Can Post-Acquisition Land Use Restrictions Change Ordinary Income To Capital Gain?

In Boree v. Commissioner, 118 AFTR 2d 2016-5742 (11th Cir., Sep. 12, 2016), the Eleventh Circuit held that the county's adoption of subdivision regulatory requirements after taxpayers had purchased certain real property was insufficient to show that the taxpayers had changed their intent in holding the underlying property from development to investment; accordingly, the taxpayers' gain from the sale of the underlying property constituted ordinary income.

The taxpayers in Boree acquired vacant real property in November 2002 (the "Property"). Shortly thereafter, the taxpayers sold one small parcel of land. The taxpayers then submitted plans to the county to rezone the Property for residential development. The county approved the plans proposed by the taxpayers and rezoned the Property to allow 10-acre lots. After the rezoning in 2003, the taxpayers sold an additional 15 lots. From 2003 to 2004, the taxpayers created a homeowners' association for the Property and held themselves out as the developers of the Property, both in writing and in actions taken by the taxpayers such as obtaining the county's approval for the Property development plan, applying for permits, establishing easements for utilities, and constructing an unpaved road.

In 2005, the county adopted a new requirement that all subdivision roads be paved. At this time, the Property had a number of unpaved roads. Accordingly, the taxpayers requested an exception from the county's new requirement, due to the high cost of compliance for the taxpayers. The county denied this request. The taxpayer submitted another rezoning request to the county for a planned unit development that would increase the density at the Property to offset the costs of paving the roads. Although the county recommended approval of this plan, the taxpayers withdrew the proposal and instead sold all of the Property to another developer that owned an adjacent tract of land.

The taxpayers reported gain from the sale to the developer as long-term capital gain, although the taxpayers had reported ordinary losses from various other lot sales occurring between the time of acquisition and the developer sale in 2007. The taxpayers argued that their purpose and intent in holding the Property changed when the county adopted the new paved roads requirement.

Generally, any property held by the taxpayer is a capital asset unless the property satisfies one of the statutory exceptions. However, a sale of "property held by the...