Wholesaling can be a lucrative cash-profit business. But can wholesaling make you a dealer? That all depends on a number of factors, but first some background. Wholesaling is rapidly re-selling a property “as is” with little or no fix-up. Frequently the investor never goes to settlement and will just assign (or flip) the agreement of sale to their buyer for a quick profit.
Unlike an investor, being identified as a dealer could be a financial disaster. As 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 and in full, and can in no way be tax deferred. Additionally, you may not use a 1031 exchange, installment sale reporting, a self-directed IRA, certain trusts, or any other tax deferral strategy. Therefore, 50% or more of your earned profits could be drained by taxes.
Being identified as a dealer could wipe you out! Its 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.
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 an enormous 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. 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!
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