The Difference Between a Real Estate Business Owner and a Real Estate Investor

The term “real estate investor” gets thrown around a lot. When it comes to the IRS, though, the term has a very precise meaning. The IRS defines what you do, how you do it and the resulting tax consequences very clearly. So, let’s start there.

What type of real estate investor does the IRS think you are?

First of all, the IRS may not even recognize your real estate investment AS an investment. You could be considered a real estate business.

Real Estate Business

There are two primary ways you could be considered a real estate business:

  • As a real estate dealer, or
  • As an owner with real estate rentals that qualify as active, not passive.

Let’s look at these two types of real estate businesses in closer detail.

The Real Estate Dealer is also known as a fix-n-flipper, flipper or wholesaler. This is someone who buys property for a short period of time, with the plan of selling quickly for a profit.

A Real Estate Dealer has a business, not an investment. That means you’ll pay self-employment tax, just like any other business, unless you’re in the right business structure. It also means you will avoid passive loss traps and won’t pay the Medicare surtax on passive income if you sell the property. The key is having the right business structure in place, using the right accounting practices and using the right business deductions. You’ll pay less tax if you plan ahead. You’ll pay more taxes, perhaps even a lot more in taxes, if you don’t plan..

The second type of surprising real estate business happens when you provide substantial services for your tenant’s convenience. For example, if you provide regular cleaning, changing linens, maid services and people rent for short periods of time, you’ve got a real estate business, not an investment.