Difference Of a Dealer and a Real Estate Professional? (Real Estate Tax Strategies For Investors)

Difference Of a Dealer and a Real Estate Professional? (Real Estate Tax Strategies For Investors)


(pleasant music tones) – [Toby Mathis] Heard something
scary on the last Tax Tuesday. Well, it was close to Halloween and I was trying to scare everyone. – [Jeff Webb] Good job. – [Toby Mathis] I wanted
to follow up to ensure that I wasn’t doing
something terrible on a flip I’m scheduled to close next week. What I heard: If you get
identified as a real estate dealer by the IRS, you get
taxed on 100% of the gain on the sale of the
property in the first year, even if selling on installments. – [Toby Mathis] Well, alright,
so if you’re a dealer, then you do not get something called installment sale treatment. Is that 475? – [Jeff Webb] I think so, yeah. – [Toby Mathis] I think it’s 475. Actually I could probably type it in here. Oops, I don’t know how to
type without a typewriter. It’s 475, I’m reasonably certain. But what it says is that
there’s an exception to being able to designate something under the installment sale method. So in other words, installment means I’m taking money over time. So if I sell Jeff my house, and I say pay me over 10 years, then I’m electing to treat
that as an installment sale, then I am receiving that
income over 10 years. And it’s a great way to defer
the tax out into the future. Now if you hold inventory for
the resale to the customer, which is what a dealer
does in real estate. I’m buying real estate. I’m holding it as inventory,
and I’m selling it. I buy property with the intent to sell it. I do not get to take installment sale. Is that a correct statement? – [Jeff Webb] No, wrong statute. – [Toby Mathis] Oh which one is it? – [Jeff Webb] 475 is market to market. – [Toby Mathis] Darn it! Alright so I’m thinking about traders. What’s the installment sale? I’m going to trip myself out here. – [Jeff Webb] It’s not participating. – [Toby Mathis] I’m going to find out. I’m going to drive myself crazy.
– 453. – [Toby Mathis] 453, so
that’s the installment method. Too many sections running
around in my head. So 453, and the exception
to that is the dealer. So here’s why it’s really
bad to be treated as a dealer if you’re doing this. You are taxed on 100% of the
gain the year that you sell it. So in real life, I’ll give
you a real life situation that happened to a client, is they bought a piece of
property for about $4 million. They were going to develop
it and sell off the pieces, and somebody comes in,
this was actually in 2007, says hey, I need that land, and they said well, we don’t
really want to sell it to you, and they said how ‘about I
give you $7 million for it? They’re like oh wow, $3 million gain, but they said we’re going
to pay you over time. They said, good, ’cause we
don’t want to have to pay tax on all this money, and of course think of the timing of it, they never got dime on the sale, and the IRS taxed them on the $3 million, and they said, but they defaulted. The land ended up not being worth half of what we paid for it. All these losses, all this stuff, and the problem was, it didn’t matter. The taxable event happened the day that they sold the property to the guy for $7 million. It took ’em two years to figure
out the project was down. In that two years, there
was interest and penalties on that non-reported $3 million of income. So they got slapped around very hard. They eventually were able
to write-off the debt having reasonably tried
to collect it as bad debt, but that took ’til year
three after the sale. Then they were able to carry
back some of those losses, but it doesn’t erase the
penalties and interest, and they ended up out about $300,000 that they never thought, and their accountant completely missed. So when they came to use they were like what do we do? And I said, well there’s
nothing you can do except we got ’em right when they were trying to collect on the note, and I said you have to
use reasonable methods to collect the note, then you have to write it
off as business bad debt. The accountant had dropped him of course because he was scared of getting sued. Anyway, so that’s dealer. Now being the president of the S-Corp, you may be able to be a
real estate professional, does that matter? The answer is no.
– Right. – [Toby Mathis] Unless you have losses. Real estate professional
status only matters if you are taking massive
amounts of depreciation on properties and creating losses. ‘Cause then you can offset your ordinary, your active income, your W2 job and everything
else with those losses, but in this case would not matter. So how should it be
carried out in the future? Don’t do installment sales on flips, ’cause you’re not going
to get that treatment. – [Jeff Webb] Right. – [Toby Mathis] It’s going to be denied. So if you’re going to do this, I wish I had an easy method for you. What you may want to do is fix the flip, sell it to something that’s
going to be owning it for a longer term period,
that’s an investment company. Like you’re going to have
to be disciplined about it and hold it for years and then sell it under installment
sale and let it season. Otherwise, don’t do that installment sale. If they need financing,
have them go to a bank. Or have them go to another lender, because you are paying tax
on 100% of that regardless. If anybody tells you
differently, they’re wrong. Flat out, simple. You can go read the statute. It says this is not available to people that hold it in the ordinary course. You can go read it yourself, 26 USC, and what’d you say 453? So, anyway, fun stuff. So I’m sorry I scared you. Hopefully we’re lessening the beating you’re going to take tax wise. If you are getting beat tax wise, it means you’re making money. It doesn’t mean that
like, this is horrible. It just means you’re not
going to pay tax in the future on that money as you receive it. The only money you’ll pay tax on, is the interest that you’re earning on that installment note. ‘Cause you’re going to pay all the taxes. (relaxed music)

One thought on “Difference Of a Dealer and a Real Estate Professional? (Real Estate Tax Strategies For Investors)

  1. So, there is no way to avoid dealer status when wholesaling land or houses no matter how you are structured?

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