United States

Flip or flop—a cautionary tale of renovation and taxation


In a recent U.S. Tax Court case, the IRS challenged the ordinary loss treatment of a foreclosed piece of residential real estate. The taxpayer worked in the field of commercial real estate construction and development for approximately 35 years and also purchased residential real estate properties that he hoped to rent or tear down, rebuild and sell.

In 2006, he purchased a property in California. In 2008, the property was foreclosed, and the taxpayer received his share of the proceeds. He reported the loss as an ordinary loss asserting it was "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business."

As stated by the Tax Court, the factors taken into account to determine ‘ordinary course' treatment are:

  1. The nature of the acquisition of the property
  2. The frequency and continuity of property sales over an extended period
  3. The nature and extent of the taxpayer's business
  4. The activity of the taxpayer about the property
  5. The extent and substantiality of the taxpayer's transactions

The taxpayer stated he began acquiring properties in 1980 and had acquired multiple properties since but supplied few concrete details. He did not maintain records of his personal real estate development activities.

The taxpayer's primary source of income was his full-time employment with a development company, and his personal real estate activities represented an insubstantial portion of his income. This led the court to decide that the real estate activities were personal and did not constitute a trade or business and that the losses were capital in nature.

This case demonstrates the need for clear recordkeeping and consistent income streams to permit ordinary trade or business treatment for real estate activities.

Rebecca Warren

Senior Manager