Real Estate Dealer vs Investor: Key Definitions and Difference

Explore the unique roles and contrasts between a Real Estate Dealer vs Investor, understand their divergent strategies in property investment, and learn how each classification influences tax implications, property handling, and long-term investment outcomes. This knowledge is important for anyone in real estate, whether you want to boost profits, handle taxes effectively, or improve the stability and growth of your real estate portfolio.

First, consider the major tax impacts of identifying Real Estate Dealer vs Investor. Individual dealer sales profits face:

• Up to 37% in ordinary income taxes,¹
• Plus self-employment taxes as high as 14.13%.²

Moreover, dealers are restricted from:

• Depreciating property intended for sale to customers,
• Reporting property disposals via the tax-advantaged installment method,
• Utilizing Section 1031 for tax deferral purposes.

Advantageous Tax Benefits for Dealers

The tax system regards Real Estate Dealers similarly to regular businesses, offering several favorable tax provisions:

1. Real Estate Dealers can classify expenses like selling costs, commissions, legal fees, and advertising as standard business deductions.
2. The $3,000 capital loss limitation applicable to investor properties does not constrain losses from dealer property sales.
3. Dealers have the ability to write off losses as ordinary losses.
4. Generally, dealers can immediately deduct these losses, although if they result in a net operating loss, the deduction may be spread over time.³

Favorable Tax Benefits for Investors

Real Estate Investor sales profits come with:

• Taxation at capital gains rates, capped at 23.8%, which are more favorable than regular income rates,
• Exemption from self-employment taxes. For instance, on a $90,000 property sale profit:
• Taxes for Dealers could reach up to $46,017,⁴
• While for Investors, the maximum tax could be around $21,420.⁵

An investor in the highest federal tax bracket enjoys a tax saving of $24,597 (a substantial amount).

Additionally, the investor:

• Can depreciate the property,
• Has the option to sell using the tax-beneficial installment sales method,
• And may defer taxes through Section 1031 tax-deferred exchanges.

However, investors are subject to a $3,000 cap on net capital losses (after balancing gains and losses).

Also, they face the drawback of counting selling expenses as deductions from sales proceeds, which means these expenses only yield benefits at the capital-gains tax rates.

Real Estate Dealer vs Investor: You Can Be Both

As an individual taxpayer, you have the ability to be both a dealer and an investor. The law assesses each of your properties on an individual basis.⁶

To turn this dual role to your favor, it’s important to clearly categorize your properties in your accounting. Distinguish between investment properties and dealer properties in your books and records.

If you don’t clearly differentiate these properties in your records, you risk being at the discretion of the IRS. Given that “mercy” is not a term found in tax laws, failing to do so could lead to unfavorable outcomes from the IRS.

Courts consider your intention when purchasing and holding a property, and your books and records play a key role in establishing this intent.

Be aware that “help” is the operative word here. Your purpose in buying and holding a property is not definitive but rather assists in the determination. Ultimately, when it matters most, courts scrutinize the property’s sale to decide its status as either dealer or investor property.⁷

Create a Solid Case by Establishing Intent

Position yourself for a convincing argument by clearly defining your intent:

• At the time of purchasing the property,
• Throughout your ownership of the property,
• And at the point of selling the property.

This article guides you in doing so.

It’s important to remember that situations can evolve. Your initial purpose for buying a property might shift due to unforeseen circumstances. This article will assist you in understanding the implications of such a change and how to strategize for a more favorable outcome.

The Essential Point-of-Sale Consideration

Prior to delving into the planning aspects of this article, which detail the characteristics of a Real Estate Dealer vs Investor, it’s crucial to concentrate on a key element: the appearance of your property at the time of sale. This point-of-sale perspective is heavily scrutinized by both the IRS and the courts, and it frequently dictates whether your property is classified as dealer or investor property.

Grasping the traits of a dealer, outlined below, as well as the investor attributes that follow, will aid you in evaluating your property accurately.

Understanding Your Property’s Tax Classifications

It’s important to recognize that each property is independently classified as either a dealer or an investor property. Your property may exhibit characteristics of both. In cases where your property shows mixed traits, the court will decide its classification based on its interpretation of the facts related to the property.

Relying on the court to make this determination is not advisable.

Many encounter issues with dealer and investor property classifications due to a lack of understanding before the fact.

By learning how tax rules can classify your property as dealer or investor, you can avoid these problems. With a clear grasp of the differences, you’ll be able to strategically plan and assign the appropriate attributes to your property.

