Avoiding Ordinary Income On Flip
Scenario: I just bought a property for $60,000, will invest $40,000 in improvements, and it will be worth $150,000.
If I flip the property as soon as rehabbed, Ithe $50,000 profit will be taxed to me as ordinary income, plus I'll have to pay SSI, etc. on it. Basically, the worst of all possible worlds, taxwise.
I see 2 possibilities:
1. I can sell the property in a 1031 exchange, plowing the $50,000 gain into a new property, and deferring realization of the gain until some future date.
--Are there any special issues involved in doing a 1031 with a property that has been held for only a short term?
--Am I correct that at the closing of the sale I can take out all moeny I paid as a down payment or for improvements tax free as a return of capital?
2. I can rent the property for a year, then sell it. After a year from date of purcahse I will only incur capital gains tax at 15%.
Am I missing anything here? Any thing I should think of further? Any other options?
Thanks!
Flip property is not eligible to participate in an exchange, so option one is not viable. Even for an eligible investment property that will be the relinquished property in an exchange, money spent to acquire and to improve the property can not be taken out of the sale proceeds without creating a taxable event.
With regards to option 2, as long as the property is not deemed to be dealer realty, you are correct that rental property held longer than one year qualifies for long term capital gains tax treatment. This same property is also eligible to participate in a 1031 tax deferred exchange.