Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 59-31

1959-1 C.B. 215

Sec. 1237

IRS Headnote

Where a taxpayer is assessed for paving expenses on a parcel of land which he donated to a city government and the paving increases the basis of adjacent land which he retains, he will be deemed to have made improvements to such retained land for the purposes of section 1237 of the Internal Revenue Code of 1954. However, for purposes of sale of the adjacent property, the improvement will not be considered substantial if the requirements of section 1237(b)(3) of the Code, relating to necessary improvements, are otherwise met.

Full Text

Rev. Rul. 59-31

Advice has been requested whether a taxpayer is deprived of the benefits of section 1237 of the Internal Revenue Code of 1954 as a result of the improvement of property subdivided and held for sale under the circumstances described below.

The taxpayer is the owner of a tract of undeveloped real estate, which he has held for more than ten years, situated within the limits of a city. During the taxable year, the taxpayer donated a center strip of this land to the city in order to facilitate the extension of a city street which came to a dead end at his property line. When the street extension was made by the city, the taxpayer was assessed for paving expenses inasmuch as the extension bisected and abutted the remainder of his tract of land. Subsequently the taxpayer subdivided such remainder into lots for sale.

Section 1237(a) of the Code, relating to real property subdivided for sale, provides, in relevant part, that any lot or parcel which is part of a tract of real property in the hands of a taxable shall not be deemed to be held primarily for sale to customers in the ordinary course of trade or business at the time of sale solely because of the taxpayer's having subdivided such tract for purposes of sale, or because of any activity incident to such subdivision or sale, if-

(2) no substantial improvement that substantially enhances the value of the lot or parcel sold is made by the taxpayer on such tract while held by the taxpayer * * *. For purposes of this paragraph, an improvement shall be deemed to be made by the taxpayer if such improvement was made by-

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(C) Federal, State, or local government, or political subdivision thereof, but only if the improvement constitutes an addition to basis for the taxpayer; and

(3) such lot or parcel, except in the case of real property acquired by inheritance or devise, or held by the taxpayer for a period of 5 years.

Section 1.1237-1(c)(2)(i)(e) of the Income Tax Regulations provides that, for the purposes of section 12-37(a)(2) of the Code, the taxpayer is deemed to have made any improvements on the tract while he held it which are made by a Federal, State, or local government, or political subdivision thereof, if the improvement results in an increase in the taxpayer's basis for the property, as it would, for example, from a special tax assessment for paving streets.

Section 1.1237-1(c)(5)(i) of the regulations, relating to the special rules for `necessary' improvements under section 1237(b)(3) of the Code, provides, in part, that an individual taxpayer may elect to have improvements treated as `necessary' and not substantial, thereby obtaining the benefits of section 1237 of the Code, if he has held the property for ten years and the improvements consist of the building or installation of water, sewer, or drainage facilities, or roads. In addition, the District Director of Internal Revenue, with whom the taxpayer files his return, must be satisfied that the improvements were necessary to enable the taxpayer to get the prevailing local price for the type of property which he sold. Further, the taxpayer must elect not to adjust the basis of the lot sold, or any other property held by him, for any part of the cost of the improvement, and not to deduct any part of the cost as an expense. This election should be made in the manner prescribed under section 1.1237-1(c)(5)(iii) of the regulations.

In the instant case, the street paving, for which the taxpayer was assessed, constitutes an improvement, within the meaning of section 1237(a)(2) of the Code, which results in an increase in the basis of the property in the taxpayer's hands. However, since the taxpayer has held the tract of land for more than ten years, the improvement (paving of the street) will be considered as a necessary improvement and not a substantial improvement for purposes of sale of the adjacent property, provided that there is compliance with the other requirements of section 1237(b)(3) of the Code.

Accordingly, it is held that where a taxpayer is assessed for paving expenses on a parcel of land which he donated to a city government and the paving increases the basis of adjacent land which he retains, he will be deemed to have made improvements to such retained land for purposes of section 1237 of the Code. However, for purposes of sale of the adjacent property, the improvement will not be considered substantial if the requirements of section 1237(b)(3) of the Code, relating to necessary improvements, are otherwise met.