Made 14K Rehabbing A Property - How Do I Avoid Taxes?!?

Thank you for reading this.

I did my first flip of a rehab property this year and made about 14K in the deal. The problem is I also got married and our combined income puts us in a pretty high tax bracket and the 14K won't help.

What is the best thing to do to avoid paying taxes on this extra money I made?!

Thank you again for your time.

Comments(7)

  • JohnMichael3rd September, 2004

    Your tax bill would be based on the difference between your basis and your sale price. Your basis is the price you paid for the house plus:

    * Closing costs you paid when you bought the house (such as property-inspection fees, title-insurance premiums, and other settlement fees).
    * The cost of major improvements that add value to the home, such as adding a new room, a roof or central air.

    Your basis can also be adjusted downward. See IRS Publication 523 for more information on adjusting your basis and a worksheet that can help you with the calculations. If you're still stuck paying something to the taxman, at least you can take advantage of lower long-term capital gains rates. The new long-term capital gains rate is 15% for most people; 5% for those in the 10% or 15% brackets.

    Short of death or Section 1031, it's hard not to pay taxes.

    You may avoid any federal tax by claiming reduced gain exclusion. (However if you're ineligible for this privilege, your entire profit will indeed be taxed.)

    It may not be as bad as you think - if you take the first step in calculating your taxable gain is to figure out your net sales price.

    1. Subtract All Your Selling Costs from the Gross Sales Price.
    You'll need a copy of your closing or settlement statement at hand to help you identify the costs involved in selling the property. But don't just assume that all costs on your closing statement can be considered selling costs.
    Pull out any expenses. Your closing statement may include items that were prepaid by you, such as property taxes, insurance, or homeowner's association fees. It may also include items that remain unpaid by you as of the sale date, such as deposits or property management fees. These items are ordinary and necessary rental expenses that you should report as part of your rental income or loss on Schedule E rather than as part of your property sale.
    After filtering out the rental items, add up all the selling costs; such as:

    1 Commissions on the sale
    2 Document recording costs
    3 Legal fees related to the sale
    4 Survey fees
    5 Title fees or costs
    6 Transfer fees

    Now, subtract your total selling costs from your gross sales price. The result is your net sales price.

    2. Subtract the Cost of the Property from the Net Sales Price.
    To figure your profit, or taxable gain on the sale, you need to subtract the cost of the property from the net sales price. But, naturally, adding up all your costs can take a little work.
    You need to know how much the property has cost you, starting way back when you bought it, and proceeding through time as you made improvements (costing your more money), or took deductions for depreciation over time (reducing your cost). The result is called your adjusted basis, because it has been heavily adjusted over time, and it forms the basis of any calculation of profit or loss. Subtract your adjusted basis in the property from the net sales price, to get your taxable gain.

    As an investor it is vary imperative to get a professional account to guide and direct when it comes to taxes.

  • nbkqbl64th September, 2004

    John,

    Thank you for taking the time to respond. Your feedback is greatly appreciated!!

    Have a great Labor Day Weekend!

  • commercialking4th September, 2004

    Well its probably too late now but you could have done a 1031 exchange, this would have allowed you to move the profits into another deal without taxes. Unfortunately there are rules about not taking the money yourself, identifying a new property in a timely fashion, etc.

  • Ruman4th September, 2004

    Go buy yourself a nice new vehicle to use for your uh... next business venture. And write it off as a business expense smile


    Quote:
    On 2004-09-04 08:19, commercialking wrote:
    Well its probably too late now but you could have done a 1031 exchange, this would have allowed you to move the profits into another deal without taxes. Unfortunately there are rules about not taking the money yourself, identifying a new property in a timely fashion, etc.

  • myfrogger4th September, 2004

    Okay you have received some very incorrect information here. I am not an accountant or attorney so my words here are for educational purposes only. Consult a competent tax professional.

