Hello and thank you for your question.
According to the IRS, "[i]f you own a tract of land and, to sell or
exchange it, you subdivide it into individual lots or parcels, the
gain normally is ordinary income. However, you may receive capital
gain treatment on at least part of the proceeds provided you meet
certain requirements. See section 1237 of the Internal Revenue Code."
Here's a summary of the Section 1237 exception:
"In limited circumstances, [Sec. 1237] allows long-term capital gain
treatment when land held for investment is subdivided into lots. To
qualify for IRC 1237 all of these requirements will have to be met.
1. A C corporation cannot own the land.
2. The land is one tract of land. Other tracts can be owned, but not
be for sale simultaneously with the tract trying to be qualified.
3. The land had not previously been for sale in the ordinary course of
your trade or business. If you had previously held it for sale under
IRC 1237, it is eligible for consideration.
4. No Substantial improvements have been made, or as part of the sale,
agreed to be made.
5. You have held the property for at least 5 years or received the
property through inheritance.
6. No other real estate can have been held by you for sale to
customers in the year of sale.
Per IRC 1237, the term 'tract of real property' means a single piece
of real property, except 2 or more pieces of real property shall be
considered a tract if at any time they were contiguous in the hand of
the taxpayer or if they would be contiguous in the hand of the
taxpayer except for the interposition of a road, street, railroad,
stream, or similar property."
So in your example, if you purchased the land at least 5 years ago (or
inherited it), you'll qualify for capital gains.
As for the amount of the gain, the two .25 acre lots account for 50%
of the 100,000 cost basis, i.e. 50,000. So the capital gain would be
90,000 - 50,000 = 40,000 [if the Sec 1237 requrements are met].
Search terms used:
subdivide capital site:irs.gov
"section 1237" capital
Thanks again for letting us help.
Clarification of Answer by
20 Jul 2005 09:49 PDT
Certainly the IRS wants ordinary income from the subdivision, which
means every dollar of the $90,000 would be taxable. And in this area,
the word "subdivide" is generally poison, which is why they enacted
the section 1237 exception to protect casual subdividers.
But really it's a question of fact - - whether
*you held the lots primarily for sale to customers in the ordinary
course of a trade or business as a developer of real estate (ordinary
income and no basis allowed) or
*you didn't hold the lots primarily for sale to customers in the
ordinary course of a trade or business (capital gain and basis
Here's a very good article on the subject--if you think the particular
facts are enough on your side you might consider reporting a capital
gain, and disclose on your return why you're taking that position.
Understanding dealer status on the sale of real estate
Taxes, Oct 2002 by Swad, Randy