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Mark S. Gardner, TC Memo 2011-137

The Tax Court decided in Memorandum 2011-137  that a self-employed contractor who regularly retained the properties he built or improved for their rental income was considered an investor.

In March of 2004, Gardner purchased property from his brother that had been approved for subdivision into five lots. He built a road to access the lots and built a house on one of the lots and conveyed it to his brother. He sold three of the remaining lots in November for $750,000, which he and his wife reported as generating a short-term capital gain of $373,841. Gardner testified that the three lots were appropriate for duplex housing and that he had originally intended to build multi-family homes on the lots, but that he had to sell them because of the expenses of building the road. The remaining lot was sold in 2005 for $215,742.

IRS recharacterized the sale of the three lots as a sale of property held for customers in the ordinary course of business, resulting in an increase in Gardner’s earnings from self-employment and the imposition of self-employment tax.  Under Code Sec. 1402(a)(3)(C)(ii), a self-employed individual can exclude the gains on the sale of real estate from self-employment income unless he realized the gains from property held primarily for sale to customers in the ordinary course of business.

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