If This Is All You Do — You’re NOT A Real Estate Investor

I love what’re known as flippers in the real estate context. They rock. Think about it for a second. They buy a run down, often ugly piece of real estate, usually a home. Then they work their magic, turning it into something that sells relatively quickly, and usually for a happy profit. It takes a high skill level in many areas to make it work. There are so many ways a flip can go wrong. Yet, many of these folks succeed time after time. I’ve done rehabs myself, back in the day, but nothin’ like what goes on now. Furthermore, in my rehabs I was the guy in the suit, walkin’ around the place as if he knew what was what. :)

It’s important to note, however, that flippers are very analogous to those who buy old cars, make ‘em like new, then sell ‘em. Ever bought a refurbished computer? Same deal. If there’s a demand for it, you can bet there are those earning a handsome living buyin’ ‘em cheap, fixin’ ‘em up, then sellin’ ‘em for a nice profit.

Flippers aren’t real estate investors any more than the reconditioned computer dealer is a computer ‘investor’. They own a business taking a product which needs fixing — fix it — then sell it. In real estate the process, generally speaking, takes anywhere from 1-2 months to 4-6 months. Their inventory is akin to what’s on the shelves at a sporting goods store.

How does the IRS treat flippers?

They treat them the same way, generally speaking, as the aforementioned reconditioned computer store. Profits are taxed much like the guy living next door who gets his paycheck as a fireman. There is no capital gains tax treatment. As a matter of fact, the IRS goes as far as defining the flipper as a ‘dealer’ — not an investor. Most flippers know this, and act accordingly. But, as usual, there’s a problem.

Most flippers realize their retirement isn’t gonna come from flipping. Duh. If they don’t Plan it that way, it ain’t gonna happen. Once they decide to accumulate enough to acquire their first long term investment property, they make it happen. However, they often assume their behavior will signal the IRS that the fourplex they bought with the clear intention of generating future retirement income, is just that, and not just another fixer. Remember, when the IRS decides a bear is a kitten, it’s up to the bear to prove otherwise. You’re essentially guilty ’til proven innocent.

Set up a steel-reenforced 20 foot high concrete wall between your short term flips and your long term investment properties.

This can  be done in a buncha ways. Most experienced flippers opt for settin’ up a company that buys the property and does the flips in the firm’s name. It can be an LLC if you wish, though your CPA is the guy ya wanna consult — NOT me. Bottom line is that the IRS will then be able to easily discern that the company is the flipper, and YOU are the long term investor. Under no circumstances do you want to be forced to ‘prove’ you’re not just a flipper. To be clear, the consequence of being forced to treat your long term investment properties like short term flips is, to employ understatement, severe.

No depreciation is allowed. None of the long term planning options are available. If at some future time you choose to sell, the tax rate will likely be double, sometimes triple the long term capital gains rate. You lose on every conceivable level.

Next week — Utilizing the principle of Strategic Synergism as a flipper.

We’ll talk about the huge advantage the flipper has as a long term investor. They can turbocharge their Purposeful Plan in order to simultaneously create a much larger retirement income and a potentially earlier retirement date. Oh sure, now you’re payin’ attention. :)

I’d love to hear from you about this. Gimme a call at 619 889-7100 and we’ll figure out your specific situation. Click the Contact BawldGuy button if you’d rather write me. Have a good one.

This entry was posted in IRS, Purposeful Planning, Real Estate Investing on by .

About BawldGuy

I'm second generation real estate, first licensed in fall of 1969. Having been mentored by several iconic brokers, I'm also CCIM trained, having completed all 200 hours back in 1980. Have successfully executed well over 200 tax deferred exchanges, many of which have been multi-state in nature. Strong points are analysis and the creation and real world application of Purposeful Plans employing several strategies synergistically. The idea is to arrive at retirement with the most after tax income possible, backed by the largest net worth.

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2 thoughts on “If This Is All You Do — You’re NOT A Real Estate Investor

  1. John Hamrick

    Hey Hairless…

    Well, I still havn’t made it out to sunny CA yet, but my SO is coming out next week and leaving me in the mountains!

    Interesting article, timely for a discussion we had in the office today, maybe you can lend a thought. Client purchases an unfinished shell in a Build-to-Suit Exchange, dumps a Mil into rehabing it into 10 Apartments. Rents the apartments out for 5 years and decides to condo them out. Is he now a dealer, or does he own 10 investment properties that he can sell and exchange back out of? Hit me up at john@section1031.com if you have run into this before.

    Hope all is well, I read you religiously, you provide more good insight than you realize!

    John

    Reply
    1. BawldGuy Post author

      Hey John — Better the mountains then down in the Santa Ana heat. :)

      My experience with condo conversions is that dealer status was indeed the result, at least in the dozen or so scenarios I’ve witnessed. That said, I like your particular set of facts. Playin’ Devil’s Advocate, it’s obvious the investor established intent — to hold for investment. Five years is solid evidence. Frankly, John, I’ve not dealt with that set of facts in my career before, but I think it’s worth getting two opinions. First, a super experienced tax attorney, heavily trained in what we do. Second, and contingent upon what the attorney opined, I’d seriously consider getting a letter from the IRS.

      I still think they may be fighting an uphill battle, but it’s worth a try if they wanna spend the time and bucks.

      What’s your take?

      Reply

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