Are You a Dealer? How the IRS Decides Dealer Status and What It Does to a 1031 Exchange

The IRS asks the question about each property and about the years before you sold it, not about your license

Section 1031(a)(1) covers real property held for productive use in a trade or business or for investment, and section 1031(a)(2) says the subsection "shall not apply to any exchange of real property held primarily for sale." Section 1221(a)(1) uses the same phrase to strip capital-asset status from property held primarily for sale to customers in the ordinary course of business, so losing on one usually means losing on both.

In Malat v. Riddell the Supreme Court held that "primarily" means "of first importance" or "principally", not merely substantial. A builder who also keeps rentals is therefore not a dealer for everything; the dealer property definition covers the vocabulary, and this page is about sorting your own holdings.

In Boree v. Commissioner the Eleventh Circuit wrote that a proper analysis "should take into account a reasonable period of time prior to the sale, if for nothing else but to determine whether the taxpayer's intent changed." The owners had sold about sixty lots between 2002 and 2006, then sold the remaining 1,067 acres in one bulk sale; the court affirmed ordinary income.

Seven factors decide it, and the number and pace of your sales count for more than the other six together

The Fifth Circuit's list in Bramblett v. Commissioner is the one examiners and courts still use:

Bramblett adds the sentence that settles most cases: "The frequency and substantiality of sales is the most important factor." Biedenharn called it "the preeminent ground in our analysis" and warned that when sales of subdivided property "extend over a long period of time and are especially numerous, the likelihood of capital gains is very slight indeed." Five sales in three years was investment conduct in Bramblett; 208 lots over thirty-one years was a business in Biedenharn.

That is why a retiring developer's last big parcel is dangerous: a tract platted, advertised and sold lot by lot for years passes that history to the bulk sale of the remainder, as it did in Boree. A tract you bought, never platted and sold once to a single buyer sits on the other side of the line: Reg. section 1.1031(a)-1(b) says unproductive real estate "held by one other than a dealer for future use or future realization of the increment in value" is held for investment. Selling a tract to a developer covers the land-only version.

• the nature and purpose of the acquisition of the property and the duration of the ownership;
• the extent and nature of the taxpayer's efforts to sell the property;
• the number, extent, continuity and substantiality of the sales;
• the extent of subdividing, developing, and advertising to increase sales;
• the use of a business office for the sale of the property;
• the character and degree of supervision or control exercised by the taxpayer over any representative selling the property;
• the time and effort the taxpayer habitually devoted to the sales.

Section 1237 lets a non-corporate owner subdivide without becoming a dealer, with a five-year hold and a toll from the sixth lot

Section 1237(a) says a lot in a tract held by a taxpayer other than a C corporation "shall not be deemed to be held primarily for sale to customers in the ordinary course of trade or business" if you did not previously hold the tract for sale and hold no other dealer real estate in the year of sale, made "no substantial improvement that substantially enhances the value of the lot or parcel sold," and held the lot for five years. Water, sewer, drainage and road work is excused only on a lot held ten years, and only if you forgo adding its cost to basis.

The safe harbor has a price: from the year the sixth lot from the tract is sold, section 1237(b)(1) makes gain on each qualifying sale ordinary income up to 5% of the selling price. It answers the capital-asset question in section 1221, not the investment question in section 1031, so treat it as evidence of investor conduct, not a ticket into an exchange.

Separate entities keep the investor and the dealer apart, if the money and the paper follow the separation

Bramblett is also the leading case on structure: a partnership bought land for investment and sold it to a corporation owned by the same four people in the same proportions, which developed and sold the lots. The Fifth Circuit held the partnership's gain was capital gain because it sold at fair market value, kept its own books and left the development profit in the corporation; "common ownership of both entities is not enough to prove an agency relationship."

Two rules police the boundary. Section 1239 makes gain ordinary income when depreciable property is sold to a corporation or partnership more than 50% owned by you, so the structure works for raw land and not for buildings, and section 1031(f) undoes an exchange with a related party when either side disposes of its property within two years.

Being wrong costs more than the exchange. Section 453(b)(2)(A) and (l)(1)(B) deny the installment method to a dealer disposition of real property, and Reg. section 1.1400Z2(a)-1(b)(11) limits opportunity zone deferral to gain that "is treated as a capital gain for Federal income tax purposes or is a qualified 1231 gain." A dealer's profit has none of the three exits.

Worked model: a builder with spec homes, an apartment building and an unplatted tract

These numbers are hypothetical and rounded. A builder winding down holds twelve spec houses sold over the last three years, a 40-unit apartment building she built nine years ago and has rented since, and a 20-acre tract bought seven years ago, never platted and now under contract to one buyer.

• Spec houses: $900,000 of profit. Held primarily for sale, so ordinary income in the year of each closing, with no installment reporting, no exchange and no opportunity zone deferral.
• Apartment building: sold for $6,000,000 against a $2,400,000 adjusted basis. Held for productive use in a trade or business, so the $3,600,000 gain, including the depreciation component, is deferred in a complete exchange.
• Tract: $2,000,000 sale against a $500,000 basis, one buyer, no improvements. Investment conduct under Reg. section 1.1031(a)-1(b); the $1,500,000 gain can be exchanged or, sold for cash, can go to an opportunity zone fund within 180 days as capital gain.
• Keep the spec-house sales in their own entity, and have your CPA re-run these figures on your actual basis before you sign anything.

Where the investment properties go: a DST ends the operating work, and the dealer gain has nowhere to hide

A builder who is retiring usually wants the apartment building's equity to keep working without a construction office behind it. Under Rev. Rul. 2004-86 a DST beneficial interest is an interest in the trust's real property, so a traditional DST can take the full $6,000,000, all-cash if the building was debt-free or financed if a loan has to be replaced. The ruling binds the trustee: it cannot renegotiate leases, take on new capital or make more than minor non-structural changes. DST interests cannot be sold on demand, the sponsor sets the holding period, and the property can lose value, so the principal is at risk.

An owner who still wants to decide when to sell can take title through a direct title security instead. The dealer gain stays outside all of these: it is taxed as ordinary income in the year of sale, and the cleanest course is to pay the tax and stop building the record that creates it.