Sales of Improved Property by a Speculative Builder

*This information is for Model City Tax Code purposes only.

Uniformed Audit Committee Guidelines

Issue:

This guideline provides direction to persons who construct improvements to real property and then sell the property, whether they perform the work themselves or hire someone to construct the improvements.

Applicable Law:

The Model City Tax Code (MCTC) Section 416 provides that someone who has constructed improvements upon real property, and who then sells or offers to sell the improved property is subject to privilege tax as a Speculative Builder in the city where the real property is located. The Code also provides for a deduction of 35% of the gross income and tax credits for taxes already paid.

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Section 416(a)(2) defines Improved Real Property as "…any real property:

(A) upon which a structure has been constructed; or
(B) where improvements have been made to land containing no structure (such as paving
or landscaping); or
(C) which has been reconstructed as provided by Regulation;
(D) where water, power, and streets have been constructed to the property line."

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The following definitions in Section 100 state:

Owner-Builder means an owner or lessor of real property who, by himself or by or through others, constructs or has constructed or reconstructs or has reconstructed any improvement to real property.

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Speculative Builder means either:

(1) An owner-builder who sells or contracts to sell, at anytime, improved real property (as provided in Section 416) consisting of:

(A) Custom, model, or inventory homes, regardless of the stage of completion of such homes; or

(B) Improved residential or commercial lots without a structure; or

(2) An owner-builder who sells or contracts to sell improved real property, other than improved real property specified in Subsection (1) above:

(A) Prior to completion; or

(B) Before the expiration of twenty-four (24) months after the improvements of the real property sold are substantially complete.

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Substantially Complete means the construction contracting or reconstruction contracting:

(1) Has passed final inspection or its equivalent; or

(2) Certificate of occupancy or its equivalent has been issued; or

(3) Is ready for immediate occupancy or use.

Discussion:

According to Section 416, a property owner does not have to directly supervise, perform, or coordinate the construction of the project for the sale of the improved property to be subject to the tax. Even though a construction contractor may have been employed to actually construct the improvements, the owner is liable for the tax imposed from the sale of the property.

A property owner who is constructing improvements with the intent of selling the property as a Speculative Builder may claim an exemption from city tax on purchases of both direct materials incorporated into the improvement and for the construction which is performed by construction contractors on the project. To do so, the Speculative Builder must provide the material suppliers and construction contractors with a written declaration, along with his city privilege tax license number, that he is improving the property for the purpose of sale for which he assumes the liability for payment of city privilege taxes.

If an Owner-Builder did not provide a declaration of exemption at the time of the material purchase or for work performed by construction contractors, the builder is allowed a tax credit for city taxes paid or charged separately. These credits must be documented to the satisfaction of the tax collector.

Most cities do not provide for an exemption for land. However, MCTC Local Option M allows for an exclusion of the purchase "cost of land," and Local Option N allows for an exclusion of the "fair market value of land." Please refer to the MCTC Section 416(b)(2) and the Local Options Chart or the appropriate jurisdiction before using this exemption.

Arizona cities impose a privilege tax on the gross income from the sale of improved real property, if the property is sold within specified periods of time following substantial completion, regardless of whether the owner has used or leased the property. According to Section 416(a)(3), a sale includes a binding contract for sale or leases for a term of thirty (30) years or more (all options for renewal are considered part of the term).

Reference Chart

1. City Tax Computation on Speculative Builder Sale of Improved Property - No Land Deduction Gross Income From Sale

2. City Tax Computation On Speculative Builder Sale of Improved Property - Land Deduction Gross Income From Sale

Note A: For cities with Local Option M, use the purchase cost of land. For cities using Local Option N use the fair market value of the land. Caution is recommended, and the city in which the project is located must be consulted to determine whether a land deduction is available.

Note B: Factored tax calculation is dependent upon a number of variables, i.e., whether the transaction is taxable by state, county, and city, or city only; and whether a land deduction is provided by that city. The taxing jurisdictions involved must be contacted to provide appropriate formulas.

Examples:

1. C/D LLC purchases a tract of raw land and retains RS Inc. to install the infrastructure. The tract is then subdivided into six commercial lots. RS Inc. completes the installation of the infrastructure (water, power, sewer lines, and streets to the property lines). Upon completion, two lots are sold immediately, then due to a downturn in the real estate market, the remaining four lots are not sold for six years.
   
   Each sale is subject to the city tax as a Speculative Builder on the gross income at the close of escrow. The first two lots are taxable when sold immediately, and the other four lots are taxable when sold six years after the infrastructure was completed.
2. Development Inc. purchases a tract of raw land. RS Inc. is hired to construct the offsite improvements. The property is subdivided into 150 residential lots.
   
   a) Ten of the lots are sold to individuals who will either retain contractors to construct homes on their property or construct the homes themselves; Development Inc. would be subject to the city tax as a Speculative Builder on the sale of each of the ten lots.
   
   b) The other 40 lots are sold to HBI Inc, a homebuilder, for construction and subsequent sale of completed homes. If Development Inc. obtains an exemption certificate at the time of the transaction from HBI, then Development Inc may exclude the 40 lots from the application of the tax as a "sale for resale." (The certificate must contain HBI's city privilege license number and a written declaration that they assume liability for payment of city privilege taxes on the sale of the lots.)
   
   c) Development Inc. hires CA Constructors to build homes on the balance of the 100 lots. Five models are immediately built, and the remainder will be constructed as they are sold. Development Inc sells all the homes, including the models over the next three years, and is taxable as a Speculative Builder on each sale as they close escrow.
3. A/B Partnership purchases raw land and retains XYZ Inc. to construct a 140-unit apartment complex. The Final Inspection and Certificate of Occupancy is issued 01/02/2000. A/B, after operating the apartment business, sells the improved property on 2/01/2001. The sale is subject to the city tax at the sales price as a Speculative Builder.
4. Same facts as in example 3, except that the contract for sale is entered into prior to completion of the project, final inspection and issuance of the certificate of occupancy. A/B Partnership s subject to the city tax at the sales price at the close of escrow.

Improvement to real property and the sale of the property within specific time-periods subjects the gross income from the sale to city tax, even though a person or firm may not designate himself as a developer or speculative builder.

The purpose of this guideline is not to provide an exhaustive list of transactions that are subject to the city tax on Speculative Builders, but rather is to be illustrative of the underlying tenets.

Generally, an owner should contact the jurisdiction in which the project is located to determine how a given transaction may be subject to taxation. The Arizona Department of Revenue should be contacted for specific information regarding state privilege tax statutes.

Explanatory Notice: The purpose of a guideline is to promote a better understanding of the Model City Tax Code for the general public. A tax guideline may also provide interpretation, details or supplementary information concerning the application of the law. Relevant statute, rulings, or case law, as well as a subsequent guideline or ruling may modify or negate any or all of the provision of any tax guideline. If the information contained in a tax guideline is found to be erroneous, and a taxpayer shows reasonable reliance on that information, the taxpayer will be liable for any tax or interest that may result from the erroneous advice, but no penalties will be imposed.