BiggerPockets

all,

i am in virginia and ready to get my first wholesale in the books, what are the tax ramifications for wholesaling? I cant seem to find this info anywhere????

Well, it depends on exactly how you do the transaction. If you own it, the income is subject to short term capital gains. If you don't, e.g.e, you do assignments, its ordinary income. But in either case, its taxed at your ordinary income rate.

May also be subject to SET (self employment tax.) And state taxes.

Wholesaling is just buying and selling, just as if you ran a shoe store and bought and sold shoes. The taxes are slightly more complex because of the special real estate rules. But those rules don't really affect what you pay in taxes.

rich, wouldn't long term capital gains only be after 2 years???

Originally posted by Jon Klaus

Originally posted by Bryan Alenky

rich, wouldn't long term capital gains only be after 2 years???

I think one year is the minimum, but CPA's like the asset appear on 2 tax returns?

As Jon said, one year and a day is the minimum for long-term capital gains. BUT, the IRS will look at INTENT more so than time.

For example, if you purchase a house, rehab it, and put it on the market, where it sits for a year before you finally sell it, the IRS could very well determine that you INTENDED to flip the house, classifying you as a "dealer" (at least for that transaction) and making you pay ordinary income tax instead of long-term capital gains.

Of course, you can lie about your intent, at which point it's up to the IRS whether they believe you or not (which will be based on supporting evidence you provide to substantiate your claim).

Regardless, your question was about wholesaling, so realistically, I don't imagine you'll own the house for anywhere near a year.

Hi Andy,

If your only real estate transactions are wholesales, you WILL be classifed a "dealer" by the IRS. As such, your income will be classified as self-employment income and in addition to your regular income tax you will be subject to the 15.3% self-employment tax. Dealer profits are not entitled to long-term capital gains rates regardless of the length of time the property is held. (The property is considered inventory.) If you buy/sell in your name as an individual, you may also have a higher audit risk since you would have to file as a sole proprietor. That's why we recommend that wholesalers use a business entity such as an LLC or corporation for his/her real estate transactions.

Income tax consequences start to get more complicated when real estate investors start wholesaling property. Title to property may not actually transfer in some cases, rather a set of rights may be created. If wholesaling becomes your primary investing activity you will likely be treated as a dealer.

If the IRS classifies your real estate investing activities as a real estate dealer then your investing will be treated as ordinary income. Capital gains treatment is not allowed. This tends to be a very gray area of the law, but there is a fair amount of case law that can help in defining your tax position.

There are several factors the IRS uses when determining if an investor is a dealer or a passive investor.

Length of time property is held before sale
Frequency of sales
Purpose or intent of purchase
Volume of sales

Consequences of being treated as a real estate dealer

If it is determined that an investor is a dealer, then the real estate activities will be considered a business. This means that income from sales from real estate will no longer be eligible for capital gains treatment; the property would not be eligible for a 1031 exchange and would be ineligible for installment sale treatment as well.

A dealer though may have some business expenses that would now be considered ordinary and necessary for a dealer that investors otherwise would not be eligible for.

Originally posted by J Scott

Remember that I'm not a tax professional, but if you decide to set up an LLC, remember that you can affect the tax consequences of your business by electing whatever tax status you desire for the LLC.

You may not be a tax professional but you are absolutely spot on here. An LLC is a disregarded entity for federal (and most state) tax purposes. That means that unless an election is made to be treated as either an S or C corp for tax purposes, a single member LLC will be taxed as a sole proprietorship and a 2+ member LLC will be taxed as a partnership. In each of the latter two instances a wholesaler will incur the self-employment tax. By electing to be taxed as a corporation self-employment tax would not be an issue. Of course, the LLC would then be subject to corporate tax rules and the advantages and disadvantages of that election would have to be weighed in order to make an informed decision.

Irrespective of whether you elect to be taxed as a corporation, sole proprietorship, or partnership the LLC has proven itself to be the most valuable business entity for real estate investors. This entity provides the greatest flexibility and provides some very nice tax and asset protection benefits.

BUT - be sure to run this by your own tax pro (preferably one who understands real estate investing). He or she should be in the best position to advise you :-)