Well, as with most tax questions, the answer is, it depends.

Investor vs. Dealer.

When we think of a real estate investor, we think of someone who purchases and holds real estate for rental income and/or appreciation over a period of time.  A typical investor might own a few rental properties, keep them for several years and eventually sell them.  An investor is thought of as being in it for the long term.

Being a real estate dealer is more involved. The IRS considers a dealer to be someone who is engaged in the business of selling real estate to customers with the purpose of making a profit from those sales, such as flipping and wholesaling.  A dealer is more of a short term proposition.  Determining who is a dealer is subjective and open to interpretation.  The IRS and the courts use several factors that have been developed through numerous court cases.  These factors are:

• The taxpayer’s purpose in acquiring the property;
• The purpose for which the property was subsequently held;
• The taxpayer’s everyday business and the relationship of the income from the property to the taxpayer’s total income;
• The frequency, continuity, and substantiality of sales of property;
• The extent of developing and improving the property to increase the sales revenue;
• The extent to which the taxpayer used advertising, promotion, or other activities to increase sales;
• The use of a business office for sale of property;
• The character and degree of supervision or control the taxpayer exercised over any representative selling the property; and
• The time and effort the taxpayer habitually devoted to sales of property.

No one of these factors is, by itself, conclusive in determining if you are a dealer.  However, the Tax Court has indicated that the frequency, continuity, and substantiality of sales of property are the most important factors to consider.

 

Tax consequences of being an investor vs. a dealer.

For an investor, rental income is generally taxed at ordinary income rates and is not subject to self-employment tax (Self-employment tax is a tax of up to 15.3% on your net income from self-employment.  Self-employment tax is in addition to your regular income tax).  If you hold your investment property for at least a year, your gain on sale will be taxed at favorable long term capital gain rates.

If you are classified by the IRS as a dealer, all of your income will be taxed at ordinary income rates.  There is no favorable long term capital gain treatment.  Installment Sales and Like Kind Exchanges are not available to dealers.  Additionally, you will be subject to self-employment tax on your profits.

If the IRS classifies you as a dealer, then all of your real estate income, including rental income, will be subject to dealer treatment.  To avoid this treatment, it is important to use separate entities for different types of real estate activities.   The best example of this would be holding rental properties in an LLC while using an S-Corporation for wholesaling and flipping.

As always, this is only meant as a brief overview.  If you feel that we can be of further assistance to you, please contact our office to set up an appointment.

Email us at: info@dohertyandassociates.com

Call us at: 302-239-3500

Visit our website: http://dohertyandassociates.com

– Doherty & Associates Team

 

Bitcoin and other virtual currencies are becoming more popular by the day.  Retailers such as Overstock.com are now accepting bitcoin as payment.  As of the end of 2013 it is estimated that over one million people owned bitcoins.

In March of this year, the IRS issued Notice 2014-21 which addresses the tax consequences of Bitcoin and other virtual currencies.

These currencies will now be treated as property for tax purposes.  Generally you will have gain or loss when you exchange of virtual currency for other property.  If the fair market value of property that your receive in exchange for virtual currency exceeds your basis, you have a taxable gain. You have a loss if the fair market value of the property received is less than your basis in the virtual currency.

If you take bitcoin or any other virtual currency in the ordinary course of business, you must include in your gross income, the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received.

For more information in question and answer format you can go to:

http://www.irs.gov/pub/irs-drop/n-14-21.pdf

As always, this is only meant as a brief overview.  If you feel that we can be of further assistance to you, please contact our office to set up an appointment.

Email us at: info@dohertyandassociates.com

Call us at: 302-239-3500

Visit our website: http://dohertyandassociates.com

– Doherty & Associates Team

Many people who are just getting involved in real estate investing are spending large amounts of money on real estate education classes. The question is not are these classes worthwhile, but whether or not these expenditures are deductible.

Several factors must be considered before this question can be answered.

• Are the expenses “ordinary and necessary” under Internal Revenue Code Section 162?
• Is the business a “functioning” entity?
• Does the training qualify you for a new trade or business?
• IRS also has additional restrictions for deducting work related education.

Ordinary & Necessary
To be considered ordinary, an expense must be usual or customary in a particular trade or business. An expense is necessary if it is appropriate and helpful for the development of the business.

Functioning Entity
A business is not considered a functioning entity until it is performing the activities for which it was organized.

New Trade or Business
If the training qualifies you for a new trade or business, i.e., real estate investor, instead of maintaining or improving skills required in an ongoing business, then it is a non-deductible personal expense.

Additional IRS Restrictions

To quote the IRS, “In order to deduct work related education expenses, they must meet at least one of the following tests:

• The education is required by your employer or the law to keep your present salary, status, or job. The required education must serve a bona fide business purpose of your employer.
• The education maintains or improves skills needed in your present work.

However, even if the education meets one or both of the above tests, it is not qualifying work-related education if it:

• Is needed to meet the minimum educational requirements of your present trade or business, or
• Is part of a program of study that will qualify you for a new trade or business”

A 2009 tax court case (Woody v. Commissioner, TC Memo 2009-93), is a good illustration of these requirements. Despite taking courses, getting an EIN, obtaining a loan, getting credit cards in the business name, and actively marketing his business, the court determined that Mr. Woody was not “actively engaged” in the real estate investment business until he acquired and rented his first property. The more than $21,000 that he spent for classes was ruled a non-deductible personal expense. This case illustrates the importance of having a functioning business before incurring education expenditures, otherwise they may not be deductible.

This is only a brief overview. Everyone’s situation is different. As with most tax related issues, the deductibility of educational expenses is determined on a case by case basis.

Please consult a qualified tax professional before you set up your real estate business. If you feel that we can be of service to you, please contact our office to set up an appointment.

Email us at: info@dohertyandassociates.com or Call us at: 302-239-3500.

– Doherty & Associates Team

If you are a business owner, you must be aware of important tax changes that could impact your company finances. While many tax rules are permanent, others are written to expire at some point in the future. Some are extended and given new deadlines, but a significant number of popular “extenders” terminated at the end of 2013, including both business credits and deductions. Here are a few changes:

• Bonus 50% first-year depreciation will no longer be available to your business in 2014 and beyond.
• Section 179 expensing limit, which allows you to deduct qualified costs immediately instead of expensing them over time, will tumble to $25,000 from $500,000, where it’s been for the last four years.

How will the end of these and other credits or deductions affect you? Contact Doherty & Associates so we can give you advice and planning recommendations that you’ll need to minimize your tax bill and enhance your business’s financial situation. Also follow us on Facebook, Twitter, and LinkedIn and stay up to date on the changing tax laws, credits, and deductions.

Doherty & Associates Team