IRS "Real Estate Dealer" status permanent? Buy/Fix/Flip 4x year?

Question

I'm currently rough planning to purchase foreclosures on the courthouse steps (up to around 4 per year) with the desire to fix and flipping them within a 90-120 day window (notice I didn't say intent there). The plan would be to do this for a couple of years to build up capital to be able to buy a few properties and hold longer term later down the road. I do not necessarily need "income" from this, although I suppose it could potentially generate more profit than other income sources.

After reading about the "dreaded" IRS classification of "Real Estate Dealer" and the long list of negatives of being tagged as a dealer. It wasn't clear to me, is that classification PERMANENT? Or is it just for the investment home(s) you currently have? I've read some cons like "you'll never be able to do 1031 exchanges again!" - which would make me think the classification is applied to the individual taxpayer and permanent.

I think I need to take a couple steps back before taking the plunge at the courthouse. I don't mind paying a little extra tax to accomplish the goal. I just want to be clear when we execute the plan and not have a "gotcha!" years later from the IRS.

I'm also trying to understand the best structure for this. From what I've read I guess it may be LLC with S-Corp status, or straight S-Corp.

Dave Foster · Answer

@Jay G. many investors who want to both flip and buy and hold will set up two separate entities and flip in one and buy and hold in the other. That could certainly strengthen your case.

Regarding your NTS idea I honestly don't know if that kind of tactic would strengthen your case or not. The reason for that is that the statute is clear that your intent must be to hold for productive use. What your talking about is a strategy where you preload your sales benchmark and when the property reaches that benchmark you sell. In one way that makes perfect sense. I want to double my money so I'm going to hold this property and rent it until its worth that much. However in your case you're really trying to shorten the time frames down to artificially match a flipping model.

I'm thinking that your intent then could very well be interpreted that you never had the intent to hold for productive use. It was always for resale. the only variable was when the property (inventory) reached market value.

Most folks feel comfortable with a year hold. But there are always circumstances where a hold of less than (or more than) a year would be justified. Accidents can happen but when too many accidents happen they stop looking like accidents.

Jay G. · Answer

@Dave Foster Thanks for the reply and insight there!

I'm going to discuss some of this with my CPA on Monday to gauge how much he knows and has worked with these types of situations. From what I've read it might be that LLC with S-Corp status is best for me for the short-term "flipping" side, but I would like to get a point where some of the homes could be held for longer term/rental.

Here's another thought though in terms of justifications with IRS for selling vs. holding within a short term window. For me, I might look at month to month NTS (notice to sell) within a county the property is in, as compared against the same from the run up to the last bust as an indicator of if I want to hold or sell.

After the property was "fixed" and ready to sell or rent, even if the indicator pointed to sell (more NTS current month than say past 3 month average), maybe I would then opt to sell instead of hold for investment (as in, this is the factor that triggers my change of intent). I suppose I could even rent on a month to month term, and depending on that 3 month average figure, decide to sell. If one were consistent with the rules, maybe there would be a reasonable justification there?

Then after cashing out, even if that indicator of a softening market or prices got me to get out of the last deal, the courthouse steps still may be offering enough value to get back in again. Again, for either short or long term depending on how the NTS indicator looks. If that makes sense?

Dave Foster · Answer

@Jay G., each sale has it's own set of facts. If you are selling a property that you had purchased with the intent of holding for productive use then the 1031 exchange is available to you.

However, each sale also creates a pattern and picture of your intent. This is why it is very easy for buy and hold folks to have an "accident", sell a property and 1031 on a property with a very short hold - because their past history and current practice are two of the things that help them establish intent.

That will also raise the bar for you if you ever want to do a 1031 exchange. Your past history and current practice are that of a dealer with the primary intent of resale. So you'd want to be very sure of your demonstrable intent.

IRS "Real Estate Dealer" status permanent? Buy/Fix/Flip 4x year?

3 Replies