Well, we had a nice year investing in preconstuction houses! We bought 2 houses back in Aug of 04 preconstruction, then whe the house was finished we closed on them in May of 05. Now we have sold both and made a 40K+ profit each. However, I thought I understood how to shelter our gains w/ a 1031 exchange.
Today I found out that I needed to hold on to the house for 1 year or rent it out if it was going to meet the criteria for a 1031 exchange.
Is this accurate?
If so, do I have any other options other than paying 28% gains?
OUCH!
Thanks for all the responses in advance!
form a C corporation. deed the properties into it and sell them.
this will also protect you from dealer status. use the proceeds to fund
you and your wifes 401k through the ccorp. deduct other expenses.
Thanks, that sounds like a good idea for future deals. I am already in contract w/ the property and it is going to close on june 30th.
Plus, my wife and I wanted to use the gains to invest in an apartment building. It looks like we may be putting less down than we would like :-[
even if its in contract you can transfer title to ur corp. if u’ve held the property for less than a yr u cannot do a 1031 and will pay regular income tax on it.
if you are able some money into your 401k, you can use that money to invest into real estate too. i suggest to talk to a competent CPA.
btk & nira,
I think y’all are mixing 1031 and capital-gains tax questions. The 12-month holding requirement is for taxes (capital gains @ 15% vs regular income tax rate).
1031 requires an exchange without receiving cash or mortgage relief and allows deferral of all federal taxes.
Do an internet search for 1031 exchange & you’ll find exchange facilitators whose websites explain the process. For now, be glad you have the $$ on which to pay taxes. For the future, hold for 12 months & pay 15% or do 1031 and defer the taxes.
Good luck,
Ray
Ray,
I called Starker Services and explained that I closed on the property in May when we bought it and will be closing on the sale on June 30th. The representative said that they can do it for $750 but the gov will not consider it as a exchangable property because we would of had to hold it for 12 months.
I was wondering if there was another way of protecting myself from paying the full income tax on this? Or just take it as a lesson learned and hold the property for 12 months after?
Thanks
how much gain do you have, which state are you in and whats your tax rate?
You appear to be flipping property. Flip property is not eligible to participate in a 1031 exchange. Property held for the production of income, held for long term appreciation, or property used in your business does qualify to participate in a 1031 exchange.
There is no mandatory minimum holding period to qualify for an exchange. However, it is difficult to convince the IRS that property that is resold quickly, was acquired for a qualified investment purpose rather than acquired with the intent to resell for profit. One way to show that your intent is an investment use, is to actually hold the property – the longer the better. Bill Exeter recommends holding at least one year before entering an exchange.
in order to qualify for long-term tax treatment, its a year AND a day. most cpa’s recommend holding property for atleast 1 or 2 years for a 1031.
You need to hold it for 5 years and at least live in it for 2 years.
no thats not true. [actually, since its out of context, its totally false]
thats only if you’re claiming a 1031 exchanged property for the 121 primary residence exclusion.
niravmd,
If there is such a thing as “dealer status” (which I don’t believe), why do you need protection from it?
BTK,
I don’t know any way to lessen the tax burden at this point. I had forgotten the holding requirement for a 1031 exchange, as it takes me over a year to complete an exchange anyway. For the next time, please hold the house as a rental (or sell on a rent-option) for at least a year.
Good luck,
Ray
Dave,
Flip three houses quickly & your local IRS buddywill explain dealer status to you for a big fee. If you are a dealer in IRS opinion, you cannot claim any property as an investment property. Dealer status stinks.
Good luck,
Ray
Ray,
The misconception I am trying to address is that the IRS “tags” individuals as dealers. Not true. There is no such thing as a “dealer status” which implies that once an individual is identified as a “dealer”, then all future transactions are dealer dispositions.
The reality is that the IRS looks at the character of the transaction to determine whether a “dealer disposition” has occurred.
I am fully aware of the income tax implications of a dealer disposition. They aren’t bad. Of course, the tax liability is higher than an investment property tax treatment, but that just means the taxpayer is making money. That is not a bad thing.
