec. 1221(a)(1). If the house is considered property that is "primarily held for sale to customers in the ordinary course of a trade or business" then you do not have a capital asset. That being said, making that determination is generally not easy - as evidenced by the plethora of court cases on the issue. In these cases the courts have identified a number of factors that they consider - what was the primary purpose for acquiring the property? what is the extent of improvements made to the property? what is the frequency and substantiality of the taxpayer's sales activity? did the taxpayer market the property? what other business activities is the taxpayer engaged in? on and on... Based on what you have said, if the JV, the S corporation and individual did this as a "one-time" thing, I would probably argue that this does not rise to the level of a trade or business and therefore is a capital asset. Anything beyond that is pure guessing....

Rosalydia (talk|edits) said:

7 January 2007
I am a little confused as to why an S corp would own title to a house and land. Why was the S corp formed? What kind of trade is the S corp involved in?

TaxTalker (talk|edits) said:

8 January 2007
Thank you for your replies.

So, for 2006 since the house was not sold, does the Joint Venture need to file a partnership return? or does the JV partnership wait to file a return until the sale takes place? I understand that the land's basis as well as costs of construction need to be capitalized; what about the following costs incurred in 2006 (costs incurred by the S-Corp): property taxes, interest on construction loan, insurance, utilities, selling/marketing/advertising costs, legal and accounting fees. Are these deductible in year incurred (by the JV partnership or S-Corp?) or do these need to be capitalized as well and will they increase the basis in the property when it is sold? Regarding the capital gain treatment, the land was held by the S-Corp shareholder as an individual and then placed into the S-Corp when formed (the S-Corp was only formed to handle this transaction). I believe it was owned for more than 1 year before being placed into the S-Corp. If the house is sold prior to one year of being constructed, does it still get capital gain treatment? Or are you just referring to a short-term capital gain rate vs. a preferential long-term capital gain rate? This was originally intended as a "one-time" thing and the land was purchased as an investment, however, if successful, the parties may continue. At what point does it become a trade or business activity?

Taxref (talk|edits) said:

8 January 2007
Even if this is only a one-time activity, I would say ordinary income. The OP stated that this was a spec house.

FTF65 (talk|edits) said:

January 9, 2007

First, please verify the following facts (I want to ensure that I understand the structure): an individual owned the land, then contributed such land to an S corporation, which, in turn, contributed the land to a JV partnership - correct? Assuming that is correct:

  1. File a partnership return for 2006;
  2. Deduction/Capitalization of construction costs: as provided under Sec. 263A, you must capitalize the direct costs (e.g., land and construction costs) as well as any indirect costs that "directly benefit or are incurred by reason of" the construction activity. Accordingly (based on the Reg. cite that I previously provided), you can deduct selling/marketing/advertising expense and any accounting fees related to tax advice; interest expense must be capitalized during the construction period (see Reg. 1.263A-8); property taxes, insurance, utilities, legal and accounting fees must generally be capitalized to basis [note: there are exceptions for legal and accounting fees if they constitute deductible service costs under Reg. 1.263A-1(e)(4)(ii)(B)];
  3. House is sold before long-term holding period: if you determine that this activity does not rise to the level of a trade or business, then you could treat the sale of the land as a long-term capital gain and the sale of the house as short-term capital gain (allocate the sale price to the land and house based on relative FMV of each). If this activity is a trade or business, all gain is ordinary income;
  4. At what point does an activity become a trade or business? There is not a "bright-line" test for determining when an activity becomes a trade or business. Such determination is based on all of the facts and circumstances surrounding the transaction. I suggest that you do some research in the "dealer vs. investor" area (you can start with a google search), discuss your findings with your client, weigh the risks vs. the rewards and let the client make a decision. How much gain are we talking about anyway?


It appears you believe that the fact that this is a "spec" house automatically equals ordinary income treatment - maybe you could share your thoughts as to why you believe this (I just want to understand your thought process)? The fact this is a spec house just tells me that the house wasn't built under contract. Moreover, I could argue that a spec house (absent a trade or business) supports a capital gain position. Consider the following - if a client comes to you and tells you that they bought some land in 2005, completed the constructed of a "spec" house as of July 2006, then sold the house in August 2007 and planned on "never" engaging in this type of transaction again - would you treat that as ordinary or capital? Without knowing anything else, I would argue that this is a capital transaction because the activity of building and selling a single house probably does not rise to the level of a "trade or business" (of course the term "trade or business" is not defined in the code, so you will have to look to the courts for an interpretation - if you do, you will find that the courts generally agree that a trade or business involves regular and continuous activity).

That being said, if I obtained and read through all of the documents related to TaxTalker's transaction, I might find that (for example) the JV agreement states that (i) the property was acquired with the intent to develop & sell, (ii) the name of the company is "We Develop & Sell Homes, LLC", (iii) the balance sheet on Form 1065 classifies the contruction activity as inventory, or (iv) there is a deduction for marketing expense on page 1 of the return (note: page 1 is reserved for income and deductions related to a trade or business) -- all of these things point to the taxpayer's intent with respect to the property and would cause me to second guess TaxTalker's claim that this was in fact a "one-time" only investment. On the other hand, if language in the agreement indicated an investment intent, the land and the house were classified as investment property on the balance sheet and any deductions were reported on page 3 of form 1065 (i.e., sched. K), this project would certainly resemble an investment activity. Is this position without risk? Of course not. Is this position too risky? That depends on the amounts involved, the taxpayer's appetite for risk, and the significance of other relevant facts that are currently unknown to us.

  • adding search terms: common law partnership (aka joint venture)

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