## Facts

- Sugar Land Ranch Development, LLC (SLRD) was formed in 1998 to acquire contiguous tracts in Sugar Land, Texas and develop them into residential lots and commercial tracts.
- In 1998 SLRD acquired roughly 942.6 acres; the land had formerly been an oil field and was near a related master-planned development.
- From 1998 to 2008, SLRD undertook preparatory activities consistent with potential development, including capping oil wells, removing lines, environmental work, constructing a levee, and entering a development agreement with the City of Sugar Land.
- During 1998–2008, SLRD sold or otherwise disposed of relatively small portions of the tract, retaining about 824.7 acres by 2008.
- The remaining acreage included several large parcels west of an easement; three parcels (TM-1, TM-2, TM-3) totaling about 580.2 acres were later sold to a major homebuilder.
- In late 2008, due to the housing/credit crisis and financing constraints, SLRD’s managers decided not to subdivide or develop and instead to hold the land as an investment until market conditions improved; this decision was documented in a 2008 unanimous consent and a 2009 member resolution.
- From 2008 to 2012, SLRD did not develop, subdivide, list, or otherwise market the TM parcels; the parcels “just sat there.”
- In 2011, the eventual buyer approached SLRD; the buyer acquired TM-1 in 2011 and acquired TM-2 and TM-3 in 2012 for lump-sum amounts.
- On its 2012 partnership return, SLRD reported approximately $9.5 million of capital gain from the 2012 sales of TM-2 and TM-3.
- The IRS issued an FPAA under TEFRA recharacterizing the 2012 gains as ordinary income on the theory that the parcels were held primarily for sale to customers in the ordinary course of a real estate business.
- SLRD petitioned for readjustment of partnership items; the only substantive dispute was the character of gain and loss from the 2012 TM-2 and TM-3 sales.

## Issues

1. Whether TM-2 and TM-3 were “capital assets” under I.R.C. § 1221 in 2012.
2. Whether TM-2 and TM-3 instead fell within § 1221(a)(1) as property held primarily for sale to customers in the ordinary course of SLRD’s trade or business, making the 2012 gain and loss ordinary.

## Decision

- The Tax Court held that, by 2012, SLRD was no longer in the business of developing and selling real property and held TM-2 and TM-3 for investment.
- The court concluded that gain and loss from the 2012 sales of TM-2 and TM-3 were capital, not ordinary.
- The court rejected the FPAA’s recharacterization of the 2012 gains as ordinary income; remaining computations were to be resolved under Rule 155.

## Legal Principles

- Under I.R.C. § 1221(a)(1), real property held primarily for sale to customers in the ordinary course of a taxpayer’s trade or business is excluded from capital-asset treatment.
- Classification turns on a fact-intensive inquiry that commonly considers: acquisition purpose; purpose at time of sale; development and sales efforts; frequency and continuity of sales; and the nature and extent of the taxpayer’s business.
- The controlling focus is the taxpayer’s purpose and conduct at the time of sale; property originally acquired for development can change character to investment property if the taxpayer credibly ends dealer-type activity and holds the property for investment.
- A substantial hiatus in development and marketing, passive receipt of an unsolicited purchase approach, and bulk sales of large undeveloped parcels tend to support investment status rather than dealer status.
- Contemporaneous documentation and consistent conduct supporting a change in business plan may be credited in determining whether the taxpayer’s primary holding purpose shifted from sale to investment.

## Conclusion

The Tax Court determined that SLRD’s documented post-2008 shift away from development, combined with years of inactivity and a later bulk sale initiated by the buyer, established that TM-2 and TM-3 were held for investment in 2012; thus, gain and loss on their sale were capital rather than ordinary under § 1221(a)(1).


Sugar Land Ranch Dev., LLC v. Comm’r, T.C. Memo. 2018-21 (2018)