    Rehabbing properties is an active trade or business. If you purchased the property in your own name or an LLC, you'll file irs form 1040 schedule C and be subject to ordinary income rates plus 15.3% extra for self employment tax.

    The way to avoid this would be to operate using an s-corp or potentially a c-corp. Corporations are not subject to self employment tax. S-corps flow through to you personally and you will still be taxed at ordinary income rates.

    A c-corp may provide you with a lower tax but you will get taxed double if you want to take that money out to spend yourself. If you plan to use it for another property, then you don't have any distributions so no problems with the double tax!

    This is a very in depth topic that I would recomend finding a tax specialist...not just some random CPA.

    I wrote an article on this subject that you may find helpful.

    http://comm.thecreativeinvestor.com/modules.php?name=News&file=article&articleid=429

    As far as right now--you're probably going to have to bite the bullet unless you can buy something that you can deduct. You should again consult your tax professional.

    Also--remember--no one ever went broke paying taxes...

  • rajwarrior4th September, 2004

    Thanks frogger for the update. I agree with you completely.

    Just a few points that I want to elaborate a little, though. A 1031 exchange may or may not have worked in this case. There are specific rules for 1031 and in most cases, rehabbers would not qualify. First, the property must have been owned for over a year. Second, there is not supposed to have been any attempt to sell the property within that year minimum. Since most rehabbers exit strategy is selling, that would disqualify them.

    The self employment tax comes up frequently, and ways to "avoid" it. In short, there is no way to avoid. All the self employment tax is is the social security tax that you would have paid if you had been getting a normal paycheck from a job. This tax is normally split between the employee and the employer. Since you, as an investor/business owner, are both, you have to pay the full 15.3%.

    Running your funds thru a corp doesn't really help because, again, you're both employer and employee. The only real benefit to a corp is that if you are making tons of $$$, then you don't have to allot all of it as salaries, and thus limiting the tax that way. But there are also the corp tax to deal with and, as said, unless you're making a bunch, the gains would be minimal at best, and possibly a loss, depending on your tax bracket.

    Roger

  • myfrogger4th September, 2004

    I'll expand on a few more points. Again I am no expert here--not an attorney or accountant.

    The law isn't clear to the holding time required for a 1031 exchange. The law doesn't say anything about the attempts to sell a property within a year. The law centers around "intent." If your intent with the property when you purchased it was for long term, then the property qualifies.

    It is true that most rehab properties would not qualify for 1031 exchange. This is because the intent of most rehabbers is to resell the property. Even if a rehab took over a year, you would still not be eligible for 1031, in my layman opinion. This is because the intent was the same--to resell.

    Now it is completely your burden as a taxpayer to prove what your intent was. Quite frankly the longer you hold a property the easier it is to prove that your intent was long term holding. Most accountants recommend 2 years although an agressive approach is 1 year. This is not set in stone. In theory you could buy the property and hold it 1 day and do a 1031 exchange. I'm not sure how you would prove your intent to hold it long term.

    Another agressive strategy is that if you purchase a property in December 2004, and resell January 2005 technically you are in two different calendar years and the liklihood of an audit for muliple years is rare unless fraud/dishonesty is found.

    Still the safest route is to hold the property long term.


    As for the self employment tax of 15.3% I should have expanded on my thoughts. By forming a corporation, you are still subject to FICA taxes which are essentially the same as self employment tax. You are taxed, however, on just the amount you pay to employees. If you have no employees the IRS could make the argument that part of your gain should have been paid to employees.

    This isn't a complete wash though. If you purchase a house, spend 200 hours rehabbing it, and make $25,000, is it fair to pay your "employees" (could be yourself) $125/hr??? Of course not. Construction type skills are valued at lets say $30/hr which would mean you will pay approx 15% employment tax on $6000, not the full $25,000. Using an s-corp just saved you approximatly $2800.

    Hope this helps clear a few things up. GOOD LUCK

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