Selling a property while the seller infrequently goes to settlement while assigning the agreement of sale to their buyer for a quick profit is know as flipping. Wholesaling is rapidly selling a property “as is” with little or no fix-up. Wholesaling can be a rewarding cash-profit business, but will it make you a dealer? Some background is necessary before that question can be answered.
Being tagged as a dealer could be a financial disaster because, unlike an investor, you are subject to the highest ordinary income tax rates, plus Social Security taxes, other employment taxes and possibly alternative minimum taxes. Therefore, 50% or more of your hard earned profits could be drained by taxes. Moreover, dealer profits (cash or paper) are immediately taxed in full and cannot be tax-deferred in any way including not being able to use a 1031 exchange, installment sale reporting, a self-directed IRA, certain trusts or any other tax deferral strategy.
If you demonstrate your status as an investor, you can be saved from the expensive pitfalls of being a dealer. If not, you can be severely impacted by being tagged of being a dealer. Its can be like being condemned to hades!
First off, just because you start to flip properties does not mean you are a dealer. Based on numerous tax courts cases (including a Supreme Court Case); actual IRS audits; and my extensive research; with planning, even a very large number of flips (in one year) could avoid costly dealer status.
Altogether, there are over 30 strategies to avoid the cost of a dealer. My experience indicates that one of the best strategies is investment intent. That is, demonstrate that the primary purpose of the quick sale profits is for investment purposes and not sales speculation. For 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.
There have been numerous cases and scenarios, some of which I have had first hand experience with, where a numerous number of sales in one year did not cause dealer status. This is because of a very powerful defense against any IRS attacks with the principle that tax follows economics as opposed to sales speculation with tax avoidance motivation. Consequently, as employed here, these flips are non-dealer, investment transactions with solid economic foundation, thus not a dealer activity.
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!