Am I a dealer? - Posted by Carl CA

Posted by Carl CA on April 14, 2004 at 17:54:23:

I agree with your point that the L/O route is full of risks, mostly on my part. Since I seem to have already satisfied the separation that the IRS would look for between flips and long-term holds, I’ve opted to take title on this deal.

I’m not willing to expose myself to the risk of the seller making dumb moves prior to me marketing, or exercising my option. This particular seller is also quite capable of making dumb moves, that’s why the houses are for sale in the first place.

To answer your last question, I’ve not done a L/O deal like this before. I’ll have to defer to more experienced guys.

Thanks again Glen.

Carl

P.S. What part of the SoCal market are you in?

Am I a dealer? - Posted by Carl CA

Posted by Carl CA on April 07, 2004 at 15:38:53:

I am negociating with a seller for two SFH rehabs. I’ve done a few rehabs and I’m comfortable with the deal, but I don’t really want to keep either of them (location). The price is very attractive and I want to pursue it.

I own 5 SFH rentals, and have an equity interest in 28 more units - all long term holds in an FLP or LLC.

If I intend to rehab and flip both houses, how can I avoid being classified by the IRS as a dealer? I’m in CA and the cost of setting up an LLC just for this transaction seems too high. If I take them on L/O and sell my option to my end buyer - does this avoid the dealer label if I never go on title? Any other suggestions?

Thanks in advance.

Carl

Re: Am I a dealer? (long) - Posted by Glen SoCal

Posted by Glen SoCal on April 11, 2004 at 06:39:03:

Carl-

I’m not a tax professional.

This subject has been covered at CREonline quite a bit. Try a search in the archives here and on the main board.

Having said that, this is my opinion about dealer status: If you acquire a property with the ‘intention’ of selling it as soon as possible, then it’s a ‘deal’; not an investment. If you attempted to sell the property in the short term, but for some reason couldn’t sell the property and it remained on the market for over a year, it could STILL be characterized as a ‘deal’ instead of a long term ‘investment’, as your intention was to sell the property immediately. If you flip enough properties to establish a ‘considerable’ volume and pattern of flipping, then you are a dealer.

The IRS can characterize ANY purchase and sale as a deal if there is enough evidence to support your intention to turn the property quickly, i.e., a deal. If you bought a property and began rehabbing, and listed the property on the MLS as soon as you began the rehab, you can see how the IRS would figure you intended to do a deal, and never intended to hold the property as a long term investment.

If you’ve held every property you’ve purchased as a long term investment, and purchased another property to hold (and taking title), but sold it immediately, it is unlikely the IRS would characterize the purchase and short term sale as a deal, or you as a dealer, as your history wouldn’t suggest that.

If you mix the purchases of your deals and long-term holds in the same entity, and if at some point the IRS characterizes you as a ‘dealer’, then all of your long term holds ‘could’ also be characterized as deals! If your investments are characterized as deals, you would no longer be able to enjoy the tax benefits of depreciation, or use long term investment vehicles such as 1031 exchanges for any of the properties. Also, you could be taxed at ordinary-income rates upon the sale of your properties even though you’d held them long term. This is a stretch of course, but I understand that it’s possible. And of course, you’d want to avoid having to have that conversation with the IRS.

A good strategy is to hold your long term investments in an entity seperate from your deals. In this way you telegraph what your intentions are to the IRS for the properties you intend to hold, and for the ones you intend to flip. As I mentioned earlier, selling one of your long term holds in less than a year can pass the ‘smell test’ if it was held in your ‘long term’ entity.

As to your question about buying on a L/O, then rehabbing and subsequently selling your option ASAP; it smells like a ‘deal’ to me. Doesn’t it you? But does that make you a dealer?

There is no number of deals you can do in a year that automatically earmarks you as a dealer. However, you can imagine that doing one deal is not going to mark you as a dealer. And that you could do a few deals a year and fly under the IRS radar for a long time; …or not.

It’s up to you and your tax professional to decide the risks and rewards for you investment strategy.

