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 lucrative cash-profit business. But will it make you a "dealer"? That all depends, but first some background. Being tagged as a dealer could be a financial disaster because, unlike an "investor", you are subject to the highest ordinary income tax rates, plus Social Security taxes, other employment taxes and possibly alternative minimum taxes. Thus, 50% or more of your hard earned profits could be drained by taxes. Moreover, dealer profits (cash or paper) are immediately taxed in full and cannot be tax-deferred in any way including not being able to use a 1031 exchange, installment sale reporting, a self-directed IRA, certain trusts or any other tax deferral strategy. Being tagged as a dealer could wipe you out! It’s like being condemned to hell. On the other hand, if you demonstrate status as an "investor" you can be "saved" and avoid these expensive pitfalls of being a dealer.
First off, just because you start to flip properties does not mean you are a dealer. Based on numerous tax courts cases (including a Supreme Court Case); actual IRS audits; and my extensive research; with planning, even a very large number of flips (in one year) could avoid costly dealer status. Altogether, there are over 30 strategies to avoid the costly consequences of a dealer. My experience indicates that one of the best strategies is investment intent. That is, demonstrate that the primary purpose of the quick sale profits is for investment purposes and not sales speculation. For 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.
With this premise, tax follows economics as opposed to sales speculation with tax avoidance motivation. That is economics first! Accordingly, as employed here, these flips are non-dealer, investment transactions with solid economic foundation. This is a very powerful defense against any IRS attacks. Consequently, there are numerous cases and scenarios, some of which I have had first hand experience with, where even a huge number of sales in one year did not cause dealer status.
Moreover, there has never been an issue of civil or criminal fraud with the issue of investor versus dealer. Entrepreneurs have literally sold hundreds of units in a short time; claimed not to be a dealer without issues of fraud and, with the right planning and documentation, even won their case. Reason: The issue is a very arbitrary question of fact and not of law. Accordingly, asserting any type of fraud (where the burden of proof shifts to the IRS) is very difficult and almost impossible. Therefore, 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); avoid inept advisors; and GO for it.
Al Aiello is a regular guest speaker at CT REIA. Go here for the current list of upcoming real estate investing seminars in Connecticut.
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