Ask Paul Wells

Thanks for the interesting and informative talk in Lake Mary/Orlando, FL recently. Your comments about the number of properties you're finding and working with through your system got me thinking:

What is the possibility of being seen as a "dealer" by the IRS, and what are the specific implications? How can you avoid being considered a dealer?

Thanks for your question; it's reasonable to be concerned about how the IRS sees your Real Estate Investment business. There are many implications, and you can find tax information for real estate investors in many Real Estate Investment books available today. Here's some ideas and advice:

A commercial real estate developer who buys large tracts of land, subdivides them and sells individual lots would be considered a dealer in most cases.

If you are marked as a real estate dealer for tax purposes, you will be taxed (up to 39.6%) on the full gain of a real estate transaction when the property is sold. You also lose the tax advantages of the installment sale when you sell real estate.

As an investor, you could be taxed as little as 28% under the capital gain tax laws for the same transaction. Until recently the tax difference between being a dealer (31%) and an investor (28%) was minimal. The Clinton Tax Act changed all of that by increasing the possible spread to 11.6%.

An 11.6% additional tax on a $250,000 real estate transaction equates to $29,000 of extra tax on the same transaction, all because you're considered a dealer.

Real estate investors need to do everything possible to avoid being labeled dealer status.

Unfortunately, there is no single answer to the question of how to avoid dealer status.

How many deals per year are too many to be considered an investor by the IRS?

If you're flipping (buying and selling in 12 months or less) 1 to 5 houses per year you probably have little to worry about if you keep a low profile. Especially if you keep a few houses here and there as rentals so you can show rental income on your tax returns.

Probably when you hit the 15-20 house mark you will be identified as a dealer.

It's a good idea to keep a few properties every year as rentals or lease/options to show passive real estate income on your taxes. If the IRS sees huge capital gains from multiple deals with no passive rental income you will raise your visibility and increase the danger of acquiring dealer status.