Hold the phone . . . - Posted by Bronchick
Posted by Bronchick on November 25, 1999 at 10:24:54:
I would NOT pay the taxes up front, EVER! There is no clear rules in the Code about what is a “dealer,” just guidelines based on tax court cases. Why pay when you are not clearly a dealer?
The following is an excerpt from the “Cash Cow” Course of ONE way to deal with the issue:
"The capital gains and installment sales rules apply for principal residences and properties held for ‘productive use.’ I.R.C. §1234. If you are actively buying and selling real estate on a regular basis, you may be considered a ‘dealer’ in real estate properties. A dealer is one who buys with the intent of reselling rather than for investment.
There is no magic formula for determining who is an investor and who is a dealer, but the IRS will balance a number of factors, (See, e.g., Winthrop, Ada Belle v. Tomlinson, 417 F.2d 905) such as:
? The purpose for which the property was purchased
? How long the property was held
? The amount of sales by the taxpayer in that year
? Amount of income from sales compared to taxpayer’s other income
? How many deals the taxpayer did in that year
? The amount of gain realized from the sale
If the IRS pegs you as a dealer, then you cannot use the installment sales method under I.R.C. §453. The installment sales will be disallowed and the entire “paper” profit is reported as ordinary income in the year of sale. The interest part of the payments will continue to be taxable in the year of receipt.
This re-characterization could be a large “hit” for the taxpayer. For example, suppose the taxpayer bought and sold ten properties on the following basis:
? Purchase: $90,000 purchase price, $20,000 down, $70,000 loan @ 8%
? Resale: $110,000 resale price, $10,000 down, $100,000 land contract @ 11%.
Thus, in each case the seller receives $10,000 in cash and $10,000 in “paper” profit. He also collects monthly net cash flow of about $440 per month. He pays taxes on the $10,000 cash and reports the balance as an installment sale. He also pays tax on the interest received each year. If the profit on the ten deals is re-characterized as ordinary income, the taxpayer now has $100,000 additional income subject to tax in the year of sale!
The following are some tips for handling the dealer issue:
? Keep One Year’s Cash Flow Reserve on Hand. Suppose that you buy and wrap 10 properties, with an average $10,000 “paper” profit and collecting an average $440/month cash flow as described above. The annual cash flow ($52,800) is enough to cover the hit if you are audited and denied installment sale treatment. Invest the first year’s income in liquid assets, such as stocks, bonds and mutual funds."