Real Estate Dealer
A dealer is someone who buys and sells real estate as part of a trade or business. Their primary goal is to profit from the quick resale of properties.
Key Characteristics:
- Purpose of Ownership: Properties are purchased with the intent to resell (flipping or wholesaling).
- Frequency of Sales: Regular and frequent property sales indicate a dealer status.
- Holding Period: Properties are typically held for a short time.
- Marketing and Advertising: Dealers actively market and advertise properties for sale.
- Income Type: Income is considered ordinary income and is subject to self-employment taxes. Profits are taxed at the taxpayer’s marginal tax rate.
- No Depreciation or Capital Gains: Dealers cannot claim depreciation deductions or take advantage of lower capital gains tax rates for their sales.
Example: A real estate professional who buys properties, renovates them, and quickly sells them for a profit.
Real Estate Landlord (Investor)
A landlord owns real estate to generate passive income through renting rather than reselling.
Key Characteristics:
- Purpose of Ownership: Properties are purchased to generate rental income, not for immediate resale.
- Holding Period: Properties are typically held long-term.
- Income Type: Rental income is considered passive income and is taxed differently than active income. Rental expenses, depreciation, and mortgage interest are deductible.
- Capital Gains Tax: If the property is sold after a holding period, gains may qualify for long-term capital gains tax rates.
- Limited Self-Employment Tax Exposure: Rental income is not subject to self-employment taxes unless the taxpayer provides substantial services (e.g., hotel-like services).
Example: A property owner who rents apartments or commercial spaces to tenants over an extended period.
Key Factors the IRS Considers
The IRS evaluates several factors to determine a taxpayer’s status. These include:
- Intent: Was the property acquired to sell quickly or to hold as a rental investment?
- Frequency of Transactions: More frequent sales often suggest dealer activity.
- Level of Involvement: High involvement in real estate activities suggests dealer status, while limited involvement aligns more with landlord status.
- Nature of the Business: Advertising and engaging in sales-related activities can point toward being a dealer.
- Holding Period: Shorter periods align with dealer activity, while longer periods indicate investment.
Why It Matters
- Dealers: Pay higher taxes due to ordinary income treatment and self-employment tax.
- Landlords: Benefit from depreciation, passive activity rules, and lower capital gains tax rates on qualifying sales.
Properly classifying your real estate activities is essential to comply with IRS rules and optimize your tax benefits.
Arch Bookkeeping Services can help you identify each transaction and manage your tax situation monthly. Don’t wait to the end of the year to figure this out! Contact us today!
