It is my understanding that if you buy a property for the purpose of resale, then you are a dealer in the eyes of the IRS. You will then pay taxes on the profit you made after all expenses. Your tax rate will depend on your bracket, 15% 28% etc.
If you buy a property and rent it for a few years (more than one) and then sell it, you are an investor and pay capitol gains tax (20%) only. Yes, you should incorporate for many reasons your company that will be a dealer in RE.
Posted by Jerry Kinard on May 15, 2000 at 12:11:59:
I am a new to REI and I plan this first year to buy properties and sell them. My understanding if I do this I can be tagged as a dealer by the IRS and catch it in the shorts. From what I have read it is best to incorporate before doing any of these type deals not only for IRS purposes but also for liability purposes. Are there any experienced real estate investors out there who are “buying and flipping” solely can tell me how I should best protect myself from this double wammy?
may i add that there are other factors. while the NUMBER of sales per year is not specified in IRS code many feel that the threshold is 5 or 6 per year. You are NOt a dealer if you hold for INVESTMENT, which can be rental real estate or raw land. if can be non-income genrating and still be non-dealer property.
it also depends what other things you do. if you have another full time job the likelyhood of being a dealer are decreased. how many entities do you have? do you have a dealer entity and a non-dealer entity? having different entities for different activities will also help to deistinguish your dealer transactions from your non-dealer transactions if you do both. Dealer transactions can be taxed as high as 39.6% federal income tax even if owned over 1 year. but non-dealer investor property owned more than 1 year will usually only be taxed at 20%, oh what a savings!
If you purchase property with the intent of reselling at a profit, your property is considered inventory (dealer property), and your profit is taxed as ordinary income at your marginal tax rate. All of your profit is taxable in the year of the sale, regardless of whether you have actually received any cash. You are not eligible for an IRC 1031 tax deferred exchange; nor, can you take depreciation on the property during the time you held it.
On the other hand, if you purchase property to generate cash flow, then later sell it after an appropriate holding period, your property is considered investment property. Your profits are eligible for capital gains tax treatment, you can take a depreciation expense while you held the property, and you can defer capital gains through an IRC 1031 tax deferred exchange. If you sell with seller financing, The IRS will let you spread out your capital gains over a number of years with an installment sale, rather than forcing you to realize all your profit in the year of sale.
While, each deal is considered by the IRS on an individual basis, a pattern of dealer activity will be used to constru your intent for all your deals and can taint your investment activities. Therefore, it is recommended that you conduct your “dealer” activities and your investment activities in separate business entities.
One advantage of doing your “dealer” activity in a corporation is the more favorable tax structure. The tax rate on the first $50K of corporate profits is only 15%. If you choose to have your corporation retain all profits as working capital for future investment, you avoid employment taxes.
Compare this to operating a sole proprietorship. All your profits are not only taxed at your marginal tax bracket, but you may also have to pay self-employment taxes on your earnings (profits).
Suggest you consult a CPA for specific guidance in your personal financial circumstances.