The first good news is that you can be both real estate investor and real estate dealer with respect to your real estate portfolio.
The next good news is that you are in control, and by knowing just a few rules about dealer and investor classifications, you can do much to increase your net worth.
Let’s take a quick look at how big a difference you can make in the tax bite. Say you have a $90,000 profit on the sale of a property.
- Real Estate Dealer taxes could be as high as $46,017.
- Investor taxes could be as high as $18,000.
The investor potentially saves a whopping $28,017 in taxes.
What Am I?
You, the individual taxpayer, can be both a dealer and an investor! The law does not cut you in half or anything. No, the law simply looks at each property in its respective light.
But you need to make the light shine on your properties by making a clear distinction in your books and records as to which properties are investment properties and which are dealer properties.
Should you fail to make the distinction, you place yourself at the mercy of the IRS. (The word “mercy” does not exist in the tax code, so expect a very unhappy result if you rely on mercy.)
How Do I Prove What My Property is?
The courts look at your intent in buying and holding the property. Your books and records help establish that intent.
Dealer property is property you hold for sale to customers in the ordinary course of a trade or business. The more properties you buy, and the more properties you sell during a calendar year, the greater the chances that you are a dealer with respect to those properties.
Properties that you buy, fix up, and sell generally are dealer properties.
Also, properties that you subdivide have a great chance of being dealer property, except when those subdivisions are done under the very limited rules of Section 1237.
Tax Breaks for Real Estate Dealers
Tax law treats the dealer just as it does any business, and that includes some good things for tax purposes.
- Dealers treat real estate selling expenses, commissions, legal fees, and advertising as ordinary business deductions.
- Losses on the sale of dealer properties are not limited by the $3,000 capital loss cap that exists for investor properties.
- Dealers deduct the loss as an ordinary loss.
- Dealers deduct the entire loss (either immediately or over time using the new net operating loss rules that allow carryforward forever).
Unlike with real estate dealer property, where the dealer’s principal purpose for owning the property is to sell it to customers in the ordinary course of business, the investor’s purpose in owning property is to
-
- have it appreciate in value, and/or
- produce rental income.
Tax Breaks for Investors
Profits on investor sales are
- taxed at tax-favored capital gains rates of 20 percent or less, and
- not subject to self-employment taxes.
In addition, the investor
- depreciates the property,
- may sell using the tax-favored installment method, and
- may defer the taxes by using the Section 1031 tax-deferred exchange.
Each property stands alone with respect to its status as a dealer or an investor property.
Thus, you (the individual taxpayer) or your corporation may own both dealer and investor properties. If you have both types of properties, make a clear distinction in your books and records as to which properties are investment properties and which are dealer properties.
Takeaways
Keep two general rules in mind:
- The real estate dealer buys property for the purpose of reselling the property to customers in the ordinary course of business.
- The investor buys property for appreciation, rental income, or both appreciation and rental income.
If your property does not fall at one end of the spectrum, make sure it meets as many of the attributes for your desired outcome as possible.
Each property stands alone with respect to its status as a dealer or an investor property.
Thus, you (the individual taxpayer) or your corporation may own both dealer and investor properties.28 In such a case, make absolutely certain that you are classifying your properties correctly. The tax consequences of failing to do so are enormous.
If you have both types of properties, make a clear distinction in your books and records as to which properties are investment properties and which are dealer properties.
If you want my help with your property classifications, please give me a call on my direct line at 509-543-7600 or send a request HERE.
September 2021
This blog does not provide legal, financial, accounting, or tax advice. This blog provides practical information on the subject matter. The content on this blog is “as is” and carries no warranties. TaxMedics does not warrant or guarantee the accuracy, reliability, and completeness of the content on this blog. Please contact us directly to discuss how this information may be used based on your actual facts and circumstances.
Pingback: Is a Property Flip, an Investor or a Dealer Property? - TaxMedics