In recent years, an increasing number of people have acquired undeveloped land for investment. Eventually they may have to decide whether to subdivide the property or sell the tract of land intact. Subdividing often results in higher per acre prices, but it also requires more cash, work and time. Tax considerations may also be an important factor in the choice of alternatives.

A person holding real property primarily for sale in the ordinary course of a trade or business is considered a "dealer" and will pay taxes at ordinary rates on his profits. However, under a special statutory provision, a person who subdivides an undeveloped tract will generally not be considered a dealer if he holds the property at least five years, makes no substantial improvements to it, has not previously held it primarily for sale to customers, and does not so hold any other real property in that taxable year. Even if the taxpayer posses these tests, gain on the lots sold in and after the year in which the sixth lot is sold from a single tract will still be taxed as ordinary income to the extent of 5% of the selling price.

Court decisions have also established that if the taxpayer does not subdivide but instead buys and sells whole parcels of land, he will nevertheless be considered a dealer if his activities are found to constitute a trade or business. On the other hand, if his activities more nearly resemble those of an investor, his gains will be treated as long-term capital gains. In a recent court case involving a professional man who had gains for buying and selling nine separate parcels of undeveloped land over a four-year period, the following factors were held to support his investor status:

Profits from the sales were small in relation to his total annual income - from 5% to 30% in the years considered;

He did not plot, subdivide, advertise or otherwise actively attempt to sell the properties. He had merely used the services of a real estate agent who was approached by interested buyers from time to time;

The low frequency of sales was not sufficient to indicate dealer status.

If a person restricts his real estate transactions to the extent indicated above, he may reasonably expect to be taxed at capital gain rates on his land sales. But any other activity regarding undeveloped property may lead to dealer status and resulting ordinary income treatment.

(Ernst & Ernst Tax Notes)