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Dealer Property defined in Oregon case

Sunday, October 18th, 2009 by Moore McLaughlin

In order for property to qualify under section 1031, the property must be held for productive use in a trade or business or held for investment. Property that is held primarily for sale is disqualified under section 1031. One of the most uncertain areas of the law under section 1031 is whether a particular piece of property is held for investment. The IRS has never given any hard-and-fast rules. Taxpayers must rely on a hodge-podge of cases and rulings.

A recent case froma state court in Oregon addresses the issue of whether a parcel is held for investment or held primarily for sale. In Bahr v. Oregon Department of Revenue, Oregon Tax Court - Magistrate Division, TC-MD 080525B (2009), the Oregon Tax Court ruled that a bulk sale of raw land, originally acquired for investment, which was subdivided into lots, partially improved and sold to a builder was held as an investment and therefore qualified for tax deferral under Oregon law which follows IRC 1031 for state income tax purposes.Oregon

In Bahr, taxpayers (a husband and wife) were in an informal partnership with their sister and brother-in-law. In 1996 the partnership acquired five acres of raw land in a 1031 exchange for a duplex. At the time of this initial exchange the partnership was considered an investor in the property. In 2001-2002 the other partners built a personal residence on a portion of the property. In March 2004 partnership applied to subdivide the land into 27 individual lots. At the time this application was submitted, the partnership agreed to sell 22 of the lots to a developer. The partnership’s subdivision application was approved in 2004. Pursuant to their agreement with the developer, the partnership immediately began infrastructure improvements on the lots including placing roads, underground utilities, excavation, engineering, permits and other indirect costs. The first lots were sold to the developer in early 2005. The decision implies that the taxpayers acquired replacement property in an otherwise valid 1031 exchange to defer gain on the lots sold to developer.

The Oregon Department of Revenue argued that the partnership’s investment intent changed after it received the offer from the developer and subdivided the land into individual lots. Accordingly, it asserted that the land was held “primarily for sale” as opposed to for “investment” thus disqualifying it from 1031 treatment.

In determining whether the land was held primarily sale the court listed factors considered in 1221 (capital gain) cases: (1) purpose for which the property was initially acquired; (2) purpose for which the property was subsequently held; (3) extent to which improvements, if any, were made to the property by the taxpayer; (4) frequency, number and continuity of sales; (5) extent and nature of the transactions involved; (6) ordinary business of the taxpayer; (7) extent of advertising, promotion or other active efforts used in soliciting buyers for the sale of the property; (8) listing of the property with brokers; and (9) purpose for which the property was held at the time of sale. The court concluded based on the length of time the property was held and the taxpayers’ lack of experience in subdividing and selling lots that these factors weighed in favor of investment intent. The court appeared to weigh heavily that the taxpayers engaged in the development activities to maximize their return on their initial investment and that they only did the minimum necessary to complete the sale.

Because the case was decided by the Oregon Tax Court this decision cannot be used as authority in IRS audits, and it is presumably of little precedential value outside of Oregon. However, it does show that according to this court at least, subdivision of land, even coupled with substantial land improvements, is arguably not enough to convert a property owner from an investor into a dealer where there was no actual building, active marketing of the subdivided property, or establishment of a sales organization.

Please contact attorney F. Moore McLaughlin, owner of All States 1031 Exchange Facilitator, LLC, by e-mail at or Alexandra L. Hart by e-mail at for more information about this case or about a particular scenario.