In today’s society real estate is a hot market to be in. The main issue for real estate professionals is whether an individual is an investor or a dealer in real estate. A “dealer” is a person who holds real property for sale, rather than for investment. If an individual is a dealer, then they hold property “for sale”, thus, the gains and losses on the property are taxed at ordinary income tax rates.
Here is a list of factors the IRS considers when determining if the real estate gets dealer or investment status:
1) Reason property was acquired and time period held
2) Effort of taxpayer to sell property
3) Substantiation and extent of sales
4) Efforts to develop, subdivide, and advertise to increase sales
5) Amount of control exercised by taxpayer over a representative selling the property
6) Time and effort dedicated to the sale
The greatest disadvantages of dealer status are: gains are subject to ordinary tax rates, unable to use the installment sale method and Sec. 1031 tax-free like-kind exchanges. On the other hand, a dealer can offset losses against ordinary income with fewer restrictions than capital losses.
Some strategies that taxpayers can use to show they are investors vs. dealers are:
1) Use words such as “investments” in organizational documents
2) Use a business code for real estate investment on tax return, rather than development
3) Display the property on financial statements as investments
4) Hold the property as long as possible, and reduce the frequency of sales, as much as possible
In conclusion, a taxpayer with the right tax planning and strategies can retain more funds for future real estate ventures.
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