With mortgage interest rates low, flipping real estate appears to be on the rise. This activity is even the theme of several popular reality TV shows. The tax treatment basically falls into three possible categories: dealers in real estate, investors, and homeowners.

Being a homeowner is easily identifiable, but the distinction between a dealer and an investor is not clearly defined in the tax code. A real estate dealer is a person who buys and sells real estate property with a view to the trading profits to be derived and whose operations are so extensive as to constitute a separate business. A person acquiring property strictly for investment, though disposing of investment assets at intermittent intervals, generally does not deal in real estate on a regular basis.

This issue has been debated in the tax courts frequently, and both the IRS and the courts have taken the following into consideration:

The distinction between a dealer and an investor is truly based on the facts and circumstances of each case. Clearly, an individual who is not already in the real estate profession and flips one house is not a dealer. But one who flips five or more houses and/or properties and has substantial profits would probably be considered a dealer. Everything in between becomes various shades of grey, and the facts and circumstances of each case must be considered. Of course, where a taxpayer occupies the home as a primary residence while making any improvements and meets the 2-out-of-5 years use and ownership tests of Sec 121, any gain would be a long-term capital gain, and the gain would be excludable up to the limits of the Sec 121 limits.