Cash Flow From Operating Activities Cash Flow From Investing Activities Avoiding Dealer Status When Flipping Houses

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Avoiding Dealer Status When Flipping Houses

Any investor who flips more than one or two properties a year will run into the issue of being marked by the IRS with “trader status” for tax purposes. This is an extremely dangerous thing. Traders, like real estate agents, are considered self-employed and subject to self-employment tax of 15.3%. Worse, the dealer cannot pay installments tax if they use equity financing. All property tax must be paid in advance, even if full payment has not yet been received.

The most important factors used by the IRS in determining whether or not someone is a real estate dealer are the frequency of real estate sales, the number of real estate sales in a year, and whether there is a continuity of process that indicates that the real purpose of the business is to exchange the real estate. If properties are held for more than a year before being sold, this may also conflict with treating the investor’s activity as a “dealer”.

There are several ways to process a significant number of transactions per year and still maintain the tax benefits of an investor versus a merchant:

1. Flip real estate through a limited partnership, self-directed IRA, Coverdell education savings account, or self-directed 401k plan. In a limited partnership, only the managing director is considered a trader. Trust funds and various types of individual retirement and savings accounts are considered passive investments and these plans do not involve active participation in the business.

2. Enter into a joint venture agreement with an active investor or agent who will essentially create a “done for you” investment strategy for buying and selling wholesale. This joint venture partner may be considered a “trader”, but as long as you or your legal entity are not the owner, you will not be directly involved in any property flipping activity.

3. Place each property in a separate LLC or trust and transfer the LLC or trust instead of the property that is inside the entity.

4. At the very least, be careful to separate your wholesale fix and flip business from other business activities, such as your buy and hold operations or any trades that will involve installment sales.

Planning how you finance and hold your property can be as critical to determining the success of your real estate investment as the actual selection of properties you decide to purchase. Being tagged with merchant status can cost you a lot of time in the long run. Make sure you trade smartly!

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