We disposed of real estate and improvement expenses that we've been carrying as inventory on our llc returns. Can we claim sale of "inventory" as long term capital gain?

[tampare]

A friend and I bought a property in 2014 under an LLC and have been reporting it and the improvements we've made to it as inventory on our returns.  We haven't taken depreciation.  The property sold in 2017 for a profit.  Can we report the sale of this "inventory" so it can be treated as a long term capital gain?  If we follow the dispose of asset process, when we enter the asset it throws the balance sheet out of whack because the $ associated with the asset is then counted under inventory and real property.

[AmandaR1]

You need to determine if you are an  Investor  or a  Dealer in real estate.  You can only handle your real estate the way you have been in inventory, if you qualify as a dealer. 

When you qualify as a dealer, your inventory sales are ordinary income. See the IRS definition:

Real estate dealer.

You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales. Rent you receive from real estate held for sale to customers is subject to SE tax. However, rent you receive from real estate held for speculation or investment is not subject to SE tax.

Learn more here: https://www.irs.gov/publications/p334#en_US_2016_publink1000313359

If you do not qualify as a dealer, keep in mind that you'll be required to increase your adjusted basis in the property, by the amount of depreciation you should have taken. You have 3 years to amend your returns for a refund. 

This article provides some deep insights into the differences between these IRS classifications: https://www.bpbcpa.com/real-estate/investors-in-real-estate-receive-better-tax-treatment-than-dealer...