Many developers unfamiliar with the real estate market in Arizona are often caught off guard by the speculative builder tax, which gives each city the ability to tax improved real property upon sale. Arizona does not have a land transfer tax, but the speculative builder tax works in much the same way. The specifics of the tax can be somewhat confusing, especially since it applies only at the city level and is not enforced by the state.

In general, however, certain guidelines apply to the speculative builder tax: In the case of commercial property, the tax becomes effective if an improved property is sold during construction or within two years of a construction project being substantially completed. With residential property, the time limit does not apply, and the tax becomes effective whenever the property is sold.

But what, exactly, is a speculative builder? According to Arizona's Model City Tax Code, a speculative builder is defined as one of two things:

• An owner-builder (or someone managing their own building or remodeling project) who sells or contracts to sell improved real property at any time. This property may include custom, model, or inventory homes regardless of the stage of construction, as well as improved residential or commercial lots.
• An owner-builder who sells or contracts to sell other types of improved real property not specified above either prior to completion or within 24 months after improvements are substantially complete.

The speculative builder tax applies to property improvements including structural additions (a new room or patio), nonstructural additions (a new driveway or landscaping), adding water or power lines, and other types of construction or reconstruction on or around the property.

There is a notable exception to the speculative builder tax: When a homeowner uses a contractor to make improvements to a family home, it is excepted if it is for the owner's “bona fide non-business purpose.” Additionally, the following conditions must be met: The immediate family of the seller must have lived in the home or used it as a vacation residence for at least six months prior to the property's sale; the seller must have sold no more than two vacation homes or primary residences during the 36 months preceding the sale; and the property must not have been rented, leased, or licensed during the 24 months preceding the sale.

If you are a real estate developer or owner-builder in an Arizona market, you may benefit from speaking with an experienced tax attorney. Call Brandon A. Keim at (602) 200-7399 today, so you know what to expect – because no one likes being caught off guard by hidden costs.