If you buy and sell real estate for any purpose other than to provide housing for your own family, it’s important to know how the IRS classifies you. It can mean the difference between paying income tax rates of from 15-20 percent — or up to 39.60 percent.
Keep in mind that, at this writing, Congress and President Trump are in the middle of trying to implement tax reform. Income tax rates could change before the end of 2017.
Which Type Are You?
Real Estate Investor
Do you consider real estate an investment? That is, do you buy properties and hold them for more than a year, hoping to eventually make a profit when you sell? Rent the properties to cover the carrying costs? Maybe you do improvements to increase their value, or maybe you just wait for the price to increase. Either way, your intent is to profit from the long-term appreciation of the property.
The IRS considers you a real estate investor, and taxes you accordingly. You’ll pay the appropriate long-term capital gains tax rate, which depends on your income tax bracket.
Real Estate Dealer
Do you consider properties as inventory? Do you buy real estate with the intention of selling it? If you are a residential developer selling lots or condominiums you could easily fall into the category of dealer. Real estate dealers pay ordinary income tax rates on their profits.
Can You Be Both an Investor and a Dealer?
Yes. The IRS’ judgment is based on individual transactions, property by property.
What About Real Estate Developers?
If you buy property (either land or existing structures), improve it to make it more valuable, and then sell it, the IRS usually considers you a dealer. In some situations, developers beg to differ, and may be able to make a case for being consider investors.
Intent is Key, But Much Gray Area
As you might imagine, the distinction between real estate dealers and real estate investors is not razor sharp. For example, you might buy a property and consider it an investment, but circumstances lead you to subdivide the property, market it, and sell it in pieces.
The IRS can’t know what you’re thinking. Your intentions when you purchase real estate are known only to you, and there have been court battles over this issue. There are several ways to signal your intent that can materially strengthen your case. We can help you sort through what can be a complex determination; contact us for a consultation.