Sc-C or Sch-D

[cientax]

Have a client that bought a house in 2008 but did not tell me until this year when they brought me 2009 paperwork. They sold the house in 2009 after they fixed it up. The made aprofit on the sale but because they didn't tell me about this when the 2008 tax return was prepared, all expenses for the fixing up that were done in 2008 were expensed on the 2008 return. The continued to fix it up in 2009 then sold it but now they don't have much to add to basis or cost. They held the property for less than one year, this is the only one that they have bought, fixed up and sold and don't intend to do this again. Husband is in the construction business and works for another developer and files Sch-C. Because of the holding period being less than one year and because the husband is in the construction business, does this have to be reported as Sch-C or can we report this sale on Sch-D?

[GeneInAlabama]

Looks like a sch D investment to me since he's not in the business of buying houses and fixing them up. I don't see that his sch C business has any bearing on this.

[GeneInAlabama]

I just reread the original post and since the expenses of fixing up the house were on the 2008 return, I would file an amended return for 2008.

[jainen]

>>n the construction business, does this have to be reported as Sch-C<<

Seems so to me. He's a builder; that's what he does for a living. He wasn't holding the property for capital appreciation, that is, profit from the action of market forces over time. His profit was a direct result of his own professional activity. And obviously he himself considers it all part of the same business, since he deducted his operating costs (including what should probably have been cost of goods sold) as business expense. And not just on the tax return--I would guess he used his contractor's deduction in purchasing materials, charged it to the business account, paid it out of the same checking account used for other business income and deductions.

In my opinion, you haven't given even a single fact that points to Schedule D.

[OldJack]

Based on the facts as stated I agree with Gene. I would argue that the deduction in 2008 was an error due to the taxpayer being a "small person" not knowing what he was doing. Fact is that a proprietorship is not required to keep a formal set of books and is not required to keep separate accounts used only for business purchases. A proprietorship only has to prove its income and deductions. Therefore, I see no reason the taxpayer could not purchase investment property materials from a supplier that he commonly purchases materials for his proprietorship Sch-C business. The main subject for this property classification is the taxpayers intent with the property and it appears to me that it was a personal investment reportable on 1040 Sch-C. Always ask the taxpayer his intent rather than assume or decide his intent.

[Gail in Virginia]

I have to agree with Jainen on this one. The increase in value comes not from appreciation, or even the addition of materials, but from the addition of the skilled labor this contractor is in business to provide. This might be a one-shot deal for him, but it is so closely related to his business that I don't see it as anything other than an extension of his business. There could be other facts and circumstances that would change my mind such as they he did not do any labor of significance on the house, but as it stands it looks to me like it is Sch. C.

[jainen]

>>I would argue that the deduction in 2008 was an error due to the taxpayer being a "small person" not knowing what he was doing... Always ask the taxpayer his intent rather than assume or decide his intent. <<

In my opinion, these two sentences are contradictory. Why would you assume that a professional does not know whether his work is professional?

I don't understand your interpretation of intent. It's a pretty vague concept at best, and is generally understood in terms of what actually happened. In this case, it appears he intended to respond to an economic slowdown by developing a new market for his business skills and resources in a short term construction project, reporting the activity on his business return. Apparently he did not intend to hold the property for investment. At least, that's the way he actually implemented whatever his true intent was.

[OldJack]

>>Apparently he did not intend to hold the property for investment.<<

I find it difficult to understand how you can decide the taxpayer's intent from the original post information provided only by a tax preparer. I have no problem with accepting that a professional can enter into an investment activity if it is his/her intent, regardless of his other business activities and their success or failure. According to your logic a construction company owner is not allowed the classification of an investor (Sch-D transaction) if he purchases any real estate property simply because he works on buildings.

[OldJack]

>>I have to agree with Jainen on this one. The increase in value comes not from appreciation, or even the addition of materials, but from the addition of the skilled labor this contractor is in business to provide. <<

An increase in value from appreciation is only one factor in entering into a business transaction for profit. The original post only said "Husband is in the construction business and works for another developer and files Sch-C." This so called construction business sounds like a developer's employee not classified as an employee and for all we know he could be a ditch digger. That would hardly be the "skilled labor" you refer to. I guess you would not allow a real estate salesman to invest in real estate and report the sale on Sch-D?

[jainen]

>>how you can decide the taxpayer's intent<<

I didn't decide it. I just said it appears that way. To me, it doesn't seem he intended to hold it for investment because he didn't hold it for investment. He sold it instead. And it further seems to me that he held it for a purpose other than investment because he treated it as other than investment.

