California Real Estate Practice Exam

A licensed real estate broker, buying and selling many properties for himself, may have his profits taxed as:

1. deferred capital gains

2. long-term capital gains

3. ordinary income

4. short-term capital gains

The correct answer is: deferred capital gains

In the context of real estate transactions involving a licensed broker who is actively engaged in buying and selling properties, the correct characterization of his profits is that they can be taxed as ordinary income. This classification is typically due to the nature of the business activities, where the broker's actions demonstrate that he is conducting a trade or business in real estate rather than simply making investments for capital gains. When brokers buy and sell properties as part of their business operations, any profits generated from these transactions align more closely with income that is derived from their profession, which is subject to ordinary income tax rates. Notably, this is different from capital gains taxes, which apply when properties are held as investments and sold for a profit. Deferred capital gains, long-term capital gains, and short-term capital gains typically apply to individual investors selling properties that they have owned for various lengths of time. In contrast, the activity described—buying and selling properties frequently as part of a business—places the profits firmly within the realm of ordinary income tax treatment. Thus, it is crucial for licensed real estate brokers to understand the tax implications of their business activities and to report their income accordingly.