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Development of Farm Ground

codeblue123
Level 3

New client developed their farm into 6 lots.  If the land were to be sold before being developed it would be taxed as long-term capital gains.  Since they paid contractors to develop the land into 6 individual lots, does that mean they cannot get capital gains treatment?

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IRonMaN
Level 15

Why would paying contractors change how the sales will be taxed?

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codeblue123
Level 3

If they develop the land does it cause it to be taxed as ordinary income?  I expect if they build a home on a lot, that they would be taxed as ordinary income and not capital gains rates.  I am trying to understand if developing the land causes these sales to be from a trade or business and subject to self employment taxes.  I know flipping a house is subject to self employment taxes.

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IRonMaN
Level 15

Sales are treated as ordinary income if you are in the business to sell properties.  The more sales you have, the more you sound like you are in the real estate sales business.

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qbteachmt
Level 15

"Since they paid contractors to develop the land into 6 individual lots, does that mean they cannot get capital gains treatment?"

"I am trying to understand if developing the land causes these sales to be from a trade or business and subject to self employment taxes."

I think the miscommunication comes from using the word "develop." What does "develop" mean in this case?

Was this an entire farm property, no longer being farmed? Inherited farm, some small section carved out of it? A parcel of land which includes their own house, bought a few years ago and now having the excess land carved into 6 individually titled lots and paying someone to do some grading and making some approaches? Putting in sewer and water and power? Putting up homes?

 

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codeblue123
Level 3

This farm ground was purchased years ago, and their personal residence is still on this property.  About half of the farm ground is still going to be farmed and the other half will be sold this year as developed lots.  Developed in this case means: sewer, water, power & grading.  Sounds like these lots would fall under the investment category and qualify for long-term capital gains rates and reported on Sch D.

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BobKamman
Level 15

@codeblue123 "Sounds like these lots would fall under the investment category"

Sounds to me like a farmer who became a real estate developer.  

codeblue123
Level 3

So do you think that developing this land to sell, changes them from Capital Gains to Income subject to self-employment taxes?

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BobKamman
Level 15

@codeblue123 "So do you think that developing this land to sell, changes them from Capital Gains to Income subject to self-employment taxes?"

Maybe.  It's a "facts and circumstances" question, and I'm sure we don't know all of them.   There is no "one-off" exception or definition in the Code.  But if there were, it would probably say that Lot #1 might qualify; Lots #2 through #6, if they were bullets instead, are what changes it from manslaughter to first-degree murder. 

abctax55
Level 15

"... I know flipping a house is subject to self employment taxes."

That blanket statement is not always correct.

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codeblue123
Level 3

Would it have to have been rented out or held on long enough to show an investment intention.  Can you tell me situations when it would not be subject to self-employment taxes?

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sjrcpa
Level 15

When it's a one off.


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qbteachmt
Level 15

"Can you tell me situations when it would not be subject to self-employment taxes?"

"When it's a one off."

I agree. That's why I listed various options in that specific way.

They are not "in the business" of buying a home on a farm, then breaking up the farm land. They are selling part of their personal property not in use as a farm, to be built on by others.

Here's what would make it fall under SE: They decide to develop and build spec homes ("spec" = "speculative" homes to be listed for sale). Each of these is part of their intent to generate a profit from a finished product, and they are doing it 6 times.

Or, they intend to build and then Rent everything out, to be the landlord, and they want to sell the properties later. That is another example of, Hey, I'm running a Business here.

Your client doesn't seem to have a business intent. They simply hope to make a profit from the property they invested in years ago.

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