Important: PropStream doesn’t offer legal advice. This article is strictly informational. Investors and dealers should consult a legal professional to decide which investing route is right for them and how to file taxes appropriately for their specific investments.
On the surface, “real estate investor” and “property dealer” sound similar. But to the IRS, they are quite different, and knowing the difference could potentially save you thousands of dollars in taxes.
In this article, we’ll define what a real estate investor is, what a property dealer is, how the IRS treats them differently, and how you can minimize your tax burden.
What Is a Real Estate Investor?
A real estate investor is someone who buys property as a long-term investment. They might rent the property out, let it appreciate, or both.
Some examples of investment properties include apartment buildings, single-family rentals, and storage facilities. Properties acquired through an inheritance, dissolution of a trust, or foreclosure of a mortgage are also usually considered investment properties.
If you acquire a property with the intent of holding onto it for a long time, you’re most likely considered a real estate investor in the eyes of the IRS.
What Is a Property Dealer?
In contrast, a property dealer is someone who regularly buys and sells property in the “ordinary course of their trade or business.”
The most common type of property dealer is a house flipper. They buy houses to fix up and sell at a profit (often fast, so they don’t risk the property depreciating from a sudden market shift).
But property dealers can also include real estate developers, real estate wholesalers, and some land investors. What distinguishes a property dealer is that they buy intending to sell quickly. It’s an active rather than a passive investment strategy.
Property dealers also tend to participate in many real estate transactions every year because flipping is a regular part of their business.
It’s important to point out, however, that you can be a real estate investor and a property dealer simultaneously. It all depends on the property types you own, as each property is classified separately.
What Are the Tax Implications of Real Estate Investing?
Now that you know the difference between real estate investors and property dealers let’s discuss why the distinction matters in the first place…
Let’s start with real estate investors. The IRS taxes any gains from owning investment property at a long-term capital gains rate, which is usually 15% or less. Keep in mind that to qualify for the long-term capital gains rate, you must hold the property for at least one year.
Other tax advantages of owning investment property include not being subject to self-employment tax, the ability to deduct property depreciation, and the ability to defer capital gains taxes through 1031 exchanges.
Also, when you sell investment property through an installment sale, you’re only required to pay taxes on the proceeds as the money comes in, not immediately after the first year.
One tax disadvantage of real estate investing is that you can only offset capital gains with capital losses of up to $3,000.
What Are the Tax Implications of Property Dealing?
Now let’s focus on property dealers.
The IRS views dealer property as business inventory, not a capital asset. So, any gains you make from selling a dealer property are taxed like ordinary income (aka short-term capital gains), with a tax rate of up to 37% for the tax year 2022.
On top of that, because house dealers are considered business owners, they are subject to self-employment taxes, which include a tax rate of 15.3% (12.4% goes toward social security and 2.9% goes toward Medicare).
Other tax disadvantages that property dealers face include not being able to take advantage of 1031 exchanges, not being able to write off property depreciation, and having taxes due on the entire proceeds of an installment sale in the first year (instead of spreading out over time as payments are collected).
But dealer properties also have some tax advantages. You can still deduct selling expenses and commissions as well as advertising, marketing, or legal fees. And since dealer property gains are considered ordinary, you can deduct any losses from a dealer property sale as an ordinary loss, and you aren’t subject to the $3,000 capital loss cap that applies to investment properties.
Tax Comparison: Real Estate Dealer vs. Investor
So, who has the better tax position overall: a real estate investor or a property dealer? Here’s an example to help you better understand:
Say you sell a property and make a $100,000 capital gain. As a property dealer, the capital gain will be subject to ordinary income tax, which at the top tax rate of 37% comes out to $37,000. Plus, you’ll be subject to a 15.3% self-employment tax, which equals $15,300. That’s a total tax burden of $52,300 ($37,000 + $15,300).
If you make the same $100,000 capital gain as a real estate investor, you’ll only be subject to a long-term capital gains tax. At the top tax rate of 20%, that’s $20,000, which means you’ll be saving $32,300 by classifying as a real estate investor instead of a property dealer ($52,300 - $20,000 = $32,300). Plus, you’ll get other tax breaks like the ability to defer capital gains taxes indefinitely through 1031 exchanges.
In short, property dealers end up paying more in taxes than real estate investors do.
How to Classify Properties to Potentially Minimize Your Tax Burden
To minimize your tax burden, you'll find it helpful to intentionally classify your property acquisitions. The best way to do this is to keep detailed records.
If you want the IRS to consider you a real estate investor and avoid house flipping taxes, consider using detailed documentation that shows you intended to keep the property long-term at the time of purchase.
Unfortunately, the IRS doesn’t provide clear-cut rules for what it considers an investment property and what it considers a dealer property.
In fact, according to a 1952 court case called Mauldin v. Commissioner, “There is no fixed formula or rule of thumb for determining whether property sold by the taxpayer was held by him primarily for sale to customers in the ordinary course of his trade or business. Each case must, in the last analysis, rest upon its own facts.”
That said, here are some general factors the IRS considers when evaluating properties:
- The purpose for which the property was acquired. Was the property purchased with the intent to buy and hold or fix and flip?
- The purpose for which the property was held. Was the property held for it to generate rental income and appreciate?
- Improvements, and their extent, made to the property by the taxpayer. Were there any renovations done, suggesting the property was acquired with the intent to sell as soon as possible?
- The frequency, number, and continuity of sales. How frequently and regularly do you sell properties, and how many do you sell per year?
- The extent and substantiality of the transaction. Were there any red flags indicating that the sale may not have been at arm's length or the price may not have been at market value?
- The nature and extent of the taxpayer’s business. Are you in the business of flipping homes or investing in them long-term?
- The extent of advertising or lack thereof. Did the property sale involve extensive marketing efforts?
- The listing of the property for sale directly or through a broker. Do you sell homes frequently enough that you don’t need to rely on real estate agents?
By answering the questions above, your accountant or financial advisor will have a better idea of how you should classify your properties on your tax returns.
In the case of properties with mixed attributes, your accountant will help you decide on the best classification; just remember to keep good records to support your reasoning.
Ultimately, the IRS has the final say on your property’s classification. Some interesting observations about past decisions the IRS has made reference the intent at the time of purchase being a deciding point for the classification. The IRS made this clear in a 1954 court case called Goldberg v. Comm'r of Internal Revenue:
Despite selling 90 properties in one year, the IRS deemed Nathan Goldberg a real estate investor. Why? Because he bought the 90 homes intending to rent them out during World War II. He only sold them after the war ended and there was no longer a need for them. Thus, his intent at the time of purchase was the deciding factor, not the number of homes sold.
Real Estate Dealers and Investors Can Find Their Next Property Using PropStream
While real estate dealers are often confused with real estate investors, the main difference between these titles relates to taxes.
Investors can often get away with paying lower taxes on their property sales and can take advantage of specific tax breaks. Flippers and wholesalers are often considered “dealers” by default; however, there is a possibility to be considered an “investor” by being strategic with records relating to your transactions.
Whether you qualify as a real estate investor or a dealer, you’re likely always on the hunt for a new property. PropStream has the robust real estate datasets and intuitive marketing tools you need to find your next opportunity and pitch to homeowners.
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