To answer your question: I don’t know if I can, but it hasn’t stopped me from trying. If you establish an entity to buy and sell flips, and one for holds, it doesn’t matter if the IRS marks you as a dealer, as your holds will be protected as OBVIOUS investments. Setting up an LLC to purchase the two properties you intend to flip won’t alter them. They are deals. And not taking title to the properties will make it harder to characterize the flips as investments. If you are trying to separate your ‘self’ from the LLC being tagged as a dealer; I don’t have an answer for that.

Doing a deal doesn’t make you a ‘dealer’, but the deal will still be taxed as ordinary income, unless you can characterize the short term flip as an ‘intended’ long term hold/investment. I think I’m correct about that tax treatment, but I’m not positive. If you purchase these flips outside of your ‘holdings’ entity, it seems to me that it doesn’t matter much if the IRS characterizes you as a dealer, as long as they understand the difference between your ‘deal’ and your ‘investment’ portfolio so that your investment polio is never in jeopardy of losing it’s favorable tax status.

I hope I haven’t bit off more than I can chew here. These are merely my opinions as I haven’t come in to contact with the IRS on this subject, nor have I interacted with an attorney on this issue other than here on this board. You should seek professional advice as opinions here can be worth as much as you pay for them.

Glen

Re: Am I a dealer? - Posted by eric

Posted by eric on April 08, 2004 at 10:57:31:

Talk to a tax professional.

I don’t know what the “magic number” is that would trigger you being a dealer. My recollection is that it has to do with how may are bought and sold in a year and not necessarily how many total properties you hold, especially when those are long term holds.

Again, look to a tax professional for this answer.

Re: Am I a dealer? (long) - Posted by Carl CA

Posted by Carl CA on April 11, 2004 at 08:05:59:

Thanks Glen. I’ve certainly learned a lot about the subject since posting here and on the main board.

I agree about the professional help, but I feel like a lamb being led to slaughter if I go into those meetings without ANY idea of what I’m talking about, that’s why I like to bat it around here first.

The impression I get is that the IRS actually classifying someone as a “dealer” is a rare thing. So many people have written about the POSSIBILITY of it happening, but not about how it happened TO THEM. I wonder what the real numbers are. Just curious.

Seems I’ve already achieved the “one-degree” of separation between my holds and my deals, since I wouldn’t have done the rehabs inside any of my current structures. Seems the easiest way to go is to pump up my liability umbrella and just do them personally, sell “as-is”.

Thanks for the thoughts Glen.

Re: Am I a dealer? - Posted by Carl CA

Posted by Carl CA on April 08, 2004 at 13:30:47:

Thanks Eric. Haven’t talked with the CPA yet, wanted to get some feedback from the veterans first. Most CPA’s are notoriously conservative when it comes to the IRS, and I wanted to go into the meeting armed with some more aggressive possibilities that have worked for others.

If there are any CPA’s out there reading this, I certainly didn’t intend to offend you, just stating my humble opinion.

Carl

Re: Am I a dealer? (long) - Posted by Glen SoCal

Posted by Glen SoCal on April 11, 2004 at 18:14:55:

Carl–

It does appear that you’ve already ‘telegraphed’ your investment intentions by setting up your entities for holding.

Of course it’s good to have enough insurance no matter what entity you choose to hold properties.

There’s an area in your plan where you might be exposed if your seller/optionor makes a financial decision negatively effecting the property’s value to you prior to your purchase/flip. If you take the properties as L/O’s and dump cash in to them, you’ll have to insure that the owner/optionor does not encumber the properties by filing for bankruptcy half way through your rehab, or create any additional liens against them.

Do you plan to escrow your L/O or something similar? Do you use an attorney to look over your docs?

A lot of questions; but one more. How do you word your proposal to the owner/optionor so that he will allow you to rehab ‘his’ properties? I’d want to control ‘your’ plans for rehabbing ‘my’ property, as there are some substandard rehabbers (hacks) out there…present company of course excluded. How do you put the owner/optionor at ease?

Thanks,

Glen