Avoid dealer status when changing house

Any investor who sells more than one or two properties a year will find themselves in trouble with the IRS qualifying them with “dealer status” for tax purposes. This is extremely dangerous stuff. Dealers, like real estate agents, are considered self-employed and are subject to the 15.3% self-employment tax. Worse yet, a dealer can’t pay taxes in installments when he uses owner financing. All property tax must be paid in advance, even if full payment has not yet been received.

The most important factors that the IRS seems to use to determine whether or not someone is a real estate broker are the frequency of property sales, the number of properties sold in a year, and whether there is continuity in the process to suggest that selling properties is the true intent of the business. If the properties are held for more than a year before being sold, this may also contradict an investor’s activity being considered a “dealer”.

There are several ways to handle a significant number of transactions per year and still retain the tax advantages of being an investor rather than a trader:

1. Invest property through a limited partnership, self-directed IRA, Coverdell education savings account, or individual 401k plan. In a limited partnership, only the general manager will be considered a distributor. Trusts and various types of self-directed savings and retirement accounts are considered passive investments and these plans do not imply active participation in a business.

2. Form a joint venture agreement with an active investor or broker who will essentially create a “made for you” investment strategy for buying and selling wholesale. That joint venture partner may well be considered a “dealer,” but as long as you or your entity do not have title, you are not directly involved in any change of ownership activity.

3. Place each property in a separate LLC or trust and transfer the LLC or trust in lieu of the property that is within the entity.

4. At a minimum, be careful to separate your wholesale fix-and-change business from other business, such as your “buy-and-hold” operations or any deal involving installment sales.

Planning how to finance and maintain your property can be just as important in determining the success of your real estate investment as the actual selection of properties you decide to purchase. Having the brand with dealer status could cost you a lot of time in the long run. Make sure you’re trading smart!

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