Question

Howard purchased raw (undeveloped) land three years ago for $1,500,000 to develop into lots and sell to individuals planning to build their dream homes. Howard intended to treat this property as inventory, like his other development properties. Before completing the development of the property, however, he decided to contribute it to Counterpart Investors LLC when it was worth $2,500,000, in exchange for a 10 percent capital and profits interest. Counterpart’s strategy is to hold land for investment purposes only and then sell it later at a gain.

Issue 1. If Counterpart sells the property for $3,000,000 four years after Howard’s contribution, how much gain or loss is recognized and what is its character? [Hint: See IRC §724.]

Issue 2. If Counterpart sells the property for $3,000,000 five and one-half years after Howard’s contribution, how much gain or loss is recognized and what is its character?

an EMBEDDED excel spreadsheet showing the comparison of tax treatment under the two scenarios above. Please verify answers

Answer 1

Answer:

a.         Under Section 724(b), any gain or loss on contributed property that was treated as inventory by the contributing partner and sold by the partnership during the five year period beginning on the date of contribution is treated as ordinary gain or loss. Thus, the entire $1,500,000 gain from the sale of the land will be treated as ordinary gain.

b.         Section 724(b) only applies if contributed property is sold during the five year period beginning on the date of contribution. Because Counterpart sold the land after the expiration of this time period and held the land as investment property, it should recognize $1,500,000 of capital gain.