ALBUQUERQUE, N.M. — Q: Six years ago my wife and I began buying, improving, and flipping homes. We both had full-time jobs and did the house flipping mostly on weekends and some weeknights. Initially this was one home at a time and it slowly started to grow. Four years ago we consulted a tax attorney to discuss how to report the sales. He told us that we could report all gains as capital gains, but we had to be careful how much activity we had because it could start to look like a “regular” business. Well now I have quit my job and am doing the house flipping full time and my wife is working part-time from our home and also helping with the houses. Can we continue to report capital gains or should we go back to the attorney to see how we might change how we do things?
A: Your question is one of the oldest, and historically most important, facing real estate investors. That is, am I an investor, who can report capital gains, or am I a “dealer,” who must report ordinary income?
The law says that you should report ordinary business income for gains derived from the sale of property held primarily for sale to customers in the ordinary course of a trade or business. This law has created headaches for everyone who dares to touch it.
Taxpayers generally want to avoid meeting this business test. The IRS then wants to contend that you do meet the business threshold purpose. That much tends to be easy to discern.