In Mauldin v. Comr. 195 F.2d 714 (10th Cir. 1952), the court explained that there is no fixed formula or rule of thumb for determining whether property sold by a taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must rest upon its own facts. The court identified a number of helpful factors to point the way, among which are the purposes for which the property was acquired, whether for sale or investment; and, continuity and frequency of sales as opposed to isolated transactions. However, in Adam v. Comr. 60 T.C. 996 (1973), acq., 1974-1 C.B. 1., the Tax Court analyzed the following factors in determining whether the taxpayer was engaged in the operation of a trade or business:
1. The purpose for which the asset was acquired: Examples of good facts that support the conclusion that the sale of property is excluded from unrelated business taxable income is when the property was originally acquired to further the organization’s tax-exempt purpose – in the case of a Self-Directed IRA – investment.
2. The frequency, continuity, and size of the sales: This factor is particularly significant in determining whether the sale constitutes a trade or business that is regularly carried on, within the meaning of Internal Revenue Code Section 512. It may range from a one-time sale of a parcel of land to many sales over a long period. If sales are infrequent, not continuous, and small, the organization will not likely be viewed as similar to a taxpayer in the trade or business of selling real estate. Conversely, as sales become more frequent, more continuous, and larger, they are more likely to be considered a trade or business that is regularly carried on, comparable to the commercial activity of a taxpayer in the trade or business of selling real estate.
However, in PLR 9247038, the IRS issued a favorable ruling to an organization that planned to sell land in up to 15 sales spread over a five- to 10-year period. The reason for the number of sales over the time period was that the value of the land was such that it was unlikely a single purchaser would be able to acquire the entire parcel. Also, market conditions dictated this sales process for the organization to receive maximum value, and keep control of the pace and type of development that would occur after the sales. Similarly, in PLR 9017058, where the exempt organization was engaged in selling 45 of 68 lots, such sales were deemed to meet the exception from unrelated business income under Internal Revenue Code Section 512(b)(5). Although this quantity of sales is admittedly significant, external forces essentially dictated the high number of sales. The organization first tried to sell the property in one block but was unsuccessful due to the high cost of developing the property in order to comply with local ordinances. According to the IRS, had these two facts been absent, i.e., (1) the organization had attempted to sell the entire property as a whole, and (2) local ordinances required certain development prior to sale as residential property, it is possible that the high number of sales in this case would have resulted in unrelated business taxable income.
Thus, a limited number of sales is usually a “good fact” for purposes of the facts and circumstances test. However, one should not assume that a set limit applies such as, for example, 15 sales. Rather, one should remember that factors such as that frequency of sales and cost of the property to be sold and market conditions play a part in the number of sales allowed and the time frame of the sales allowed. If an organization has significant amounts of acreage, or the cost of the property precludes finding one purchaser, then it is more likely that the organization will be permitted to sell the property in more than one transaction, and still comply with the requirements of Internal Revenue Code Section 512(b)(5).
3. The activities of the seller in the improvement and disposition of the property: The smaller the extent of improvements by the organization to the property, the more likely the sale will fall under the exclusion for unrelated business income under Internal Revenue Code Section 512(b)(5). In PLR 8043052, an organization proposed to sell a parcel of undeveloped raw land . The fact that the land had remained undeveloped was significant in determining that gains from the proposed transaction would not constitute unrelated business taxable income. In PLR 8522042, the property in question consisted of both developed and undeveloped lands. The developed lands included residential land improved with single-family dwellings or condominium apartments. However, all the improvements were constructed by unrelated third parties. The absence of development activity by the organization demonstrated that it was not holding property for sale to customers in the ordinary course of trade or business.
4. The extent of improvements made to the property; The more minimal the activities of the owner in improving and disposing of property, the more likely its sale will meet the exclusion from unrelated business taxable income under Internal Revenue Code Section 512(b)(5). Of course, the greater the number of improvements allowed, the greater the likelihood of maximizing gain from the sale. So there is a balancing act that organizations must exercise when preparing land for disposition in order to maximize its return, while not acting too much like a dealer and triggering UBIT.
The IRS ruled favorably on improvements made to property in accordance with city or local ordinances requiring the organization to construct a street as well as curb, gutter, sidewalk, drainage, and water supply improvements in order to subdivide the property for sale.
Retaining limited control of the redevelopment project before the land is eventually sold also has been an acceptable activity by a tax-exempt organization when the organization is not involved in any way with advertising, marketing, or otherwise attempting to sell the lots. In PLR 200544021, an organization maintained control over the development process to ensure a compatible environment for the adjoining high school. The IRS recognizes that even though an organization is concerned with receiving a high yield from the sale, it may be equally concerned that the property be developed in keeping with the surrounding features of the property. In addition, an organization’s interest in preserving the natural beauty of a tract of land to be developed is not generally indicative of a normal sales transaction.
In PLR 8950072, a tax-exempt foundation’s largest asset was a parcel of unimproved real estate. The foundation was examining four ways of using the property: (1) continue leasing the property; (2) sell the property as is; (3) complete some preliminary development work — obtaining permits and approvals — and sell the property; or (4) completely develop the property before sale. The last alternative would provide the highest return. The IRS ruled that the first three alternatives would not subject the foundation to UBIT or adversely affect its exempt status. However, the last alternative, to assume all the responsibilities of development, would result in UBTI , but would not affect the foundation’s exempt status. Alternative 4 is very similar to the situation in Brown v. Comr. Like that case, the taxpayer intended to subdivide and develop the property for sale to the general public. Such sales would not be isolated or casual transactions. The organization planned to be extensively involved in both development and marketing activities. Thus, the IRS concluded that the property will be held primarily for sale to customers in the ordinary course of trade or business and not subject to the exclusion from unrelated business income of Internal Revenue Code Section 512(b)(5).
Aside from development activities, the lack of marketing of the property by the organization helps differentiate it from a taxpayer in the trade or business of selling real estate. For example, in PLR 8522042, an organization’s lack of promotional or development activity in connection with the proposed sale demonstrated that it was not holding property for sale to customers in the ordinary course of a trade or business. Moreover, the use of real estate brokers or other independent contractors is not determinative. Rather, the pertinent facts involve the extent of the activities of the organizations themselves in promoting and marketing the property.
5. The proximity of sale to purchase: In evaluating this factor, generally the longer the period between purchase and sale, the more likely the sale will be excluded from UBTI . For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period of time was considered a favorable factor, and the IRS did not impose UBIT on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.
6. The purpose for which the property was held during the taxable year: In evaluating this factor, generally the longer the period between purchase and sale, the more likely the sale will be excluded from UBTI . For example, in PLR 9505020, the fact that a school received land by bequest and held it for a significant period of time was considered a favorable factor, and the IRS did not impose UBIT on the sale of the land when the school was facing condemnation proceedings and it did not actively advertise the sale.
In Adam and subsequent cases, the Tax Court found that no single factor is controlling but all are relevant facts to consider in determining whether the sale of property occurred in the regular course of the taxpayer’s business. In numerous private letter rulings, the IRS cites and applies these same Adam factors. The IRS has characterized these factors as a “facts and circumstances test.” The IRS has even applied these same factors when analyzing the activities of an exempt organization that are carried out through a limited partnership between the exempt organization and the developer.
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