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TITLE 26-INTERNAL REVENUE CODE divided such tract for purposes of sale or be- cause of any activity incident to such subdivi- sion or sale, if- (1) such tract, or any lot or parcel thereof, had not previously been held by such taxpay- er primarily for sale to customers in the ordi- nary course of trade or business (unless such tract at such previous time would have been covered by this section) and, in the same tax- able year in which the sale occurs, such tax- payer does not so hold any other real proper- ty; and (2) no substantial improvement that sub- stantially enhances the value of the lot or parcel sold is made by the taxpayer on such tract while held by the taxpayer or is made pursuant to a contract of sale entered into be- tween the taxpayer and the buyer. For pur- poses of this paragraph, an improvement shall be deemed to be made by the taxpayer if such improvement was made by- (A) the taxpayer or members of his family (as defined in section 267(c)(4)), by a corpo- ration controlled by the taxpayer, or by a partnership which included the taxpayer as a partner; or (B) a lessee, but only if the improvement constitutes income to the taxpayer; or (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, is held by the taxpayer for a period of 5 years. (b) Special rules for application of section (1) Gains If more than 5 lots or parcels contained in the same tract of real property are sold or ex- changed, gain from any sale or exchange (which occurs in or after the taxable year in which the sixth lot or parcel is sold or ex- changed) of any lot or parcel which comes within the provisions of paragraphs (1), (2) and (3) of subsection (a) of this section shall be deemed to be gain from the sale of proper- ty held primarily for sale to customers in the ordinary course of the trade or business to the extent of 5 percent of the selling price. (2) Expenditures of sale For the purpose of computing gain under paragraph (1) of this subsection, expenditures incurred in connection with the sale or ex- change of any lot or parcel shall neither be allowed as a deduction in computing taxable income, nor treated as reducing the amount realized on such sale or exchange; but so much of such expenditures as does not exceed the portion of gain deemed under paragraph (1) of this subsection to be gain from the sale of property held primarily for sale to custom- ers in the ordinary course of trade or business shall be so allowed as a deduction, and the re- mainder, if any, shall be treated as reducing the amount realized on such sale or ex- change. (3) Necessary improvements No improvement shall be deemed a substan- tial improvement for purposes of subsection (a) if the lot or parcel is held by the taxpayer for a period of 10 years and if- (A) such improvement is the building or installation of water, sewer, or drainage fa- cilities or roads (if such improvement would except for this paragraph constitute a sub- stantial improvement); (B) it is shown to the satisfaction of the Secretary that the lot or parcel, the value of which was substantially enhanced by such improvement, would not have been marketable at the prevailing local price for similar building sites without such improve- ment; and (C) the taxpayer elects, in accordance with regulations prescribed by the Secre- tary, to make no adjustment to basis of the lot or parcel, or of any other property owned by the taxpayer, on account of the expenditures for such improvements. Such election shall not make any item deductible which would not otherwise be deductible. (c) Tract defined For purposes of this section, the term "tract of real property" means a single piece of real property, except that 2 or more pieces of real property shall be considered a tract if at any time they were contiguous in the hands of the taxpayer or if they would be contiguous except for the interposition of a road, street, railroad, stream, or similar property. If, following the sale or exchange of any lot or parcel from a tract of real property, no further sales or ex- changes of any other lots or parcels from the remainder of such tract are made for a period of 5 years, such remainder shall be deemed a tract. (Aug. 16, 1954, ch. 736, 68A Stat. 330; Apr. 27, 1956, ch. 214, §§ 1, 2, 70 Stat. 118; Sept. 2, 1958, Pub. L. 85-866, title I, § 55, 72 Stat. 1645; Jan. 12, 1971, Pub. L. 91-686, § 2(a), 84 Stat. 2071; Oct. 4, 1976, Pub. L. 94-455, title XIX, §§ 1901(a)(138), 1906(b)(13)(A), 90 Stat. 1787, 1834.) AMENDMENTS 1976-Subsec. (b)(3). Pub. L. 94-455, § 1906(b)(13)(A), struck out from subpars. (B) and (C) "or his delegate" following "Secretary". Subsec. (d). Pub. L. 94-455, § 1901(a)(138), struck out effective date provision making the section applicable only with respect to sales of property occurring after Dec. 31, 1953, except that for purposes of subsec. (c) defining tract of real property and for determining the number of sales under subsec. (b)(1) of this section, all sales of lots and parcels from any tract of real proper- ty during the period of 5 years before Dec. 31, 1953, shall be taken into account, except as provided in subsec. (c). 1971-Subsec. (a). Pub. L. 91-686, § 2(a)(1), substitut- ed "other than a corporation" for "(including corpora- tions only if no shareholder directly or indirectly holds real property for sale to customers in the ordi- nary course of trade or business and only in the case of property described in the last sentence of subsec- tion (b)(3))". Subsec. (b). Pub. L. 91-686; § 2(a)(2), eliminated sen- tence which made subpars. (B) and (C) inapplicable in the case of property acquired through the foreclosure of a lien thereon w hich secured the payment of an in- debtedness to the taxpayer or (in the case of a corpo- ration) to a creditor who has transferred the foreclo- sure bid to the taxpayer in exchange for all of its stock and other consideration and in the case of prop- erty adjacent to such property if 80 percent of the real Page 691 § 1237