If you have purchased and/or sold a variety of real estate "investments", you are probably aware of dealer vs investor status. While there are many well known factors the IRS considers during an audit including intent, duration of ownership and frequency of sales, etc., one overlooked area is how you account for each property. This is especially important if you own a variety of holdings with both dealer and investor status.
If you are just getting started, let me briefly explain the difference from a tax perspective. Dealer status on the sale of real estate is treated as sale of inventory subject to ordinary federal income tax rates in addition to self employment tax. The tax you pay on this transaction varies based on your federal income tax bracket, which could be as high as 39.3% in 2018 plus the 2.9% medicare portion of SE tax. Investor status on the sale gives you favorable capital gains rate, which in 2018 is as high as 20% plus 3.8% NIIT for some tax payers. This roughly 16% difference in rates means you should probably have all your ducks in a row and the right mindset even prior to purchasing a property.
Having dealer status on one transaction does not automatically categorize properties as dealer status. However, it is even more important for this type of real estate investor to segregate properties in their accounting and records. In the case of
Robert P. Walsh, the contemporaneous accounting records revealed that Walsh had included a property he deemed held for investment with other dealer status properties. Therefore, from an accounting perspective, it appeared as though this parcel was inventory like his other parcels.
While this wasn't the only deciding factor in determining Walsh's dealer status, segregating the property in the accounting records was a simple way to help build his case against a claim of $120,000 underpayment of tax in 1986.
Here are two recommendations for real estate investors who own real estate under both dealer and investor status:
1. Keep a separate set of books for both types of properties. If using QuickBooks, have a separate file or subscription for your dealer status properties and a separate set for your investor status properties.
2. For your investor status properties, report expenses incurred as investment expenses especially if your property records are housed in one file. Don't mingle these expenses with other operating expenses where they could be construed as being a part of ordinary operations.
While these two recommendations won't in themselves provide air tight support for investor status on a property, they will further build your case against dealer status.