Taxes On A Rehab
How much tax would be owed on the sale of a rehab if the person holds a full time job and only rehabs 1 or 2 houses a year? Lets say the rehab is unoccupied and held for less than a year. I am thinking it is the short term capital gains rate of 15%. It is my understanding that if you rehab houses for your main source of income then the IRS will consider you a dealer and you then pay the full earned income taxes on your rehabs. Am I on the right track?
Forget capital gains. You are going to pay income taxes on the income you earn.
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rbjj - An alternative you may want to consider is renting the place for 1 year and then selling if your buyer backs out for some reason. You will then only have to pay LT capital gains taxes (15%) plus state taxes and any depreciation recapture (minimal since you will own it for 1 year). If you decide to do a 1031 exchange you can defer the taxes if you follow the rules under 1031.[ Edited by finniganps on Date 08/01/2006 ]
Thanks for all the replies. I think I have decided to go live in the house for several months then rent it out or sell it after a year for the 15% rate or maybe live in it for 2 years and keep the government from getting any of the money.
But you assume the position is wrong and there is cheating going on. When you have tax law judges give opposite ruilings for dealer cases with similar paramaters then its not settled law rather its gray which means its legally arguable so if one wanted to take an aggresive tax position then they have some legitimate case law behind them that backs them up. Cheating is a criminal activity, taking an aggresive tax stance based on case law backing you up is not.
The fact is there is legitimate case law in tax court where judges have supported the stance that 1-2 homes a year is not dealer activity as they defind a dealer as someone who does it extensively with volume over a period of time.
The fact also is there is legitimate case law where someone doing one house and rehabbing it was tagged a dealer by the tax court.
Of course there are risks involved and again it depends on your personal tolerance of risk, if the extra profits you make from taking an aggresive tax stance is worth the possibility that if you are audited that you may be ruled against if it even gets that far as often its settled way before that.. But the risk is not criminal though its only monetary so one has to weigh the potential reward with the risk. People have taken multiple approaches ot this question and whatever each person is confortable with doing is ultimately the right answer for them.
Lawyers are not necessarily tax professionals. Go back to the definition of a dealer disposition.
The first words are "ANY DISPOSITION". Given that ANY includes the instance where you only do it once, it is not too hard to see that the IRS employee you talked to completely ignored the definition in the first place. Perhaps s/he just told you how they wished it would be, rather than how it is.
The question to ask your tax advisors is whether you have at least a 40% chance of successfully defending your capital gains tax treatment for your flip in the event of an audit, or in tax court if it goes that far. If so, then take an aggressive posture.
If not, then take the dealer disposition tax treatment because the penalty for losing your case could be up to 100% of your profit and you will still owe the back taxes with interest.
The CPA we talked to was a IRS auditor at one time.
I am going to call him and run this pass him again, and see what he says about this situation one more time.
Will post back .
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Fixer,
The IRS has definitions for dealer realty and for investment property. You can not engage in a dealer disposition as an investor. Instead, you are acting as a dealer to real estate for that transaction.
Remember that dealer activity is determined by the character of the transaction; each transaction is considered individually.
It could change your tax liability depending on what state you are located in. California has a gross receipts tax based on the sales within an LLC. If it is a sale of a capital asset it does not triger the gross receipts tax, but some operations or uses may. This is not an area that I am an expert in, so I strongly suggest that you consult with a tax advisor located in the state in which you are in.
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In my opinion, your property is dealer realty. Dealer realty can not participate in a 1031 exchange.
You can always try it anyway if you want to play tax audit roulette with the IRS. Penalty for losing is 100% of your profit as a fine.
You must have the INTENT to HOLD investment properties for rental, investment or use in a business. These areas can be tricky, and are quite often in the aggressive areas of tax planning. I would be happy to discuss your situation in more detail if you like.
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