I wish there was a simple answer to this question, but there is not. Life would be terrific if the IRS had set concrete rules and guidelines. In reality, though, it does have one simple rule: dealers hold property for resale to customers in the ordinary course of business. All flippers are dealers. The arguments and lawsuits arise over what is meant by the words “in the ordinary course of business.”
Over the course of many years and many lawsuits between taxpayers and the IRS, we are left with some guidelines on this question. Primarily it is a matter of considering several factors, and then analyzing if those factors point toward investor or dealer. It is only the most rare occasions when one factor, all by itself, will result in someone being a dealer.
The factors are:
• the number and frequency of sales (there is no magic number that pushes you over into dealer status);
• the extent of improvements (massive improvements usually indicate a dealer);
• the sales efforts (A “for sale” sign in the yard indicates an investor; a large advertising campaign indicates a dealer. You probably fall in the middle somewhere.);
• the purpose for acquiring, holding, and selling the property (If you acquired the property with the intention of reselling it fairly quickly in order to make a profit, you are a dealer. That one catches most flippers.);
• the manner in which the property was acquired (generally, if you inherit property or receive it by gift, you are more likely to be classified as an investor);
• the holding period (The longer you hold property before resale, the less likely it is that you are an investor. There are no time limit rules here. Waiting one year and one day to sell property does not guarantee your status as an investor, contrary to advice in some other books.);
• the percentage of income from real estate activities (the higher the percentage, the more likely you are a dealer);
• the use of proceeds (using the money to buy another house, more inventory, tends to indicate a dealer); and,
• how you present yourself to the community (if you call yourself a flipper and actively solicit flip opportunities from others, you are probably a dealer).