Sales of Real Estate Equal Ordinary Income or Capital Gain

SI Boo LLC was formed as a multi member LLC, treated as a partnership for tax purposes. SI Boo purchased real estate tax liens (certificates) at public auctions held by county tax collectors. These certificates could be assigned to other parties.  These certificates could also be "redeemed” by the real estate owners for various amounts based on the price sold at the auction. If the real estate owner didn’t redeem the certificate within a specific time frame, the holder of the certificate became the owner of the real estate.

After acquiring certificates, SI Boo attempted to sell them to third parties.  SI Boo’s method of making money was to borrow money to purchase these certificates and resell them at a profit.  If certificates were not transferred to other parties, SI Boo would try to negotiate a redemption by the property owner, tenants, or neighbors.  If this was unsuccessful, a “For Sale” sign would be put in the property’s yard or a real estate broker was hired to sell the property.  Some of the unredeemed properties sold were held for more than one year.  SI Boo’s 2007 partnership return showed $0 gross receipts, about $700,000 of deductions (mostly management fees paid to related companies), $1 million of short term capital gain, and $500,000 of long-term capital gains.  (SI Boo did not have any employees and relied entirely on the staff of the related companies, thus the management fees.)

Tax Court agreed with IRS determining SI Boo LLC’s purpose was to acquire certificates primarily for sale to customers in the ordinary course of a trade or business.  The subsequent sale of property not redeemed was considered to be a part of this same activity.  This “acquire and resell” activity was deemed to be a business activity and not an investment activity, therefore the income from the sales should be reported as ordinary income and not as capital gain.  Side note – Since this is ordinary income from a trade or business activity, it is also self-employment income.

SI Boo LLC, TC Memo 2015-19


This text has been shared with you courtesy of David & Mary Mellem, EAs & Ashwaubenon Tax Professionals.