Tax Type
Individual Income Tax
Description
Out-of-state credit disallowed; Capital gains
Topic
Credits
Taxability of Persons and Transactions
Date Issued
12-20-1995
December 20, 1995
Re: § 58.1-1821 Application: Individual Income Tax
Dear****************:
This will reply to your letter of February 13, 1995, in which you appeal the disallowance of a credit for income tax paid to another state claimed by your client, ********** (the "Taxpayer"), for taxable year 1991.
FACTS
The Taxpayer and several family members inherited unimproved land, and have held this land since 1943. This land is located in a state other than Virginia. The family subdivided the land, and a portion was sold in 1991 at a gain. The Taxpayer, a Virginia resident in 1991, paid income tax on her share of the gain to the state where the land is located.
The Taxpayer's 1991 Virginia return was subject to an office audit and an assessment was issued. The department denied the Taxpayer a credit for income tax paid to another state because Code of Virginia § 58.1-332(A) limits this credit to "earned or business" income. According to the copy of federal Schedule D submitted with the Taxpayer's return, the gain from the land was accorded capital gain treatment under Internal Revenue Code ("I.R.C.") § 1237.
You now maintain that the Taxpayer and her family should be considered partners in a partnership, and that their activities with regard to the land qualify them as dealers in real estate. Therefore, you believe the sale of the land constitutes business income. You submit an amended 1991 Virginia return with an attached Schedule E reporting this gain as the ordinary income of a partnership. You request the department grant the Taxpayer a credit for income tax paid to another state.
DETERMINATION
Code of Virginia § 58.1-332(A) provides that "whenever a Virginia resident has become liable to another state for income tax on any earned or business income...derived from sources outside the Commonwealth and subject to taxation under this chapter, the amount of such tax payable by him shall...be credited on the taxpayer's return with the income tax so paid to the other state." (Emphasis added).
The department did not allow the Taxpayer a credit for income tax paid to another state because the Taxpayer's sale of land was not "business income" within the meaning of the statute. You contend that the Taxpayer and her family were actively engaged in the conduct of a business, therefore, the Taxpayer is eligible for the credit granted by Code of Virginia § 58.1-332(A).
Congress enacted I.R.C. § 1237 to make it easier for noncorporate taxpayers who hold real estate for investment purposes to subdivide the realty for disposition and receive capital asset treatment. In order to qualify for I.R.C. § 1237 treatment the taxpayer must show: (1) the property (or any portion thereof) has not been held for sale to customers in the ordinary course of business, (2) no other real estate was held for sale to customers in the ordinary course of business in the year the property was sold, (3) the property has been held at least 5 years, and (4) no substantial improvements were made to the property during the period the property was held or as a condition under a contract for sale.
The mere fact that the Taxpayer's gain qualified for I.R.C. § 1237 treatment does not support your claim that the Taxpayer was a dealer of real estate. In a prior ruling, the department held that qualification under I.R.C. § 1237 is a strong indication that a taxpayer has acted as an investor, and has not engaged in a trade or business activity on a regular and continuous basis. See Public Document ("P.D.") 95-157, (6/16/95), copy attached
However, P.D. 95-157 recognized that I.R.C. § 1237 primarily characterizes income as ordinary income or capital gain. This ruling held that the characterization of income for federal income tax purposes has little bearing on the factual determination of whether income arises from the conduct of a business. As stated in P.D. 95-157, the treatment accorded for purposes of the Virginia tax credit is dependent on the facts and circumstances surrounding the asset.
-
- Virginia Regulation (VR) § 630-2-332 defines "business income" as;
...income derived from an activity which constitutes a "business" for federal income tax purposes for which a federal Schedule C, E, or F must be filed, for example, a sole proprietorship, provided that if the business incurred a loss such loss would be allowable under federal law. Thus income from hobbies and other activities not engaged in primarily for profit is not business income even though a Schedule C, E, or F may be filed for such activities.
- Virginia Regulation (VR) § 630-2-332 defines "business income" as;
In the instant case, the Taxpayer and her family members did not regularly buy, sell or list properties, and there is no evidence that they were licensed as brokers or sellers of real estate. They did not maintain a place of business, and there is no evidence that the Taxpayer and her family devoted substantial time to the actual selling of the land.
The Taxpayer and her family inherited the land in question. This land was later subdivided into seven lots. One lot sold in 1964, three lots sold in 1967, and two lots were combined and sold in 1991. Third party agents were engaged to advertise and do the actual selling of the property, and the Taxpayer derived her livelihood from full-time employment apart from the land in question.
In light of the evidence presented, the activity appears to reflect that of a long-term investor, holding an asset in anticipation of the rise in value over time. The mere fact that an investment is held in anticipation of profit does not make the activity a trade or business.
Based on the above facts, the department cannot conclude the Taxpayer's gain from the sale of land constitute business income within the meaning of Code of Virginia § 58.1-332(A). Accordingly, the department's assessment must be upheld. Attached is a schedule indicating the tax liability plus interest accrued through the date of this letter. The assessment should be paid in full within 30 days to avoid the accrual of additional interest. Please forward your payment to the Office of Tax Policy, the Virginia Department of Taxation, P.O. Box 1880, Richmond, Virginia 23282.
Should you have additional questions regarding this matter, please contact ********* at **************.
Sincerely,
Danny M. Payne
Tax Commissioner
OTP/9390L
Rulings of the Tax Commissioner