The 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. Both
Disadvantages of Being a Real Estate Dealer
Profits on dealer sales are generally subject to taxes at both
- ordinary income rates of up to 37 percent, and
- self-employment rates of up to 14.13 percent.
In addition, dealers may not
- depreciate property held for sale to customers,
- use the tax-favored installment method to report their property dispositions, or
- defer taxes by using the Section 1031 tax-deferred exchange on dealer properties.
Advantages of Being a Real Estate Dealer
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).
Disadvantages of Being a Real Estate Investor
- Investors face the $3,000 limit on net capital losses (after offsetting gains against losses).
- Investors also suffer the disadvantage of treating selling expenses as reductions in sales proceeds, meaning that selling expenses produce benefits only at capital-gains tax rates.
Advantages of Being a Real Estate Investor
Profits on investor sales are
- taxed at tax-favored capital gains rates of 20 percent or less, and
- not subject to self-employment taxes.
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.
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.
You Decide
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 courts look at your intent in buying and holding the property. Your books and records help establish that intent.
Who is a Real Estate Dealer?
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.
Who is a Real Estate Investor?
Unlike with 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.
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.