In this episode of Coffee with Carl, attorney Carl Zoellner talks about the disadvantages of being classified as a “dealer” by the IRS and strategies to avoid dealer status.
In the IRS’s eyes, being a real estate “dealer” means that your real estate activities are conducted in such a way that the real estate is considered “inventory.” As a result, real estate investors who are on the active side of real estate investing (flipping, wholesaling, property development, etc.), need to be aware of the major downsides of dealer status.
Some of the reasons you should avoid dealer status in your real estate investing activities involve losing access to attractive benefits, including:
- 1031 exchanges
- Installment sales
- Long-term capital gains on real estate
- Depreciation deductions
On top of that, dealers are responsible for paying a 15.3% self-employment tax on rental real estate.
So, how does the IRS determine who qualifies for dealer status? The IRS considers the following when determining if your real estate activity qualifies as being a “dealer”:
- Purpose for which the property was acquired
- Number of improvements made on the property
- Number of sales done in the past
- Nature and extent of your business
- Extent of advertising and promotion for the sale of the property
- Use of a broker
If these rules sound broad, you’re right. These rules are designed to cast the widest possible net. Due to these broad rules, almost everyone actively investing in real estate could be classified as “dealers.”
So, how do you avoid dealer status for your real estate investing? Use a corporation for your active real estate activities. Corporations are not only tax deduction vehicles — they’re also useful for avoiding dealer status and holding onto your passive income.
Watch as Carl covers dealer status as defined by the IRS and breaks down what this classification means for real estate investors and how to avoid its pitfalls.
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