Avoiding Dealer Status When Flipping Houses

Any Investor who flips more than one or two properties a year will run into the issue of being branded with "dealer status" by the IRS for tax purposes. This is an extremely dangerous thing. Dealers, like Real Estate Agents, are considered to be self-employed and subject to self-employment taxes of 15.3%. Even worse, a dealer cannot pay tax on an installment basis when using owner financing. All the tax must be paid on the property up front, even if all of the payment has not been received yet.

The most important factors the IRS seems to use in determining if someone is a real estate dealer or not are the frequency of selling properties, the number of properties sold in a year, and whether there is continuity to the process to suggest that flipping property is the real intent of the business. If properties are held for more than a year before they are sold this may also weigh against considering an Investor's activity as being that of a "dealer."

There are several ways to handle significant numbers of transactions per year and still maintain the tax advantages of being an investor as opposed to a dealer:

1. Flip properties through a limited partnership, a self-directed IRA, a Coverdell Education Savings Account or a solo 401k plan. In a limited partnership only the general manager will be considered a dealer. Trusts and the various kinds of self-directed retirement and savings accounts are considered passive investments and these plans do not take active participation in a business.

2. Form a joint venture agreement with an active investor or agent who will essentially create a "done-for-you" investment strategy for wholesale buying and selling. That joint venture partner may well be considered a "dealer" but as long as you or your entity are not on title you will not be directly involved in any property flipping activity.

3. Put each property into a separate LLC or trust and transfer the LLC or trust rather than the property that is inside the entity.

4. At the very least, be careful to separate your wholesale fix and flip business from other business activity such as your "buy and hold" operations or any deals that will involve an installment sale.

Planning how you fund and hold your property may be as critical to determining the success of your real estate investing as the actual selection of properties that you decide to buy. Being branded with dealer status could cost you big time in the long run. Make sure you are doing deals the smart way!

Source by Bob Massey