How you define “Real Estate Investor” and “Real Estate Dealer” can make a huge difference in your taxes.
Let’s take a 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.
• 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.
You, the individual taxpayer, could be both a dealer and an investor! The law does not cut you in half or require a split personality or anything like that. No, the law simply looks at each property in its respective status. But you need to (in advance) build the case 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.) The courts look at your intent in buying and holding the property. Your books and records help establish that intent.
Dealer property is an asset that 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, very restrictive rules of IRS code Section 1237 (we won’t go there today).
Where the dealer’s principal purpose for owning 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.
Each property stands alone with respect to its status as a dealer or an investment property. Thus, you (the individual taxpayer) or your corporation may own both dealer and investment properties.
It’s best not leave this to chance. Contact us if you need planning help in this area.
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