Source: https://www.currentfederaltaxdevelopments.com/blog/2016/1/13/real-property-taken-in-foreclosure-sale-was-a-capital-asset-ordinary-loss-disallowed
Timestamp: 2019-04-24 04:28:21+00:00

Document:
Real estate held by a taxpayer could be either an asset held for investment, an asset used in a trade or business, an asset held for personal purposes or an asset held for sale to customers in the ordinary course of the taxpayer’s trade or business. The nature of the property affects the tax treatment of any gain or loss incurred when the property is sold.
In the case of Evans v. Commissioner, TC Memo 2016-7, the determination of the reason Mr. Evans held the real estate would determine if he had an ordinary loss from the sale of a property or a capital loss.
Mr. Evans claimed that the property in question was held primarily for sale to customers in the ordinary course of his trade or business and thus was not a capital asset pursuant to IRC §1221(a)(1). The IRS agrees the property in question was held for sale, but took the position that the activity of Mr. Evans in this case did not rise to the level of a trade or business, thus rendering it a capital asset (which is the default for an asset unless it is excluded under one of the rules found in §1221).
These factors include: (1) the nature of the acquisition of the property, (2) the frequency and continuity of property sales over an extended period, (3) the nature and extent of the taxpayer's business, (4) "the activity of the seller [i.e., the taxpayer] about the property," and (5) the extent and substantiality of the taxpayer's transactions.
Before deciding to purchase the Newport Beach property, Evans considered purchasing several properties on which he would have torn down existing structures and constructed new ones. Evans's principal objective in acquiring the Newport Beach property was to tear down the existing structures, build a two-unit home, and sell the property for a gain. If Evans was unable to obtain a desirable sale price for the property, he planned to hold the property and rent it to tenants. In order to develop the property, Evans planned to (and did) work with contractors, such as an architect and an electrician. These facts indicate that, at the time he purchased the Newport Beach property, Evans's main intention was to tear down existing structures and develop and sell the property. However, even if Evans acquired the Newport Beach property with the intention of developing it, this does not mean that he was in the business of property development and sale. See Buono v. Commissioner, 74 T.C. at 199-200. Therefore this intention does not dispose of the question of whether Evans held the Newport Beach property as part of a business of developing and selling properties to customers.
Evans testified summarily that he began acquiring properties as early as 1980 and had acquired multiple properties since that time. However, he supplied us with few details about these properties. He estimated that he had invested in a total of eight or nine properties, some of which he planned to rent to tenants and some of which he planned to develop and sell. Apart from the Newport Beach property, Evans specifically identified only two properties he had previously acquired. One was the rental property in Corona del Mar, California. The other was the tear-down property in Corona del Mar. Evans developed the tear- down property in Corona del Mar into a two-unit condominium, then sold it. The Newport Beach property was sold in a foreclosure sale. Evans's testimony about other properties he may have acquired for development and sale was too vague to be reliable. The limited record shows that Evans's property sales were sporadic, not frequent and continuous. See, e.g., Buono v. Commissioner, 74 T.C. at 200; Phelan v. Commissioner, T.C. Memo. 2004-206, slip op. at 21-22 ("[T]wo sales of real property by * * * [the taxpayer] in 4 years were of insufficient frequency to support the conclusion that * * * [the taxpayer]'s sales were in the ordinary course of its business.").
Evans was actively involved in developing the tear-down property in Corona del Mar and the Newport Beach property. He hired and managed contractors and dealt with permit issues. In addition to the time he spent developing these two properties, he actively sought new properties to acquire and develop. These activities notwithstanding, the record indicates that Evans held only a few properties for development and sale and that he acquired the properties sporadically. From this we conclude that Evans's personal real-estate development activities were each rather isolated.
The court also found that his failure to produce records of the activity at court also suggests this wasn’t a “serious” business.
The Newport Beach property was sold in a foreclosure sale in 2008. This does not detract from the fact that Evans intended to sell the property. However, this intention does not answer the question of whether Evans was in the business of selling property. Cf. Buono v. Commissioner, 74 T.C. at 200 (involuntary sale of properties by taxpayer was not significant in determining whether taxpayer's transactions were frequent and substantial).
As discussed supra, Evans testified that he had acquired several properties. However, he specifically identified only three properties he had acquired: (1) the rental property in Corona del Mar, California, (2) the tear-down property in Corona del Mar (which he acquired for development and sale), and (3) the Newport Beach property (which he acquired to rent or to develop and sell). Evans testified that he developed and sold a two-unit condominium on the tear-down property in Corona del Mar, but he did not indicate in his testimony whether the sale generated income. The Newport Beach property was sold at a loss in a foreclosure sale. Thus, of the two properties that Evans identified and that were potentially held for development and sale, only one may have produced any income. We surmise that Evans's primary source of income was his full-time job at Athens Group and that any income he may have earned from developing properties accounted for an insubstantial portion of his income. Cf. Gamble v. Commissioner, 242 F.2d 586, 591-592 (5th Cir. 1957), aff'g T.C. Memo. 1955-289.
Thus the Court concluded the IRS was correct—Mr. Evans did not have a trade or business for the purposes of IRC §1221(a)(1) and the loss therefore was a capital loss.

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