Let's talk "DEALER" status and S.I. tax - Posted by Jeff Denney

Posted by JPiper on January 15, 2000 at 11:00:51:

Dan:

I don?t know the exact IRS cite to give you. Some of the other people here undoubtedly do, and perhaps if they see the post here will give it to you.

But according to my CPA, the definition of a dealer is one who buys and sells real estate as a business. HOWEVER, the IRS does not define the number of transactions necessary to become classified as a dealer. Rather, it is a status that is determined by the IRS, based on your INTENT.

INTENT would be established by looking at the factors surrounding what you do. One of those factors would be how long you owned the property. According to my CPA, two years is the preferred holding period for convincing the IRS your property is an investment property?.particularly when you are also involved in dealer activities. He had even given me a private letter ruling number which I?ve posted here in the past?and which I cannot find now?.but the holding period in that ruling was 2 years. I?ve seen others who claim that 1 year is sufficient. The fact though is that they base the decision on intent, so that in general the longer you hold property the better.

Another factor would be how many transactions you have per year. They don?t say how many would put you over the line?.again, it?s a question of intent and this is just one of the factors. Probably if you do one or two a year you?re not going to have a problem?BUT, again, it does depend on intent and what the IRS determines.

A third factor would be what other business or occupation you?re involved in. Clearly, if this is not a business you would presumably have some other occupation.

In connection with the above they would undoubtedly look at the size of the profits versus your earnings at that other occupation. A huge disparity in favor of real estate would clearly work against you in terms of your intent.

Let?s say you have a corporation that you do flips/rehabs in?and the name of the corporations is Rehabs Unlimited, Inc. Do you suppose the IRS would draw any conclusions from the name alone? In my case my corporations have relatively obvious names?so that I think they work against my tax status.

But again, as with many other issues, this issue is not clearly defined by the IRS?.it?s going to be decided based on what they perceive your intent to be. And, as mentioned above, they don?t one day ?peg? you as a dealer, and then thereafter you pay tax as a dealer. It isn?t a game where they have to catch you. If they happen to audit you for some reason, determine you are a dealer, they will calculate the tax you should have paid, levy interest and penalties?and may even take a look at prior years. If you were doing these deals personally, and therefore you were liable for self-employment tax, that?s a large tax each year that would be due, and would have interest and penalties associated with it. There?s a big risk to gamble with this one.

In your case hopefully your tax person has carefully considered some of these issues before using Schedule D. Again, one of the advantages of Schedule D is that no self-employment tax was paid. If you were a dealer this tax should have been paid?.and if I recollect you mentioned in a prior post that you had been rehabbing full time for the last 3 years. I would have a detailed conversation with your tax person regarding this issue?.it?s an important one.

Most people claim that a corporation is preferable for rehabbing. I would think that you could use an LLC. HOWEVER, if you use the LLC you need to select the option of paying tax corporately?.otherwise you just shot yourself in the foot regarding the self-employment tax issue. Make sure you require your tax expert to THINK about some of these issues as they apply to you personally as a rehabber. Better yet, take a look at some of Bronchick?s articles on the subject published on this site.

JPiper

Let’s talk “DEALER” status and S.I. tax - Posted by Jeff Denney

Posted by Jeff Denney on January 15, 2000 at 03:00:37:

I just finished my last 1/4 taxes and I have a new tax guy, so I want to make sure he isn’t going to accidentally get me pegged as a dealer in my personal name.I bought,rehabed, and sold 5 properties last year as a sole proprietor. My tax guy has me paying self employment tax on the profits and a schedule C on the business. Real estate is my sole income. This year I have formed a S corp to to the quick flips in. Now that the cash is built up I want to get some long term properties to keep for mo cash flow in my personal name or separate entity.
My questions for you that know are:

  1. Can self employment tax be avoided on the flips ?
  2. Since I like to carry back small 2nds when I sell. How do I avoid dealer status and the inevitable tax on money I did not recieve.
  3. If the tax guy puts my occupation down as real estate investor do I run a bigger risk of being pegged.

What is the smart way to handle things here.
Thanks much,Jeff

Re: Let’s talk “DEALER” status and S.I. tax - Posted by chris

Posted by chris on January 15, 2000 at 04:32:17:

Jeff-

JPiper was comprehensive as always. The only thing I can add is that you may want to check out Mr. Bronchick’s material and articles on asset protection. You can find it on this website and at his website (www.legalwiz.com).