Tax Traits of Dealers

“Dealer property” refers to real estate that you hold for sale to customers as part of your regular business activities.⁸

The frequency of your property transactions plays a significant role in this classification. If you buy and sell more properties within a year, you’re more likely to be seen as a dealer for those properties.⁹

If you’re expecting a specific transaction threshold from the courts or the IRS to define what constitutes dealer property, unfortunately, no such definitive number is established. There’s no set transaction count that automatically categorizes property as dealer property.

To eliminate any assumptions about a specific number for dealer status, consider these court cases:

• S & H, Inc. gained dealer status from a single sale as they had committed to selling the property to another party prior to acquiring it.¹⁰
• Conversely, Nathan Goldberg didn’t receive dealer status despite selling 90 homes in a single year.¹¹

The complexity of these classifications is highlighted by the Goldberg case. Initially, the Tax Court ruled against Nathan Goldberg, but the Fifth Circuit later reversed this decision. In this situation, the homes were constructed as rental properties during World War II. After the war, when the rental demand ceased, these homes were sold. The sequence here was:

• The homes were built for rental purposes,
• Utilized as rental properties,
• And then sold.

The homes were never originally intended for resale to customers as part of regular business operations.

From these examples, it’s clear that there isn’t a specific number of sales or purchases that definitively categorizes a property as either dealer or investor property.

However, a common trend observed across numerous court cases is that the more properties you buy and sell, the higher the likelihood they will be considered dealer properties.

Typically, a property that is purchased, renovated, and then sold is classified as a dealer property.¹²

Similarly, properties that are subdivided are often regarded as dealer properties,¹³ except in cases where the subdivision adheres to the specific conditions of Section 1237.¹⁴

Removing a lien to enhance a property’s salability can also suggest dealer status.¹⁵

The amount of effort you put into selling is crucial. Courts often consider a property as dealer property if you actively engage in extensive marketing and sales activities, especially when compared to those who take a more passive approach to marketing.¹⁶

Additionally, holding a property for a brief period is indicative of dealer status,¹⁷ as courts recognize that efficient cash and profit management motivates dealers to quickly turnover their properties.

If your primary source of income is from dealing in properties, it’s more probable that the courts will classify your properties as dealer properties.¹⁸

However, earning a living from these activities is just one aspect of dealer status. The amount of time you dedicate to buying and selling property for personal gain is another crucial factor. If this occupies most of your time, your properties are likely to be viewed as dealer properties.¹⁹

Additionally, if you frequently reinvest the proceeds from property sales into buying more real estate, courts are more inclined to consider you a dealer rather than an investor.²⁰

Dealing with a Dealer Attribute’s Influence

We’ve discussed various attributes that could categorize some or all of your properties as dealer properties. However, just because a property exhibits a single dealer attribute, it doesn’t automatically become a dealer property.

Moreover, having dealer properties in your portfolio doesn’t exclude the possibility of also having investor properties. It’s crucial to remember that each property is assessed independently.

Consider the dealer attributes as indicators guiding your property management journey. Aim to align these attributes with your property from the time of purchase until the sale. This approach helps in clearly defining the nature of each property in your portfolio.

Tax Traits of Investors

In contrast to dealer property, where the primary goal is to sell to customers in regular business operations, the investor’s objective for owning property is different. An investor typically aims for the property to:

• Appreciate in value, and/or
• Generate rental income.

Investor properties are not sold as frequently as dealer properties.²¹

Properties primarily purchased to yield rental income are categorized as investor properties. This distinction is key in understanding the different tax implications and strategies for real estate investors compared to dealers.²²

Typically, courts consider you to be holding property as an investor when you acquire it through:

• Inheritance,²³
• Dissolution of a trust,²⁴ or
• Foreclosure of a mortgage.²⁵

Generally, when you use these methods to acquire properties, it suggests that you have an investment-focused approach to owning real estate.

You can substantially upgrade a decedent’s real estate and still maintain investor status.²⁶ However, exercise caution in this area. If you make significant improvements to the decedent’s property and then sell it, reinvesting the proceeds in other real estate, it becomes more challenging to persuade the court that your role is solely that of an investor. Actively improving and reinvesting in your property could be seen as leaning towards dealer activities.

