Tax lien purchasers held properties acquired by tax deed primarily for sale in the ordinary course of their business and earned ordinary income from the sale of those properties (SI Boo, LLC v. Commissioner, T.C., No. 174-11, T.C. Memo. 2015-19, 2/4/15).
The U.S. Tax Court held Feb. 4 that a group of entities that purchased Illinois real property tax liens primarily to earn income from the penalty percentage paid by the owners when the liens were redeemed were also in the trade or business of holding those properties for sale when they acquired the tax deeds.
Judge Elizabeth Crewson Paris said the related entities, S.I. Securities LLC, Sabre Group LLC and SI Boo LLC, couldn’t treat income from the sale of the real properties they acquired by tax deed as short- or long-term capital gain as the entities had reported on their 2007 and 2008 tax returns.
Capital Gains Reported
The entities reported for the 2007 and 2008 tax years a combined ordinary business loss of $1.5 million, short-term capital gain of $2.73 million, long-term capital gain of $1.04 million and installment sale income of $353,922.
The entities argued that the gain from the sale of properties shouldn’t be treated as ordinary income, because the sales weren’t frequent compared to the number of certificates of purchase of tax liens they acquired.
The Internal Revenue Service said the property sales were frequent and regular without any trend to holding the properties as investments. Paris agreed with the IRS.
Frequent, Regular, Substantial
“The entities’ own accounting records, as well as the testimony presented at trial, showed that the entities desired to dispose of the real properties quickly and frequently and with the intent to make a profit and were successful,” Paris said.
“Frequent, regular, and substantial sales of real property are indicative of sales being made in the ordinary course of a trade or business, whereas infrequent sales of these properties are more indicative of real property held for investment purposes,” the judge said.
The sales of the properties were integral components in the entities’ “respective trades or businesses, permitting them to profit from both the acquisition of the certificates of purchase of tax lien and the sales of properties if those certificates were not redeemed,” Paris said.
Paris further found that the entities couldn’t use installment sales method of accounting under tax code Section 453, because the sales were “dealer dispositions” under Section 453(b)(2)(A).
In addition, Paris ruled that “the entities should have included the income in their reported net earnings from self-employment” under tax code Section 1401(a) and (b).
Farrell, Hamilton & Julian PC represented S.I. Securities, Sabre and SI Boo. Stephen A. Haller represented the commissioner.
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