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FAQs: Real Estate Investor vs. Real Estate Dealer
by Mark Minassian, CPA

Real estate investors and real estate dealers are taxed in completely different manners when they sell their properties. Knowing the differences between the two will help investors avoid unfavorable tax treatment on their real estate gains.

Q: What are the differences between real estate investors and dealers?

A: Real estate investors purchase real estate with the intention of holding their properties and gaining a financial return.

Real estate dealers buy and sell real estate as part of their everyday business. Real estate professionals who are involved in “flipping” (i.e. buying real estate with the intention of selling it for a profit in a short time frame) are usually considered dealers. Also, builders and contractors who build houses and sell the finished houses to customers are also considered dealers.

Q: What are real estate developers and are they investors or dealers?

A: Real estate developers buy property (usually raw land) and make improvements to it thereby increasing its value. Land developers make improvements to existing land by doing such things as adding utility connections and paved roads. They will then sell the land (or subdivide it and sell it) to building developers or other individuals. Building developers buy raw land, improved land or existing structures in order to construct building projects. The completed projects are then either sold to others or kept and rented to produce income.

Real estate developers are usually treated as dealers by the IRS because they are in the business of buying and selling real estate. However, if developers work on individual and sporadic long-term projects, they may be able to convince the IRS that they should be taxed as investors.

Q: How are investors and dealers taxed?

A: When a real estate investor sells property that has been owned for more than one year, any gain on the sale i7s taxed at the favorable capital gains tax rate of 15% for federal tax purposes. (Your state may also have its own capital gains tax rate).

When real estate dealers sell their properties, those properties are considered inventory and any gains are taxed at the dealers’ ordinary income tax rates, which can be as high as 35% for federal tax purposes.

If a real estate investor sells property that has been owned for less than one year, any gain on the sale is taxed at the investor’s ordinary income tax rate as well.

Q: How does the IRS determine if someone is a real estate investor or dealer?

A: Unfortunately, there is no easy way to answer this question. The main factor in making the determination is the intent of the person with respect to their property. However, it is difficult for the IRS to prove intent one way or another and the courts have debated the issue, often arriving at seemingly contradictory conclusions.

Also, just because an individual holds a piece of property for a short period of time does not automatically mean he or she is a dealer. Many times people buy real estate with the intent of holding it for investment purposes, but sell it earlier than planned due to financial or economical reasons.

Q: Can an individual be considered an investor and dealer at the same time?

A: Yes. The classification of an individual as an investor or dealer is determined on a property-by-property basis.

Disclaimer:  Any tax advice contained in this article is not intended or written to be used, and cannot be used, to avoid penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

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