Many real estate investors don’t mind whether they are considered an investor or a dealer. The difference between the two can have a big impact on how much money you make in this business. Real estate investors benefit from several tax advantages, while dealers do not. The biggest difference is that investors are taxed at the capital gains rate while the dealers’ profits are taxed like regular income, which can be significantly higher. It’s up to the Internal Revenue Service (IRS) to determine who is taxed with each rate.
What is a Real Estate Investor?
A real estate investor is someone whose main goal is to purchase a property from which he or she can generate a profit. The profit is made by selling or renting the property to other parties.
One of the options that a real estate investor has when purchasing a property is to finance it with a loan. Other real estate investors, ones who have a better financial situation, choose to purchase the property without getting a bank loan. The goal is to sell the property for a profit when the prices increase. If the property’s value increases over time, the real estate investor will be able to receive a large return on their investment.
Some real estate investors choose to rent a property that they have purchased, generating a profit through rental income. The real estate investor becomes a landlord, with the responsibility of providing proper living conditions for the tenants, and maintains the property. The investor must determine the cost of running a rental property, taking into account things like repairs, regular maintenance, taxes, insurance and mortgage. After determining all of these costs, he or she can determine the appropriate rent amount that the tenants will be charged.
What is a Real Estate Dealer?
Dealers, like real estate investors, buy and sell properties for a profit as fast as possible. While real estate investors make long-term investments in properties, dealers are in it for the quick profit, and try to resell their purchases as soon as they can.
The Internal Revenue Service doesn’t allow real estate dealers, who are basically short-term investors, to benefit from the same tax rate that real estate investors benefit. Real estate investors are charged a long term capital tax rate, which is much lower than the rate that real estate dealers get from the IRS.
Factors That Determine Investor vs. Dealer
The Internal Revenue Service doesn’t have a clear set of rules that you could use to determine whether you are considered a dealer or not. The IRS analyzes your business in order to determine your classification, using the following factors:
- Ownership Duration. If you own several properties for less than 2 years, you will most likely be considered a real estate dealer. If you hold on to properties for more than 2 years, they will be considered investments, and you will be classified as a real estate investor.
- Statement of Intent. If your intentions of buying and reselling are expressed, then you will be considered a real estate dealer.
- The Level of Advertising. Significant advertising and strong efforts to sell will be regarded as a real estate dealer tactic.
- Number of Sales. The more sales you have over time, the greater the chance that you will be regarded as a real estate dealer by the IRS.
There are no fixed criteria to determine if you are a real estate investor or a dealer. The difference in tax between the two is significant, but it is up to you to decide if being a real estate dealer is worth the extra money that you will have to pay to the Internal Revenue Service. Understanding the difference between a real estate dealer and an investor will be important for your ability to take advantage of the lower tax rate, and save you a considerable amount of money.