April 6, 2020
Real estate markets are hot in cities across the United States. Many people are eager to take advantage of these conditions but aren’t sure how. Although we can’t help you make a surefire investment, we can help you with one of the biggest factors you’ll need to consider before you buy: whether the IRS will classify you as an investor or a dealer. This will have a significant impact on your taxes.
You are considered an investor if you purchase real estate with the intention of holding the property for more than one year to realize a financial return. When you sell the property, your gain will typically be taxed at capital gains rates. “Depending on your tax situation, that rate could be as low as zero but as high at 20%,” says Adriane Reams, CPA and Manager. “You’ll definitely want to look into that before you take the plunge.”
What if you end up selling your property at a loss? The tax implications in this scenario represent one of the downsides of buying real estate as an investor rather than a dealer. Because of the way capital losses are deducted, the maximum capital loss you can take is $3,000 a year if you don’t have any offsetting capital gains income. Reams gives us this example: “If you sell at a $9,000 loss, you can deduct the full amount, but it must be done $3,000 at a time over the course of three years. And remember, that is only if you don’t have any offsetting capital gains income.”
A dealer is someone who acquires and sells real estate as part of their everyday business. A house flipper — someone who quickly rehabs and resells properties for short-term profits — is an example.
“The downside of being a dealer,” says Reams, “is that when you sell the property, your gain will be taxed at ordinary income tax rates. Federal income tax can be as high as 37%, depending on your tax bracket. In this sense, it pays to be an investor.
Dealers do have an advantage, however, when it comes to selling at a loss. In that scenario, you can deduct 100% of that loss in full, no matter what your capital gains income is for the year.
A Bit of Both
Can you be both a dealer and an investor? “Absolutely!” Reams tells us. “A dealer can hold real estate as an investment, and an investor can have dealer activities. You simply have to determine, upon the sale of a piece of real estate, the gain and the intention with which it was purchased.”
Purchasing Through a Business Entity?
Perhaps you’re interested in purchasing property through your business. If so, you need to classify your business as an investor or dealer, just like you would as an individual. An investor holds the real estate as a fixed, long-term asset — such as property, plant, and equipment — and depreciates the property over time. A dealer, on the other hand, holds the real estate as inventory, making it a current asset. It is not depreciated over time because it is designed to sell quickly.
Whichever approach appeals to you, you can count on us to correctly report real estate transactions for you and help you manage your balance sheet and profit and loss activity. “If you’re not sure what would be best for your goals, I’d be happy to talk more in depth,” Reams says. “Real estate could be an exciting opportunity for you!”
Contact Adriane at firstname.lastname@example.org or 209-527-4220.