-Good Luck, Chris

Re: Let’s talk “DEALER” status and S.I. tax - Posted by JPiper

Posted by JPiper on January 15, 2000 at 04:14:33:

You know Jeff, one thing I think we can say for sure: when you make a statement like ?I bought,rehabed, and sold 5 properties last year as a sole proprietor. My tax guy has me paying self employment tax on the profits and a schedule C on the business. Real estate is my sole income.??.this is the definition of a dealer.

When you make the statement ?I want to make sure he isn?t going to accidentally get me pegged as a dealer?, let?s understand that the tax law is what pegs you as a dealer?not your tax guy. The tax guy is merely interpreting the law, and is filing your taxes accordingly. It sounds like he has done it correctly.

Just to correct what seems to me to be a giant misnomer bandied about this newsgroup, the tax law DOES NOT say that you are a non-dealer until the IRS catches you acting like a dealer, at which point you are ?pegged? a dealer. This creates the impression that if you can only successfully hide your transactions and the IRS misses them, you aren?t going to be ?pegged? a dealer. Rather, if you are buying/selling houses as a business, you are a dealer. It?s a requirement by law that you pay taxes correctly according to your status. If that status is ?dealer? then you pay your taxes that way. There?s no requirement that the IRS ?peg? you as a dealer at all.

Here?s how the IRS ?pegs? you as a dealer. They audit you, and decide that you are functioning as a dealer?.whereupon they charge you penalties and back interest on the taxes you should have paid, and perhaps audit some of the prior years tax returns as well. You don?t want to be ?pegged? in my opinion.

With that said, my answer on your questions:

  1. Yes?.self employment tax can be avoided on flips. You flip with a corporation. Of course again, saying that self-employment tax can be avoided is a little bit of a misnomer. A C Corporation does not pay self-employment tax. But if you receive a salary from the corporation, you and the corporation would pay social security tax. Understand that it may be possible to shelter some of those flip profits with various writeoffs within the corporation?deductions for expenses that might have otherwise been paid for by you personally. (No, not Rolex watches that you won in a sales contest). But to the extent that you pay out corporate profits in salary, you?re going to pay social security tax. You may be able to distribute some of the profits in the form of dividends. Social security tax is not levied on a dividend. HOWEVER, a dividend is not a deduction at the corporate level either. Therefore, a dividend has already been subjected to corporate tax?and when it is paid out to the shareholder, it is subject to that individuals? tax. How this is handled in an S Corp I can?t say.

  2. If you?re going to buy/sell properties where you carryback small seconds, the first thing to know is that you are a dealer, and this type of transaction will be taxes accordingly (unless you want to play audit roulette). See above. There is no way to avoid this. What you do is mitigate against the circumstances through your writeoffs in your dealer entity?.presumably your corporation.

  3. See my arguments above about being ?pegged?. If what you?re proposing is to carry out what you and I both understand as dealer activities?but claim that you?re not a dealer by naming yourself as something else other than a real estate investor?.I think this would be ill-advised.

My advice is to do your buy/sell transactions in a corporation. This means that your corporation will be a dealer. Properties that you hold should probably be held in an LLC or individually?..although I?m told that I could hold properties in my corporation despite it?s dealer status, and still be accorded an ?investment? treatment on that property. This would make little sense however since rental income which would not normally be subject to self-employment tax/social security tax is now going to be subject to that when paid out in the form of salary?or alternatively be subject to double taxation if paid out as a dividend.

Sorry I can?t give any advice on S Corps?I know nothing about them.

JPiper

Question # 2, short term capital gain instead - Posted by Jeff Denney

Posted by Jeff Denney on January 15, 2000 at 04:07:12:

Instead of paying Self Employment Tax and filing a schedule C (business income) on the 5 properties I sold last year, should I try to list them on a schedule D (short term capital gains) instead. Would this make me look like an Investor instead of a dealed of properties.
Thanks ,Jeff

Re: Let’s talk “DEALER” status and S.I. tax - Posted by Dan (NY)

Posted by Dan (NY) on January 15, 2000 at 09:06:31:

Jim,

What are the exact IRS definitions for a dealer vs. investor?

In the past, my accountant recommended I list my rehab projects as capital gains on Schedule “D”. Starting this year I plan to do all my projects through an LLC (or even multiple LLC’s).

My real estate “dabblings” have evolved over time into a full time business. Surely the IRS must have some method to take this into account…Dan

Re: Question # 2, short term capital gain instead - Posted by JPiper

Posted by JPiper on January 15, 2000 at 04:17:26:

Filing a form to “make you look like” an investor rather than a dealer does not change your status. If you walk like a duck, sound like a duck, you’re probably a duck Jeff. Filing a different form is not going to change that.

JPiper