Real Estate Dealer vs Investor

[Jay Thomas]

How do you know if IRS tags you as a dealer. Every information out there is only talking about the differences between a dealer and investor. No one is really talking about the actual process. How do you know your current IRS designation? I usually do my own taxes on TurboxTax and I have never come across this IRS designation while my filing taxes. 

[Ashish Acharya]

To determine if the taxpayer is a dealer three questions must be answered:

(a) What is the taxpayer's trade or business?

(b) Did the taxpayer hold the property primarily for sale in that business?

The Supreme Court holds that primarily for sale means of “first importance” or “principally” (MALAT V. RIDDELL).

Determining if the property is held primarily for sale to customers in the ordinary course of business is based on the facts and circumstances. Among the facts to consider are the (Ralph S. Norris; Pool)—

i. owner's intent (nature and purpose for which the property is acquired);

ii. The extent of improvements and advertising to increase sales;

iii. number, frequency, and substantiality of sales [this generally is the most important factor (Suburban

Realty Company)]; See (c) below

iv. duration of ownership;

v. continuity of activity related to sales over a period of time;

vi. extent and nature of the efforts to sell the property;

vii. The extent of subdividing and development to increase sales;

viii. use of a business office for the sale of the property; and

ix. character and degree of supervision or control over representatives selling the property

Note: Per court case SUBURBAN REALTY CO. v. U.S: The "holding purpose" inquiry may appropriately be conducted by attempting to trace the taxpayer's primary holding purpose over the entire course of his ownership of the property [Not just time of the sale]

(c) Were the sales ordinary in the course of that business?

Sales are ordinary if they are normal for business, which may be based on their frequency and substantiality

Note: Per court case SUBURBAN REALTY CO. v. U.S: It will remain true that the frequency and substantiality of sales will be the most important factor. But the reason for the importance of this factor is now clear: the presence of frequent and substantial sales is highly relevant to each of the principal statutory inquiries listed above. A taxpayer who engages in frequent and substantial sales is almost inevitably engaged in the real estate business. The frequency and substantiality of sales are highly probative on the issue of holding purpose because the presence of frequent sales ordinarily belies the contention that property is being held "for investment" rather than "for sale." And the frequency of sales may often be a key factor in determining the "ordinariness" question

Note: Per court case TIMOTHY J. PHELAN, ET UX. V. COMMISSIONER: Frequent and substantial sales of real property more likely indicate sales in the ordinary course of business, whereas infrequent sales for significant profits are more indicative of real property held as an investment.

Classification of gain as capital or ordinary is determined property-by-property, based on the statutory determination of whether the property is a capital asset or property held for sale to customers in the ordinary course of business. This means a person can be both a dealer and an investor.