[Pacun]

From 2005 Enrolled agent exam:

56. John is a furniture maker and carpenter. John makes

half of his income as an employee of Concept Designs,

Inc., a fine furniture manufacturing corporation. John

makes the other half of his income from a personal business

where he purchases, renovates and then resells

houses. In January of 2004 John purchases a house

that is not his residence for $50,000. He spends $10,000

in materials renovating the house, which he sells in November

of 2004 for $90,000. What is the amount and

character of Johns gain from this transaction?

A. $20,000 ordinary gain

B. $30,000 short-term capital gain

C. $30,000 ordinary gain

D. $20,000 short-term capital gain

Answer is C.

I know this gives both Jainen and Oldjack equal ammunition. The key on this question is that "John

makes the other half of his income from a personal business where he purchases, renovates and then resells

houses." That's not the case with the taxpayer on this posting.

From a logical point of view, Let's imagine that I buy a buiding for $600K, then spend $100K in materials and I remodel the building, meaning that I work doing this type of construction work. It takes me 13 months to remodel the building and then I sell it for $900K. Somehow, I should pay SE taxes on a good portion of the $200K profit, if not all. I don't think that reporting this on Sch D long term gain is correct.

I agree that we don't know what kind of work the TP does in a construction but a hole digger will not have much expense for materials.

I would not amend 2008, wait a minute, maybe I should amend because materials should be added to the basis of the house and the benefits of such expenses should be in 2009 taxes when the house was sold, NOT in 2008.

[Gail in Virginia]

>>I have to agree with Jainen on this one. The increase in value comes not from appreciation, or even the addition of materials, but from the addition of the skilled labor this contractor is in business to provide. <<

An increase in value from appreciation is only one factor in entering into a business transaction for profit. The original post only said "Husband is in the construction business and works for another developer and files Sch-C." This so called construction business sounds like a developer's employee not classified as an employee and for all we know he could be a ditch digger. That would hardly be the "skilled labor" you refer to. I guess you would not allow a real estate salesman to invest in real estate and report the sale on Sch-D?

If you will re-read my post, I did say that there could be other facts and circumstances that would change my mind. If the taxpayer does dig ditches for the developer and therefore did not provide any skilled labor of his own on this house, but rather hired sub-contractors to do the work, then this could be investment property rather than inventory. Many times in these questions we do not have the entire picture and can only offer opinions based on past circumstances and situations we have dealt with. A real estate salesman would be in a different situation than a contractor.

[GeneInAlabama]

>>If the taxpayer does dig ditches for the developer and therefore did not provide any skilled labor of his own on this house, but rather hired sub-contractors to do the work, then this could be investment property rather than inventory.<<

Even if the contractor does NO work and contracts ALL of it out, if he is in the business of buying houses and fixing them up for resale, it would be a schedule C. In the original post, it stated that this was his first house and he had no intention of buying any other houses to fix up. I don't see that the fact that he has a schedule C business (plumber, electrician, brick layer, whatever) has anything to do with THIS house. If he bought this house with the INTENT of going into the house fixing up business, then it would be a different story. The original post states that he was in the construction business and WORKS FOR ANOTHER DEVELOPER which I take as being a sub contractor or a mistitled employee. It seems that he found a house that he could buy at a good price and bought it with the intention of reselling it and making a profit. Does the amount of work he had to do to it to resell it make a difference?

[GeneInAlabama]

>>To me, it doesn't seem he intended to hold it for investment because he didn't hold it for investment. He sold it instead.<<

If you buy something and never resell it, how can it be an investment? If I buy a widget for $10,000 and someone comes along the next day and wants it bad enough to pay me $20,000 for it, would that make it not an investment if I sold it to him? I bought a dining room table one time at an auction and before I got it loaded on my truck, a lady came by and offered me a price much higher than what I paid for it. I loaded it on her truck instead of mine.

[jainen]

>>If you buy something and never resell it<<

The question is not the purpose for which it was sold, but the purpose for which it was held. I am not going to cite tax rulings, so you can ignore my opinion if you dare. In both the general understanding of economic theory, and the specific usage in our tax code, investment implies property held for appreciation due to market forces over time.

[OldJack]

so you can ignore my opinion if you dare. In both the general understanding of economic theory, and the specific usage in our tax code, investment implies property held for appreciation due to market forces over time.

So now we can all quote Jainen as a tax authority (if you dare)!!

I disagree that the definition of investment is only property held for appreciation. Investment property can be held for various reasons including income production or protection of other property.