Additionally, if you begin subdividing the land or engage in activities typical of a dealer, the courts are likely to classify you as a dealer.²⁷ However, there are strategies to manage such situations while still securing beneficial outcomes. For instance, using an S Corporation when selling appreciated land can help lock in favorable capital gains treatment. For more detailed information on how to approach this, refer to resources like “Selling Appreciated Land? Use the S Corporation to Lock in Favorable Capital Gains Treatment.”

Typically, investors tend to have a longer holding period for properties compared to dealers. Holding onto a property for a longer period of time makes it more likely to be classified as an investment property.²⁸

Investors do not engage in a buy-remodel-sell approach. While they may undertake remodeling projects, their primary goal is to enhance rental income, not to remodel solely for the purpose of selling the property as a regular business activity.²⁹

Key points to remember about Real Estate Dealer vs Investor:

1. Dealers acquire property with the intent to sell it to customers as part of their regular business operations.
2. Investors purchase property primarily for the purpose of achieving appreciation, generating rental income, or a combination of both.

If your property doesn’t fit neatly into one category, strive to ensure it possesses as many of the characteristics aligned with your desired outcome as possible.

Each property is individually classified as either a dealer or investor property.

As an individual taxpayer or a corporation, it’s possible to own both dealer and investor properties.³⁰ In such a scenario, it is crucial to ensure the accurate classification of your properties. Failing to do so can have significant and potentially costly tax implications.

If you own both types of properties, you must actively maintain a clear separation in your financial records, ensuring a distinct distinction between properties categorized as investment properties and those designated as dealer properties. This helps ensure proper documentation and compliance with tax and legal requirements.

Get ahead with expert tax guidance! Call 832-303-3995 or book your appointment today.

1 2023 Federal Tax Rates.
2 Self-employment rate of 15.3 percent times the 92.65 percent Schedule SE adjustment equals the effective rate of 14.13 percent.
3 IRC Section 172(b)(1)(A)(ii).
4 For example, if your spouse has a good income and your only earnings are taxed at the highest federal rate of 37 percent, you’d also have to pay self-employment taxes at a rate of 14.13 percent.
5 Here, you have the 20 percent capital-gains rate plus the 3.8 percent net-investment income tax.
6 Tollis v Commr., T.C. Memo 1993-63.
7 Sanders v U.S., 740 F.2d 886.
8 IRC Section 1221(a)(1).
9 Sanders v U.S., 740 F.2d 886; Suburban Realty Co. v U.S., 615 F.2d 171.
10 S & H, Inc. v Commr., 78 T.C. 234.
11 Goldberg v Commr., 223 F.2d 709, 55-1 USTC paragraph 9519 (5th Cir. 1955).
12 Jarret v Commr., T.C. Memo 1993-516.
13 Rev. Rul. 57-565 allowed capital gains treatment for the land not subdivided when the taxpayer had subdivided 40 percent into lots and sold those lots.
14 IRC Section 1237.
15 Miller v Commr., T.C. Memo 1962-198.
16 Hancock v Commr., T.C. Memo 1999-336.
17 Stanley Inc. v Schuster, aff’d per curiam, 421 F.2d 1360, 70-1 USTC paragraph 9276 (6th Cir.), cert. denied, 400 US 822 (1970); 295 F. Supp. 812 (S.D. Ohio
1969).
18 Suburban Realty Co. v U.S., 615 F2d 171.
19 Armstrong v Commr., T.C. Memo 1980-548.
20 Mathews v Commr., 315 F2d 101.
21 Rymer v Commr., T.C. Memo 1986-534.
22 Planned Communities, Inc. v Commr., 41 T.C.M. 552.
23 Estate of Mundy v Commr., 36 T.C. 703.
24 U.S. v Rosebrook, 318 F.2d 316, 63-2 USTC paragraph 9500 (9th Cir. 1963).
25 Cebrian v U.S., 181 F. Supp 412, 420 (Ct. Cl. 1960).
26 Yunker v Commr., 256 F.2d 130, 1 AFTR2d 1559 (6th Cir. 1958).
27 U.S. v Winthrop, 417 F.2d 905, 69-2 USTC paragraph 9686 (5th Cir. 1969).
28 Nash v Commr., 60 T.C. 503, acq. 1974-2 CB 3.
29 Metz v Commr., T.C. Memo 1955-303.
30 Harbour Properties, Inc. v Commr., T.C. Memo 1973-134; Howell v Commr., 57 T.C. 546; Real Estate Corp. v Commr., 35 T.C. 610 (1961), aff’d, 301 F.2d 423
(10th Cir. 1962); Mieg v Commr., 32 T.C. 1314 (1959)