charles e. mcwilliams, jr. - bepress.pdf

The Partnership: Preserving Capital Gains on Real Estate Investments Charles E. McWilliams, Jr. Abstract This paper considers the use of partnerships as an effective tool for preserving capital gains on real estate investments. For tax purposes, the Internal Revenue Service generally treats a limited liability company as a partnership. This form of organization is widely used for real estate investments, and by taking a few simple precautions an LLC may ensure that any gain on its investments in undeveloped real property will be treated as capital gains. Such treatment may reduce the LLC’s tax costs substantially. The Fifth Circuit developed a framework that has proven invaluable for analyzing the activity of the LLC to determine whether it will be afforded capital gains status. This paper spends a considerable amount of time analyzing that framework as well as exploring examples of how the courts have applied this framework. Additionally, this paper discusses choice of entity concerns for investors and briefly analyzes the life cycle of a typical real estate investment partnership. Table of Contents I. Introduction to the Real Estate Investment Partnership 1 II. Choice of Entity Concerns 2 A. The Individual 2 B. The Corporation 5 C. The Partnership 7 III. The Fifth Circuit Framework 11 IV. Substance over Form 19 A. A Simple Sale of Undeveloped Property 20 B. The Sale of Undeveloped Property to a Related Corporation 21 C. Sale to a Related Corporation – Phelan v. Commissioner 23 V. The Life Cycle of a Real Estate Investment Partnership 27 A. Formation 27 B. Financing and Land Acquisition 31 C. Sale of the Investment and Dissolution of the Partnership 34 VI. Conclusion 37 I. Introduction to