Real Estate "Dealers", Installment Sales, Deferred Taxes, and the IRS

[Mack Fleming]

The IRS does not allow real property Dealers to use the Installment Plan method of accounting. This means that if the Dealer does an Owner Financed sell, he/she is responsible for the tax liability for the entire paper profit, all due in the tax year of sale. This is not fair.

One of the only exceptions I have found is: (1) The Dealer is engaged in selling unimproved residential lots. (2) He/she must pay a special tax on the deferred tax liability. Again, the Dealer is responsible for the tax liability for entire paper profit. The only difference here is if it is not paid to the IRS in the tax year of sale, then interest must be paid to the IRS on the amount of the tax liability. This is not fair.

Assuming I am correct in my understanding, I would like to know what others think of this.

Thank you,
Mack

[David Krulac]

Mack Fleming

Fair or not fair, that is not the question, whether tis nobler....

The dealer status question has been around a long long time. Some of the cases go back to the 1950s, and 1960s. I've been to the mat on this issue, so I'm very familar. It was be easy for the IRS to clarify this issue, but they have never seen fit to do so. There are cases where selling only 1 property has been court ratified as being a dealer and other court cases where selling 100 proeprties has not made the taxpayer a dealer.

A simple number would probably be a great thing. "5 sales in 1 year not a dealer, 6 sales in 1 year you are a dealer" but that is NOT happening soon or in our lifetimes.

Being a dealer is also a bad thing in that:

1. You can NOT do a 1031 tax free exchange.
2. You can NOT depreciate property.
3. You can NOT take long term capital gains.
4. You can NOT take favorable installment sales treatment.

Seperation by entities does NOT always work either. In an audit, they will look for reasons to blend your activities. Like do you have seperate bank accounts for each entitites? Do you have seperate EIN? Do you have seperate books, corporate minutes? Do you ever co-mingle funds? etc. etc. etc. There are if I remember correctly 8 criteria, any 1 can upset the apple cart. Are you under capitalized in any entity?
Ask me how I know this stuff?

Bottom line, in the eye of the tax man, you should sell the entire property in one sale. Once you have mutiple sales, you are a developer, a subdivider, and a dealer.