I have a couple of general questions regarding income taxes.
I bought 4 properties last year(2010) and have sold a couple this year(2011).
Should I deduct my purchase and rehab cost off of 2010 taxes or wait to do it with 2011 taxes to offset the income I will have from those properties?
The properties were purchase in mine and a silent partners name. When we closed on the sale the title company sent me and him a 1099 for half of the gross proceeds. I have all the records and expenses, so how do we handle these expenses so that he is not hurt financially.
On one of the houses the sales price was $72k, he has a 1099 for $36k and I do also. I don’t want him owing taxes on that money, but how do we offset the income with the expenses?
Rehabs are inventory. you record the sale and cost when sold. If it sold in 2011, sale and cost both go on 2011 Sch C. Rehabs are not a Sch D capital gain.
What was the written agreement up front on how the proceeds, costs and funding would be split? That’s how you should split it.
Didn’t put it in writing? Then the two of you need to reach some kind of agreement, write it down and sign it.
Things to consider: who financed the property? Who made payments/interest, funded the renovation? Who did all the work? Was the “silent partner” just the money man? What was your time and his money worth?
Once you decide this, allocating the expenses between the two of you so that you arrive at the agreed split of net income is just math.
Ideally you have a set of books on quickbooks or quicken where you can easily arrive at the TOTAL cost of the rehab. Hard costs, utilities, insurance, interest, bank charges, everything. Don’t forget purchase price and closing costs. Net income is sales price minus all these costs. Split net income as agreed, then decide how much expense each gets so that his 36k income is reduced to the appropriate income split. Divide the expenses line by line on each return as needed.
Or hire a CPA. On a problem like this, a good CPA can probably save you enough on taxes (and time) to offset the cost of the return.
Also, if you’re not, you should consider doing this flipping activity within an LLC (with S-Corp tax election) or just a straight S-Corp. You can pay yourself a modest salary from the entity, and the rest of the profits will be ordinary income that will not incur self employment taxes (social security and medicare). This can save quite a bit in taxes. The entity will also provide asset protection benefits (along with plenty of liability coverage, including an umbrella liability policy of at least 1mm). The LLC also provides a lot of latitude with splitting profits between the respective members; does not have to be pro-rata based on capital contributions of members to LLC.
That only works if the taxpayer isn’t the one doing all the work in the S-corp.
Courts have ruled that when the shareholder performs substantially all the work of the S-corp (or LLC taxed as one) that S-corp income is subject to self employment tax.
To avoid SE, you need to have a business that can operate somewhat independently of how much work the shareholder personally performs.
Thanks for the info. Just to clarify, the houses were not sold until 2011, so for 2010 taxes I act as if they didn’t exist. All of the deductions to offset any profit would be done on my 2011 return??
It was a family member who allowed bought the properties in his name(I am have no W-2 income and could not qualify for the financing). I did all of the work and pay all of the bills.
I am just trying to keep him from owing any taxes or even be burdened with additional work he might have to do on his return.
repair/rehab costs would go in 2011, when the inventory was sold.
other expenses (phone, business cards, utilities, advertising) would go on the year incurred.
the person who “owns” the property will receive the 1098 for mortgage interest, etc under his SSN. If you’ve put in cash to cover the rehab, then you have now created a joint venture and you’ll probably need to file a partnership return.
you have created some tax headaches for yourself by not having a tax plan before you started.