Q: I have put down $10,000 for two beach condos in a pre-construction deal.
The cash is to hold my position and the initial price at which the properties were offered for sale.
The condos are priced at $403,000 and $500,000. In August, I have to put down an additional 15 percent.
I want to know what the tax consequences would be if I were to flip these properties before construction is scheduled to be finished (in about 15 months). When does the time period start for the long-term capital gain requirement?
Is it when I put down the $5,000 per unit option price to hold my place? When I put the down payment cash into escrow or when I actually close on the properties?
I’m in the highest tax bracket and I know that I would save a lot of money if this purchase were viewed as a long-term gain. Thank you so much for your time.
A: I know it’s tax season when the complicated questions start arriving in the ThinkGlink.com mailbox.
I ran your question by Chet Burgess, an enrolled agent who also owns Brookwood Tax Service in Atlanta (www.brookwoodtax.com).
According to Burgess, if you make a profit by selling something that you own, you have a taxable gain. Just what kind of gain hinges on the question of what it is that you bought and when you are considered to have made the purchase under tax law.
Burgess says if the initial $10,000 payment buys you a transferable contract or an option to buy the property, then your holding period begins with that payment.
If you do not have a transferable contract or option until you make the 15 percent down payment in August, then your holding period begins with that payment.
If you do not have a transferable option to buy until some time after August, then your holding period will begin at the point that you have a transferable option to buy.
In any case, if you sell your transferable contract or option to buy less than 12 months after you obtained it, any gain will be a short-term capital gain, taxable at your top ordinary income rate.
If you sell your transferable contract or option to buy more than 12 months after it was signed, any gain may be considered a long-term capital gain taxable at the 15 percent capital gains tax rate.
Of course, if your contract or option to buy is not transferable prior to completion of construction, then your holding period does not start until you close on the purchase of either condo.
For more information, you might want to check out IRS Reg 1.1234-1, “Options to Buy or Sell,” which is available for free at www.irs.gov. As the regulation explains, capital gains tax rates apply to capital assets and real estate is considered a capital asset.
However an option to purchase real estate might or might not be considered a capital asset. Much will depend on the terms of the document you have signed and the rights it does and does not give you. What many pre-construction buyers don’t realize is that often, developers will write contracts that prohibit you from assigning your rights under the contract.
The characterization of your right to buy is going to be the determining factor in finding out whether long term gains are achieved when you signed the contract or whether you have to wait until you close on the purchase of the units.
As always, each taxpayer’s position is unique and any advice offered here is by necessity general and educational in nature. You should consult a tax professional for advice specifically tailored to this particular situation.
Feb. 21, 2006.