The point I challenge is the belief that there is a stigma attached to being a dealer to real estate. There isn’t.
i dont know whether i’d call it a stigma or not, but if you’re a dealer you basically treat sale of property as regular income instead of capital gains.
this used to be an issue when capital gains was 20% and regular income was taxed at 70%. [source - tax stragies for real estate investors- albert aiellos]
once you have dealer status, i believe you can’t claim depreciation losses on your properties even if they’re held as long term investments. i could be wrong, but i’d still
rather put my flip properties in a CCorp for other fringe benefits.
[b]i dont know whether i'd call it a stigma or not, but if you're a dealer you basically treat sale of property as regular income instead of capital gains.[/b]
This is a misconception. Individuals are not tagged by the IRS as dealers. The facts and circumstances, form and substance of each real estate transaction are evaluated to determine whether a dealer disposition has occurred.
A taxpayer can have sales of investment property that get capital gains tax treatment, and at the same time, have dealer dispositions that are denied investment property tax treatment.
The problem for the taxpayer – keeping the dealer dispositions from tainting the investment property sales – is best addressed by conducting dealer dispositions in a business entity that is separate and distinct from an entity that holds investment property. While separate business entities are not absolutely required with good record keeping and distinct subaccounts in the taxpayers accounting system, separate business entities makes it easier to segregate the two activities.
[b]once you have dealer status, i believe you can't claim depreciation losses on your properties even if they're held as long term investments. [/b]
Since there is no such thing as dealer status for an individual, you are basing your comment on a false premise.
Real estate transactions that are deemed to be dealer dispositions are denied investment property tax treatments. This means that
[]all profit from the sale is considered realized in the year of sale even if the seller carries back financing as in an installment sale. []Installment sale tax treatments are prohibited[]the property is considered to be merchandise (dealer realty) to the business, and, as merchandise, can not be depreciated.[]dealer realty can not participate in a 1031 exchange.[*]income from dealer dispositions, in the absence of a business entity, is self-employment income taxed at the taxpayers ordinary income tax rate.
Investment property and the sales of investment property still qualify for investment property tax treatments. It is up to the taxpayer to insure that his investment property activities and his dealer dispositions are properly segregated so the dealer dispositions don’t taint the investment property sales.
so are you saying that its myth that flipping a dozen homes a year invites dealer status?
if so, why does almost every real estate investment website mention this? where did the myth come from?
Don’t take what I said the wrong way. The IRS does treat dealer dispositions differently from investment property dispositions. I only said it is a misconception to apply the term “dealer status” to the individual taxpayer. Applying the term to the individual has further connotations, such as
[*]Having attained “dealer status” implies that once the individual is identified as a dealer to real estate, s/he can never be treated as an investor. This is a misconception.
[*]Having attained “dealer status” implies that all dealer dispositions prior to attaining the status get investment property tax treatment. This is a minsconception.
[*]Having attained “dealer status” implies that there is some number of deals per year that the taxpayer needs to complete before the status is conferred. I have seen numbers of deals in the 3 to 5 range bandied about in the forums as a threshhold for attaining “dealer status”. This is a misconception.
Perhaps the source of this particular misconception does have some foundation in some state laws. There are states that require an individual to have a business license if five or more deals are accomplished in a single year – most often associated with mobile home reselling activities. This may even be called a “dealer” license by those individual taxing jurisdictions, but local law is not the Internal Revenue Code.
If you can find a reference in the tax code to the term “dealer status”, please cite it for me. I can’t find it.
The tax code does define a “dealer disposition” and there is a body of case law that is supposed to help the IRS auditors determine when an individual is acting as “a dealer to real property”, but nowhere have I seen the term “dealer status”.
As far as I can tell, it is a made up term that has gained widespread use in the internet real estate discussion forums. Everyone tells you that you want to avoid “dealer status”, but then most everyone fails to tell you that the property flip you are doing is a dealer disposition.
The character and substance of the property flip make you a dealer to real estate for that transaction, even if you only do one. Does it forever brand you as a “dealer”, labeling you with the dreaded “dealer status”? No Way.
thanks for clearing that up. i tried looking for dealer status in IRS code too last night and didnt find anything either.
DaveT is right on the money. It is applied on a property by property basis and not to an individual. Well said DaveT!