A real estate dealer is one who is in the business of owning property with the primary intent of resale. Think of a real estate flipper here.
Landlords should strive to avoid qualifying as a real estate dealer as negative tax consequences, such as being subject to FICA taxes, can be the result.
The IRS will look at the following factors to determine if you are a real estate dealer:
- The number and frequency of sales
- The original intent for buying the property
- The extent of your improvements
- How the property was acquired
- The sales efforts you engage in and the holding period
- Income generated by sale compared to your other income sources
- Whether the dealer worked continuously in the property or held it passively
- Offices and buildings held by the dealer that help the dealer facilitate sales of property
Being classified as a dealer can be detrimental to your tax position. The biggest negative consequence is that gains on sale will be treated as ordinary income subject to self-employment taxes. Additionally, dealers cannot claim depreciation from the real estate, cannot enter into 1031 exchanges, cannot enter into installment sales and must file Schedule C rather than Schedule E.
Evaluation of dealer status occurs at the property level. This means that even if you primarily flip properties, you can still own rentals that qualify as a non-dealer property. Conversely, if you own a large rental portfolio and flip a property here and there, you may be able to get away with not classifying those flipped properties as dealer property.
It’s a good idea to keep separate records of flips and rentals. It’s even better if you can hold rentals in an entity structure completely separate from your flip activities.