Sole Proprietor/ Investor?

[Brian EA]

Client has been buying property since 2003 and incurring expenses.He claims to be a Real Estate investor.

The question is: how should his expenses be reported when the income is Capital gains

Thanks in advance

brian

[OldJack]

Depends upon what kind of expenses. If he has not already deducted them somewhere they probably are added to cost basis.

[Bees Knees]

Investment expenses that are not added to basis are deducted on Schedule A, subject to the 2% AGI limit. Real estate taxes are deducted on Schedule A, not subject to the 2% AGI limit, unless it is rental property or business property. You also have the option of capitalizing certain expenses, depending on whether it is unimproved land, or if there is some kind of construction going on.

If too many properties are purchased for investment, it could turn it into a Schedule C business, where all expenses would then be deducted on Schedule C.

[Bill Tubbs]

When does it become a Sch C

If too many properties are purchased for investment, it could turn it into a Schedule C business, where all expenses would then be deducted on Schedule C.

I have to disagree with Bees, specifically on the "If too many properties are purchased" part. It doesn't matter how many properties are purchased, but rather what are done with them. If, in one year, someone buys 100 properties and sells them all without doing any improvements to them, I would still have no problem with Sch D. (After all, if someone buys and sells 100 stocks, that's Sch D, right?) If, however, the taxpayer buys the home, fixes them up, then sells them, then I would go with Sch C.

Bill

[Brian EA]

Investment expenses that are not added to basis are deducted on Schedule A, subject to the 2% AGI limit. Real estate taxes are deducted on Schedule A, not subject to the 2% AGI limit, unless it is rental property or business property. You also have the option of capitalizing certain expenses, depending on whether it is unimproved land, or if there is some kind of construction going on.

If too many properties are purchased for investment, it could turn it into a Schedule C business, where all expenses would then be deducted on Schedule C.

He purchased many properties including raw land. In 2005 he sold 2 lots. This year he has a few construction going on.

If the gain on the sale of the land is capital gain, does any income go to sch C or just the expenses.

thanks
brian

[OldJack]

If, however, the taxpayer buys the home, fixes them up, then sells them, then I would go with Sch C.

I agree with Bill, intent and use is much more important than number of properties even if the investor spends full time (not hours, just no other work) managing the said properties. Also bill if taxpayer buys the home, fixes them up, rents them, then sells them, then I would go with Sch E and form 4797 with gain subject to ordinary income if unrecaptured ordinary losses during the last 5 years. Same 4797 and recapture with your Sch-C. Bill I know you knew that I was just stating it for the record.

[Bees Knees]

I have to disagree with Bees, specifically on the "If too many properties are purchased" part. It doesn't matter how many properties are purchased, but rather what are done with them. If, in one year, someone buys 100 properties and sells them all without doing any improvements to them, I would still have no problem with Sch D. (After all, if someone buys and sells 100 stocks, that's Sch D, right?) If, however, the taxpayer buys the home, fixes them up, then sells them, then I would go with Sch C.

Bill

I disagree.

The term trade or business is defined by IRS as any activity carried on for the production of income from selling goods or performing services. Buying real estate and making improvements is not a requirement for being in the business of buying and selling real estate. The mere buying and selling of real estate for profit could be enough to turn the activity into a trade or business. Certainly the amount of activity can play a role in tipping the scales towards being a trade or business. Buying and selling 100 pieces of unimproved land would most definitely be categorized as a trade or business.

[Bees Knees]

IRS Pub 334 says, "Real estate dealer You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales."

No where is any mention of a requirement that you have to improve the property to be categorized as a trade or business.

[OldJack]

IRS Pub 334 says, "Real estate dealer You are a real estate dealer if you are engaged in the business of selling real estate to customers with the purpose of making a profit from those sales."

