What strategies are you useing to reduce the tax burden on income from flips that happen fast enough to be considered ordinary income?
I am NOT looking to to circumvent any tax laws illegally. I am looking for legal avenues to reduce my tax on flips.
Thanks for any advice you may have…
Jason.
flips are always ordinary income, irrespective of the holding period. buying with the intent to sell (as opposed to hold as an investment) is business income, goes on the Sch C, and is subject to ordinary income tax plus self employment tax.
total tax bite ~45%
the only way to reduce this is to make sure that you have accounted for all of your expenses: mileage being the most important and a large one (be sure you have a log) cell phone, utilities, insurance, tools, signage, advertising, bank fees, credit card interest (only on the project costs financed). anything and everything that went in to getting that house ready and sold is deducted somewhere.
Wow, 45% I’m not even in that bracket.
What about a 1031 to the next flip?
understand, that’s income tax (assume 28%) plus self employment tax (15.3%)
you can’t 1031 a flip. 1031 is for investments. Flipped houses are, by definition, not held for investment. they are inventory, sold in the course of ordinary business.
I thought you could use a 1031 with the profit of your previous flip and put it into your next property flip of similar likeness within 45 days of closing of the first flip?
It’s sounds like you are a dealer, and so there’s not too much you can do to avoid taxation on the flips.
Like someone said previously, 1031’s are for investment property, so you can’t really go down that road.
And the only additional tip that I usually tell people is to become a real estate professional so you can claim unlimited losses… but it doesn’t sound like you have a loss.
In this case, it would probably be worth it to pay a professional for their advice. They might be able to do something nifty, like set up an S-Corp. You didn’t mention anything like that, so I am assuming you haven’t looked down that alley.
I myself am not a flipper, but I have brokered many for clients that are. They do use a C-Corp or LLC taxed as a C-corp for all the flip income they incur. They use a series of “expenses” to pay for their business activities, including paying each flipper partner a wage or consultation fee depending on how much income a property has at the flip. C-corps are also able to set aside a certain amount of income for “future expansion” that effectively defers taxes. I don’t have too many details beyond that, as I have a CPA that does this for my clients and they are pretty happy with him.
JasGot, income taxes are not sole or the biggest potential financial problem you face as a flipper.
You cannot use capital gains tax rates to shelter your profits, as you know, but that also applies to rents you may collect while holding the property
You cannot claim depreciation on your rental properties
You would be subject to Self Employment (SE) taxes of 15.3% on your profits and rents, this with your Federal, State and City taxes could well equal 50% or more!
You cannot do 1031 tax free exchanges
You cannot do installment sales, you would have to pay the tax on the gain up front
Fortunately, a C-Corp is the answer to most of these problems.
It shields you personally from becoming a dealer and losing all the advantages of being an investor
It shields your other assets from liabilities created by your flipped properties
You would only pay SE tax on the money you take as salary, which you can minimize, within reason
You have more potential tax deductions with a C-Corp than with most other entities
You can shelter 10’s of thousands of dollars from the tax man with a generous retirement plan
There may be other factors I have omitted. I am not a CPA (although I did sleep with one, once)
Please consult knowledgeable professionals (not all doctors do heart surgery) before making decisions.
Perhaps others can add or make correction to this post, but I think you get the message.
Good luck!
Bill Young
dealer or not, flips are always ordinary income, subject to income and SE tax. always.
let me say that again for those that are not paying attention:
flips are always ordinary income. never capital gain.
to take capital gain and be eligible for 1031, the property must be held for investment (rental, unsold parcels of land you developed, etc). the key here is that if you intend to resell it, it is not held for investment. if you intend to resell it, it is inventory.
Now, what complicates things is that if you both flip AND rent properties, the IRS can attempt to classify you as a “dealer.” This means nothing more than your rental efforts are merely incidental to your greater flipping business. The solution here is to keep good records: copies of advertisements, rental applications, tenant interview notes, property management agreements, anything that substantiates that you intended to rent the property. Facts and circumstances supported by documentation will avoid having the IRS reclassify a property sale as a dealer transaction, which preserves the capital nature of the transaction.
Setting up a corporation can be useful to keep your flipping business seperate, but is not perfect: you have to know up front how you will dispose of the property. Suppose you buy a home in the corp with the intent to flip it, but it doesn’t sell or not at your desired price. You end up putting a tenant into the property for two years. Now what do you do? You have a rental in your “flip” corporation. Suppose you buy a rental, but a buyer makes you an offer you can’t refuse? Now you have a flip in your rental business. Uh oh.
Neither will a corporation magically save you taxes. business expenses are always deductible irrespective of whether it’s a corp or a Sch C. Likewise, assuming that you take a salary for the full amount of profit, all that salary is subject to the same FICA and Medicare load as paying SE tax on a Sch C, so you don’t save anything there. If you leave the profit inside the corp, you pay the corporate income tax, plus a 25% tax on dividends if you take a distribution from profits. That may end up costing you more in taxes than the Sch C.
You can usually put away more tax advantaged retirement funds with a SEP than a corporate 401(k), although those differences are fast disappearing.
Then you have the additional hassles of dealing with the entity (no comingling)…
A corporation is a valuable tool and has many advantages. Saving taxes is generally not one of them.
We are talking about a property flipping business. The tax treatment of the business profit or loss is not changed by becoming a real estate professional.
for you tax guys:
I’ve read through post after post about the advantages of an LLC, or a S or C corp as opposed to being self employed sole proprietor.
Besides the legal protection that a LLC or Corporation provides, is there much of a tax advantage to these? It seems from my reading there is not, but I may be misunderstanding some. And I’m speaking in regards to a property flipping business, not investment in rentals.
everything that is deductible to a corp or LLC, is also deductible on Sch C.