Are You A Dealer or Investor?
Why should you be concerned with being labeled a Real Estate Dealer as compared to a Real Estate Investor by the IRS? There are some serious tax implications that should make you VERY AFRAID of being labeled a Dealer.
What is a Property Dealer?
- This is a person who is involved on a regular basis in the development, improvement, and advertisement of property for sale.
What is a Property Investor?
- A property investor is a person who generally holds real estate for appreciation and/or cash flow from rental activities.
Why should it matter what you are labeled by the IRS?
If you are considered a property investor, then you file Schedule E for all of your investment properties and can take current year operating expense plus depreciation on your tax return. You can also file Schedule D when you sell the property and qualify for long term capital gains rates (currently at 15%) on the profits of the sale.
However, Dealers must report their activities on Schedule C and report their income/expense as ordinary income. They will also face the Self-employment tax on top of their regular federal tax rates when they file a Schedule C. (A savvy Dealer will choose to incorporate and file as an S-Corp to avoid the self-employment tax, but that is a different subject) They are not allowed to depreciate any of their capital expenses. They claim their capital expenses when they sell the property held in inventory. Finally, they do not enjoy long term capital gains benefit, but must report their profit on the sale of the property as ordinary income and pay tax at ordinary rates.
So, as you can see, the way you are classified by the IRS has serious tax implications.
What can place you in a Dealer status?
There is no written rule that sets a number on the properties you can buy and sell before you are labeled a dealer. If you sell multiple properties in a single tax year or a few properties over the course of two or three years, you may find yourself at risk of being labeled a Dealer. Everything falls on your intent at the time of the purchase. If you intended to purchase the property to hold for income and appreciation, you are an investor. If you purchased the property with the intent of reselling it, you are a Dealer.
You have the burden of proof.
All the IRS has to do is assert that you are a Dealer and the burden of proof falls on you to show otherwise. Here are some main areas that are looked at:
- How long the property was held. Properties held for less than two years are more likely to be considered Dealer property.
- The number of sales by the taxpayer in a single year.
- The type of improvements made to the property. The more extensive the improvements, the more likely that it was a renovation intended for resale.
- The purpose for acquiring the property.
- The amount of income from property sales compared to the taxpayers other income.
- Advertising – The more advertising and sales agents there are, the more likely it is a resale property.
- Use of a business office to sell the property.
This is an area that is too complex to consider all of the ramifications of being labeled a Dealer in one article. Individuals may have both types of properties. What can they do to protect themselves?
Contact me if you have any specific questions relating to your personal situation.
Richard Hart EA, CAA
Hart & Associates
Tax consulting, preparation and IRS Audit representation
Offices in Las Vegas NV, Manhattan NY and Beverly Hills CA