Gees Bees, there you go again... quoting something out of context. Pub 334 is titled "Tax Guide For Small Business" and says, below the title, "For Individuals Who Use Schedule C or C-EZ". The quote is only to confirm to someone that wants to know if they can qualify for real estate dealer status. Under your interpretation no one would qualify as a real estate investor.

[Bees Knees]

The quote is only to confirm to someone that wants to know if they can qualify for real estate dealer status. Under your interpretation no one would qualify as a real estate investor.

So let me get this straight. You think IRS Pub 334 is for people who want to be categorized as a business. As though people have some kind of choice?

I didn't know that. I guess that means if I prefer to pay 15% on capital gains rather than 35% ordinary income tax plus 15.3% SE tax, then all I have to do is say I don't want to be a business. I prefer to be merely buying and selling investments, and POOF, it is done...

Gee, I didn't realize how simple it is to convert income into capital gains.

[OldJack]

So let me get this straight. You think IRS Pub 334 is for people who want to be categorized as a business. As though people have some kind of choice?

Oh please. There you go again twisting the subject and your interpretation. And yes, some taxpayers want to qualify for certain tax status in order to do something else, such as wanting Sch-C losses to offset ordinary income and SE tax.

edit: Some tax preparers refer to it as tax planning.

[Kram BergGold]

Brian, you start at the begining not at the end

Brian, You keep saying, "if the sales are going to be capital gains, then what do I do with the expenses". To me, the question is, is this taxpayer a real estate dealer or an investor? From your post it sounds like this person is devoting himself full time to buying property, then either fixing it up for resale or just flipping it. To me he is a dealer and reports all income and expenses on Schedule C. But this is just my opinion. Yours is the one that counts.

[Bees Knees]

Oh please. There you go again twisting the subject and your interpretation. And yes, some taxpayers want to qualify for certain tax status in order to do something else, such as wanting Sch-C losses to offset ordinary income and SE tax.

I'm still not sure what your point is. What makes buying and selling real estate a business?

A. When the person wants to be a business.
B. When the person improves the real estate.
C. When the person buys and sells 10 or more properties per year.
D. When the person buys and sells 100 or more properties per year.
E. When the person buys and sells 1 million or more properties per year.
F. When OldJack says its a business.
G. None of the above.

Should we have BB do a poll for us?

[Brian EA]

Brian, You keep saying, "if the sales are going to be capital gains, then what do I do with the expenses". To me, the question is, is this taxpayer a real estate dealer or an investor? From your post it sounds like this person is devoting himself full time to buying property, then either fixing it up for resale or just flipping it. To me he is a dealer and reports all income and expenses on Schedule C. But this is just my opinion. Yours is the one that counts.

This Taxpayer started to purchase lands in 2003 with the intention of putting up buildings and then flipping or renting them out depending on what options are available at that point in time.
In 2004 he filed a Sch C showing expenses as a real estate investor- for the last 2 months of the year. His primary occupation was Mortgage closing agent.There was no income from his investment.

In 2005 he sold 2 lots and reported capital gains on Sch D.

He now has 2 buildings under construction.One would be completed at the end of this month and he intends to put it on the rental market.

He came to me last night requesting a letter saying that he is an investor in order to procure a loan to complete his other building under construction. The lending institution needs a letter to confirm this.
Before I put my name on this letter I need to confirm that he is indeed an investor' after perusing his returns.
He was not an employee for all of 2006. All of his time is spent on this real estate business he calls investment

Any other suggestions

thanks
brian

[Bees Knees]

In 2004 he filed a Sch C showing expenses as a real estate investor- for the last 2 months of the year. His primary occupation was Mortgage closing agent.There was no income from his investment.

In 2005 he sold 2 lots and reported capital gains on Sch D.

Do you see anything wrong with this????

Don't you think that is sort of trying to get the best of both worlds?

I wonder if I could do that with my tax prep business...file a Schedule C for all my business expenses, and then report my income on Schedule D for the capital gain of selling paper to clients with a bunch of printing that sort of resembles a tax return on it and stuff....