Rehabbing homes - and a Schedule C??

General Real Estate Investing
1

I am going to begin “seriously” getting into rehabbing homes, now.

This year I am going to do probably 3-6 transactions (fixing up, and selling homes for a profit).

Next year I’ll shoot for double or triple that.

I will be using my own funds in combination with bank money (I have no real need for hard money loans since I have great income & assets already, and I can get far better terms).

This is a completely seperate business than my existing businesses,including my collection of rentals, and I plan on using one of my extra / unused single-member LLCs (a pass through entity) and reporting any earnings on a seperate Schedule C.

But I have a couple questions.

→ To confirm, this business SHOULD be reported on a seperate Schedule C (and NOT a schedule E) right?

And say I purchase $500k worth of homes in 4 transactions before the end of 2012, I have $100k in fixup and holding costs (factor in all other business and whatever expenses too) - and I sell them all for $750k. In that scenario, I clear $150k.

→ Do I report $500k in inventory or COGS, $750k in sales, and deduct the $100k in expenses like I normally would any other business?

I am a tad bit confused, as I understand that real estate agents do not report their total sales of their homes - which could easily be well into the millions upon millions for an agent - but just report their commissions as income/sales and deduct expenses like normal. I also understand they are mediators / salesman and not actually home buyers and sellers.

I am going to logically assume the answer is “YES” to both of my questions above, but I would like to here from some experienced rehabbers or tax experts out there to confirm that. =)

2

yes, rehabs are ordinary Sch C income, subject to both income and self employment taxes.

Rehabs are not a SchE/4797 transaction.

rehabs are considered “inventory.” the purchase price, plus improvements are treated as cost of goods sold on the Sch C, in the year sold. So if you buy in year 1, fix up in year 1, and sell in year 2, both the sales and the cost of goods are reported in year 2.

holding costs such as interest, insurance, utilities, etc I usually do not include in COGS and report in the year incurred. Others may include them in COGS. It really doesn’t matter much, as they’re deductible either way it’s only an issue if the expense and the sale do not occur in the same year (timing issue.)

3

Thanks for your feedback Mark. However I have a couple more questions…

What if I make a rehab acquisition in September 2012, make all the repairs to it in 2012, have no additional ongoing expenses except the basics (insurance, property taxes, HOA, etc) … but the property sells in February 2013.

→ I assume I would just carry over the inventory (the house) into 2013, and deduct 2013’s expenses - though minimal - on my 2013 tax return. Right?

→ How exactly would that negatively or positively affect my Schedule C though, in either calendar year (2012 or 2013)? Would I have a great writeoff in 2012, but much more taxable income in 2013?

→ And how advantageous or not, once the business becomes successful, do you think it would be to convert the LLC to an S-Corp or C-Corp (at the federal tax level only) for the additional writeoffs - examples - S-Corp savings on the employment taxes, and C-Corps using additional benefits/writeoffs such as a benefit plan to pay for all healthcare expenses of all employees that are not covered by insurance, daily food allowances, etc.

4

In your scenario, business expenses paid in 2012 would be deducted in 2012 even though there is no revenue in 2012. Cell phone, mileage, insurance, interest, tools, business cards, office expense, utilities etc. Some people include insurance on the property (not general liability), utilities and interest into the inventory cost.

In 2013 you would have the revenue from the sale, record the COGS from the purchase of the property plus renovations (inventory) as well as whatever business expenses you pay for in 2013.

So you should probably see a Sch C loss in 12. 13 would see the profits from the house, minus any business expenses for 13.

Keep in mind, again, that Sch C income is also subject to self employment tax. When income tax plus SET are factored in, it could easily be a ~45% tax hit.

I would not worry about converting to S-corp unless the business starts generating enough cash to sustain a salary. Only if you have maxed out the SEP retirement contribution and desire to go with a defined benefit pension plan would you consider a C-corp. Otherwise it’s too difficult to get cash out of a C-corp to be beneficial.

5

From what I have read, a single member LLC is a bad idea. Multiple member LLC’s are recommended for tax reasons to prevent audits from the IRS and you don’t use a schedule C.

6

What you read is wrong, and probably written by someone who is selling something.

LLC is a construct of state law that means nothing to the IRS. To them a single member LLC is just another Sch C. It has no more or less audit risk than any other Sch C.

If you follow the rules and laws, you have nothing to fear from an audit.