For many savvy real estate investors, land banking can be a strategic investment with a favorable long-term payout. However, as you acquire land, it’s important to know and understand its tax implications to ensure you minimize your overall tax liability and maximize your investment.  

Below is an overview of land banking and key tax considerations to keep in mind as you build your real estate investment portfolio.  

Land Banking Explained  

Land banking is the acquisition and holding of undeveloped land for future development or sale. Once you purchase land, the length of time you hold onto it before either making any enhancements or selling it is critical from a tax perspective, as it will trigger whether the land activity will be taxed as ordinary income or capital gains income.  

According to the IRS, individuals involved with land banking are primarily classified as either a:  

• Dealer: An individual who is engaged in the business of buying and selling real estate for gain or profit. Once land is purchased and the taxpayer begins any development activity (i.e., starts digging or making land enhancements), the IRS will classify the property owner as a dealer. 
• Investor: An individual who holds onto property as a “capital asset.”  The IRS classifies a taxpayer as an investor when they’ve intentionally held onto property with no intent to conduct land development activity. 

The tax treatment of the land you acquire will largely depend on whether the IRS classifies you as a dealer or an investor based on your land development activity. Dealers will be taxed at the ordinary income tax rate, which could be up to 37%, if any land development activity occurs within a year of acquisition. Investors who hold onto their land for more than one year from the date of their acquisition have a more favorable tax treatment. When investors sell their land, it will be taxed as a long-term capital asset, and therefore, subject to the capital gains tax rate of 20%, plus an additional 3.8% net investment income tax rate for certain taxpayers.  

Leveraging the Bramblett v. Commissioner Case 

In the case of Bramblett v. Commissioner, the IRS challenged four owners of a partnership and related corporation when they reported the income from the sale of land from the partnership to the corporation as capital gain. The owners argued they held the land under the partnership for an extended period before selling to the corporation, therefore, should be considered a capital asset. The IRS argued the profit from the sale should be taxed as ordinary income due to the activities occurring within the corporation and its relationship to the partnership.  

To determine whether sales of land are considered sales of a capital asset or sales of property held primarily for sales to customers, the court developed a framework of principle questions to be considered: 

1. Was the taxpayer engaged in a trade or business, and if so, what business? 
2. Was the taxpayer holding the property primarily for sale in that business? 
3. Were the sales contemplated by the taxpayer "ordinary" in the course of that business? 

They also considered these seven factors when determining the intent of the partnership selling the land when they purchased it:  

1. The nature and purpose of the acquisition of the property and the duration of the ownership. 
2. The extent and nature of the taxpayer's efforts to sell the property. 
3. The number, extent, continuity and substantiality of the sales.  
4. The extent of subdividing, developing and advertising to increase sales. 
5. The use of a business office for the sale of the property.  
6. The character and degree of supervision or control exercised by the taxpayer over any representative selling the property. 
7. The time and effort the taxpayer habitually devoted to the sales.  

Based on a review of these factors, the appeals court found the partnership was not in the business of selling land.  

To determine whether the corporation was an agent of the partnership and whether its activities were related, the appeals court reviewed the outcome of the National Carbide 336 U.S. 422 (1949) case, where the following activities were questioned: 

1. Did the corporation act in the name of the partnership? 
2. Did the corporation have the authority to bind the partnership? 
3. Did the corporation not act in an arm’s length transaction on the purchase of land from the partnership? 
4. Did the employees of the corporation contribute to the generation of income by the partnership? 
5. Is there common ownership between the corporation and the partnership? 
6. Is the corporation’s business purpose similar to that of an agent? 

As a result in the Bramblett case, the court found the corporation was not an agent of the partnership, so the activities recorded from the corporation cannot be attributed to the partnership.  

Since this outcome, investors and business owners have used this method to strategically manage land they own within separate entities.  

Corporate Structuring

With the right strategy, land banking can continue to be a worthy investment for real estate purchasers. For example, a limited partnership could be created to purchase the land with the intent to hold the land for at least one year. Once a parcel/portion of the land is ready to be developed, that parcel/portion of land can be sold to a C corporation or S Corporation.  The owners of the partnership can be the same as the owners of the C or S Corporation (with limitations) as long as both entities are operating independently of each other.   

Additionally, to alleviate the need for cash to be paid for the full fair market value of the land to be developed, an installment note can be given, which will also mitigate a huge tax bill in the year of sale.

Here to Help

If land banking is part of your overall real estate strategy, it’s important to work with real estate tax advisors who know how to maximize your overall return on investment. To obtain assistance or for help navigating your real estate taxes, we're here to show you the way.