What is the Difference Between a Real Estate Dealer vs. Real Estate Investor

If you buy and sell real estate, you need to know the difference between being classified for tax purposes as a real estate dealer versus a real estate investor.

Descriptions

Real estate dealers are in the business of buying and selling real property - property is their inventory.

Real estate investors own property primarily to earn income from rents and/or long-term appreciation. Their real estate activity is not a business, it is a passive activity.

Tax Treatment

Why is this distinction important? Because dealers and investors receive very different tax treatment. As business owners, dealers pay taxes on their profits at ordinary income tax rates, which can be as high as 37%. They also pay self-employment taxes.

Real estate investors, on the other hand, pay taxes on their profits at capital gains rates and pay no self-employment tax. If they hold their property for over one year, they pay tax at long-term capital gains rates of 0%, 15%, or 20%. They may also have to pay the 3.8% net investment income tax (NIIT).

Tax Impact

The difference in tax rates can have a big impact if you sell real property at a substantial profit. For example, if you earn a $100,000 profit from the sale of a property held for over one year, your taxes as a dealer could be as high as $51,130 (37% income tax + 14.13% self-employment tax). If you are an investor, your taxes could be as high as $23,800 (20% capital gains tax + 3.8% net investment income tax). That is a $27,330 difference.

Dealers may also not deduct depreciation, use installment sales, or defer tax through Section 1031 tax-deferred exchanges of their property.

Things are not all bad for real estate dealers, however. Unlike investors, dealers may fully deduct their losses. Investors may deduct no more than $3,000 in losses from ordinary income (after offsetting gains against losses).

Definitions

Unfortunately, the tax code does not provide a concrete definition of "real estate dealer". Instead, there are various factors that are considered when determining if somebody is a dealer, including:

• How many of your properties do you sell, and how frequently?

• Did you buy with the intent of reselling at a profit?

• Did you improve the property to increase its resale value?

• What is the extent of your sales efforts?

• How did you acquire the property?

• How long did you hold the property before selling it?

• How much time did you spend selling the properties?

• What portion of your income comes from selling your properties?

Real estate dealers typically include (but are not limited to):

• real estate flippers - people who buy homes, fix them up, and resell them quickly;

• real estate speculators - people who buy and sell many properties each year;

• real estate subdividers - people who buy large tracts of vacant land, divide them into smaller lots, and then resell the lots piecemeal; and

• real estate developers and home builders - people who construct new houses and resell them soon after completion.

To make things even more complicated, you can own some property for sale as a dealer and other property as a long-term investment. Whether you are a dealer is determined on a property-by-property basis. If you have dealer and investor properties, you should keep separate books, records, and bank accounts.

If you want to discuss more about this, please submit your information here and we will be in touch.

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To ensure compliance with requirements imposed by the IRS, we inform you that any US federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and it cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Seek advice based on your particular circumstances from an independent advisor.