Posted by JHyre in Ohio on September 24, 2001 at 20:53:47:
Check out my article on “Dealer issues” under How-To Articles…the idea that you MUST have separate entities for respective dealer & non-dealer activities is a myth…you can have the same kinds of properties in one entity, if your record-keeping is good enough to distinguish the two. The “passive” or “active” label on 1065 sets the tone, your specific activities and the related facts determine whether you will be viewed as a Dealer or Investor with respect to that entity in GENERAL …and your records document the exceptions on a property by property basis. Dealer & Investor property, living in perfect harmony, here on my keyboard…ohhhh, Lord it’s much too late for humor.
Bottom line: Separate entities most effectively segregate dealer & non-dealer property BUT both can be safely held in single entity with good documentation.
Posted by Ben (NJ) on September 19, 2001 at 06:47:11:
Worst case scenario, even if this forum turns out to be just me and JHyre proselytizing to each other it will be well worth it! Anyway, enough of idle chit-chat, we have an article to tear apart (er, analyze, LOL). I have spent the
past few years carefully crafting my real estate sales to conform to investor rather than dealer status. This year it all kicked in nicely, (or so I thought). Title was transferred from a few tax liens held by my corporation to an LLC of which I am a member. The LLC took final judgment thereby vesting title to the property in the LLC. I have sold one property already for a huge capital gain, and have two more in contract, (these will be part of a 1031 exchange). No property has been owned for longer than 8 months. The LLC also owns some stock, some tax liens and other incidental investments as well as the real estate. Here is the problem, my accountant says my gains from the sales of the RE will so utterly DWARF any other gains (or lack thereof from the other investments) that the IRS will probably brand me a dealer on that basis ALONE. This doesn’t seem fair. What is your view?
Posted by JHyre in Ohio on September 19, 2001 at 11:14:10:
sounds so…dirty, LOL!
Your CPA is correct in that the IRS will certainly argue for dealer status given the relative magnitude of your RE gains. In fact, most of the case law is against you. In most instances were the income from RE sales was huge relative to other sources of income, dealer status applied.
There are exceptions, none of which perfectly match your facts…but as a lawyer, you know that the match needn’t be perfect to have an argument. In several cases, “odd years” where RE sales constituted the bulk of income where disregarded as anomolies. The best example is liquidation of investments…as when a traditionally rental-oriented operation liquidated inventory. Your argument would be that you purchase tax-liens for the interest income, but that ocasionally the liens result in your getting a house that is liquidated and reinvested into yet more liens…is this an accurate description of your business? If yes, you’ve an argument. The question then becomes: Is the argument strong enough to constitute “substantial authority”, hence avoiding penalties and disclosure (disclosure avoids penalties but invites audits) under IRC Section 6662? You or your CPA need to search for cases that support the “abnormal year” view…there’s lots of general language out there to that effect, but no cases that I know of close to your facts. Given the LARGE amount of dealer/investor cases out there, something comparable to your facts may exist, my lack of cites notwithstanding.
If, however, your tax liens regularly result in getting the RE (or worse yet, you structure your lien purchases to produce that very result) which you consistently sell instead of holding, you will lose any dealer argument. In fact, even if you do not regularly get properties out of the liens, but always sell what you do get, the odds are against you sucessfully arguing for investor status. It boils down to:
What are your exact facts;
If the facts leave some room for argument, does the strength of your argument rise to the level of “substantial authority”?
To figure that out, some general language from “aberrant year” cases would be helpful. Cases that ruled for investor status in “non-complete liquidation of the company/” or “periodic liquidation of investment” scenarios would be golden.
Posted by JPiper on September 19, 2001 at 11:36:42:
Congratulations to you and Bill on the new endeavor. The prospect of free legal advice seems tantalizing…the admonitions above notwithstanding
Clear something up for me. If anyone (anything) were ever a dealer my corporation would be. However, I’ve never been “notified” by the IRS that I’m a “dealer”. I’ve never been “tagged” a dealer.
My understanding is that each transaction stands on it’s own…that no “dealer status” is actually conferred. So in my case for example, in my corporation I pay taxes as a dealer for those transactions where I have entered into dealer activity.
So give me the “real” scoop here: Is there really a status called “dealer” or do we look at each transaction on it’s own?
In my “dealer” corporation I do happen to own some properties that I lease/optioned…wouldn’t necessarily have been my choice but “stuff” happens. My understanding is that this corporation can have “rental” properties even if it is a dealer…however I still wonder as I mentioned above whether there is such status.
Posted by David Krulac on September 19, 2001 at 12:00:18:
Jim,
My understanding, I’m not an attorney/CPA, is that the IRS does not notify, tag, or confer Dealer Status on you.
However, when and if you are audited the IRS can disallow your capital gains treatment of a long term gain, by saying, “Sorry, Jim but you’re a dealer and as such are not eligible for 1.)long term capital gains treatment, 2.) Section 1031 exchanging, 3.) favorable treatment of installment sales income.”
Posted by JHyre in Ohio on September 19, 2001 at 12:00:10:
Get used to those words! There is no such thing as a formal “Dealer” sticker that gets slapped on your forehead (or brightly lit helmet, as the case may be). Nor is there a statutory section entitled “Dealers”. Rather, the rules that apply to “those who sell things in the regular course of their trade or business” are a hodge-podge of add-ons and jury-rigged provisions scattered throughout the Internal Revenue Code. The concepts of “Dealer” and “Dealer Status” are a convenient, if slightly misleading, shorthand for all of the otherwise inexplicable and well-dispersed Code sections that stick it to those who regularly sell things.
Each transaction does stand on its own…but there is a presumption that if you or an entity “deal” in other properties, then ALL properties held by you or the entity are “dealer” properties. So, strictly speaking, each transaction stands on its own BUT a bunch of transactions will be lumped together (always in an unfavorable manner) unless you can prove that specific transactions should be treated differently. Guilt by association, so to speak. Documentation of the factors in my “Dealer” article with respect to “non-Dealer” properties should suffice to distinguish the respective Non-Dealer and Dealer properties.
Soooooo, there is no formal “Dealer” tag in the internal revenue Code, but it does exist as a practical matter in the case law and vernacular.
John Hyre
PS: That’s free EDUCATION, not advice! Don’t SCARE me like that, LOL!
Posted by Kent Cheatham on September 24, 2001 at 20:41:21:
Just a note from a non-lawyer non-CPA. In a partnership you file on a form 1065 that generates passive K1 flow-thru’s to the partners. IRS says you can fill this form out starting on page one as “Business/Trade” (read Dealer) or the next page as “Rental Realty” (read Investment). I called a CPA to veryfy what the tax software was telling me and she said the partnership had “to be one or the other but NOT both”. This seems to be a valid arguement for the “dealer status” or “investor status”. So how to handle a year where you owe capital gains tax on one house sale and “all” tax on a flip?..I havent been there yet.
At the very least I need a second partnership.
Does an LLC allow passive and active “sales” under one entity in one year?
