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3 Ways to Avoid Dealer Status when Flipping Houses


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Be Smart when Flipping Houses

 

Obviously you can invest in rental properties in multiple ways, and pursuing a short term strategy of flipping houses is certainly one way to do it.  Although I prefer a long term investing strategy, if you have the proper team, expertise and capital in place then flipping houses can be extremely lucrative.  That said, like any short term investment strategy, flipping is rife with risk.  And one of these risks is being labeled as a dealer by the IRS.


If you flip more than 2 houses a year then you might be labeled as a dealer by the IRS.  This is not desirable, because as a dealer you’ll be considered self employed and as such you’ll be exposed to an approximate 15% self employment tax annually.  There are other financial implications as well, none of which are preferable.  The bottom line is that you want the IRS to consider you an investor, NOT a dealer.


Luckily there are some measures you can take to prevent being labeled as a dealer, even if you flip multiple properties year in and year out.  One tactic is to put each property in its own real estate LLC, and transfer the LLC in its entirety to the buyer, not just the underlying property.  Thus, instead of flipping houses, you will technically be flipping LLCs that contain a piece of property as the underlying asset.

Another option is to conduct your business through a 401K or self-directed IRA.  The reason is that the assets within these investment vehicles are considered passive by the IRS, which by definition means that you are not a dealer.

The third option is to form a limited partnership to hold the assets.  In a limited partnership, only the general manager would be viewed as a dealer.  Thus, if the partnership has multiple partners then everyone could essentially split the self employment tax levied on the general partner, thereby effective reducing each person’s self employment tax liability.

The bottom line is that dealer status has the potential to suck your profits dry, so for the small time investor or landlord this must be avoided at all costs.  The 3 remedies listed above are a good place to start, but please make sure you talk to your accountant for the specific steps necessary for your specific situation.  And above all, make sure your flipping operations are legally separate from your other businesses so you don’t receive a blanket label from the IRS.  Yes, flipping houses can be lucrative, but you must be smart about it.  Good luck!



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