Wholesaling is quickly selling a property as is with little or no fix-up. Many times the entrepreneur never goes to settlement and will just assign (or flip) the agreement of sale to their buyer for a quick profit. Wholesaling can be a profitable cash-profit business. But will it make you a dealer? That all depends, but first some background.
As a dealer, 50% or more of your earned profits could be drained by taxes. Therefore, unlike an investor, being identified as a dealer could be a financial disaster. Classified a dealer, you are subject to the highest income tax rates, plus Social Security taxes, other employment taxes, and possibly alternative minimum taxes. Dealer profits (cash or paper) are taxed immediately in full and cannot be tax deferred in any way. This includes not being able to use a 1031 exchange, installment sale reporting, a self-directed IRA, certain trusts or any other tax deferral strategy.
You could be wiped out if identified as a dealer, feeling like you have been condemned to hell! However, you can demonstrate your status as an investor and be saved while avoiding these expensive pitfalls.
Flipping properties does not automatically make you a dealer. With good planning, even with a very large number of flips (in one year), you could avoid the costly dealer status. This statement is based upon numerous tax courts cases (including a Supreme Court Case), actual IRS audits, and my own extensive research.
One of the best strategies to prevent being classified as a dealer is investment intent. You must demonstrate that the primary purpose of the quick sale profits is for investment purposes and not sales speculation. As an example, the primary purpose (or purposes) of the quick sale profits can be for a number of investment necessities, such as down payment funds to acquire long-term investment keepers, or working capital for property investment operations including preventive maintenance. Remember, there are over 30 strategies to avoid the penalty of a dealer. Look at all of them.
A very powerful defense against any IRS attacks is that with this premise, tax follows economics as opposed to sales speculation with tax avoidance motivation. Accordingly, as employed here, these flips are non-dealer, investment transactions with solid economic foundation. On this basis, there have been numerous cases and scenarios, some of which I have had first hand experience with, where even a larger number of sales in one year did not cause dealer status.
Many entrepreneurs, who have literally sold hundreds of units in a short time, claiming not to be a dealer, have won their cases when challenged. With the right planning and documentation you may do so also. As of this writing, there has never been an issue of civil or criminal fraud with the issuance of investor over dealer classification.
The issue here is a very arbitrary question of fact and not of law. With the burden of proof shifts to the IRS when considering cases of fraud, the difficult and almost impossible task is rarely tried. Thus, real estate entrepreneurs have everything to gain and little (if any) to lose. They should do so by planning in advance with dealer-avoidance strategies (especially investment intent), avoiding inept advisors, and go for it!
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