J Scott - Based on your podcast, you may be hard pressed to avoid dealer status. Remember, dealer status is solely based on your “primary investment intent.” Investment intent is inherently finalized on the “front end” of the transaction and should be seriously considered. People commonly let what they did tell the story of what they intended to do. These are different. If your intent is to "flip” the property you are a dealer as you are buying with the intent to sell. I am not suggesting a person with the intent to sell the property do this (sorry Stephen). I am not trying to be deceptive, rather I merely take exception with the initial, absolute comment that a quick-sale = self-employment income. Both I and a multitude of court cases disagree with that view.
I am not trying to be cute here, but I offer an example. A person buys a home and rehabs it with the intent to hold it. Later on, that person may get two great opportunities to do the same thing under contract; but to finance these next two investments this person must monetize the first investment to fund deals 2 & 3. In this example, all three of these deals were investments as the person intended to hold them as investments, but an after-the-fact review of what was actually done (rather than what was intended) may appear to create doubt regarding this original intent. [This is why you document what your true intent is] It is times like this that this person often asks someone, generally a tax preparer/CPA what the tax implications were, but when you ask them about the tax consequences, they will ask you to outline the details of the transaction but as I just mentioned these details DON’T create or reflect your real intent, as spelled out above. But ignorantly, the deal facts generally are left to tell the story because the taxpayer wasn’t documenting their real intent and honestly by the it was probably too late. When it comes to dealer vs investor, the burden of proof is with the taxpayer, so don’t let the unknown/uncontrollable future dictate the future perception of today’s intent.
SideNote: Stephen, you will generally always be successful with the IRS if you have your clients take the most punitive path through their return. Congrats on those great stats though. To correct your statement, dealer/investor status IS WHOLLY driven by your intent not your actions as you noted in your last point. Bill seems to have this right on point.
If you are buying a house at a discount with the intention hold the investment then you should document your primary intention is to hold the property as an investment. To do this, you should really be planning to hold the asset based on what you know at that point in time, but you should understand that the future may bring things beyond your control. You will want to document (put in your minutes and notarize) that your original investment intent may be changed by an unanticipated events generally beyond your control such as 1) you need money for working capital, 2) a change in market conditions, 3) availability of new investment opportunities, etc. You clearly would have comps for the rental of the building and upon completion of any rehab you would have plans to market for a tenant. And clearly you would document that proceeds from the sale would be used in their entirety for investment purposes.
This is, for a lot of investors, the actual thought process they go through and investors don’t “just sell” because the renovations done. Often times if there were no future “deal flow” the investor would prefer not to sell the asset but rather hold the asset as a rental (because they are primarily investors). Conversely, the dealer would always look first to sell the home even if there were no deals to be done as they’re primary business of being sellers (dealers).
Don’t get me wrong, this approach isn’t for everyone, but for some it fits their objectives/intentions perfectly, so I have developed a little of a peeve toward broad, uninformed statements like “flip income is self-employment income.” As anyone who knows these rules understands there are no real bright-lines here and often times you can go into a deal to buy and hold and end up selling it based on a wide array of unintended factors. Some just allow the periodic “quick-sales” to tell the story that they are a dealer when in reality only they know their intent…I am only suggesting you document it.
