Capital Gains On A Rehab
I'm sure this question has been asked on this site about a million times, but I figured I'd ask and hopefully get some advice. I have a property that I've been fixing-up. I have had if for about 7 months. I'm planning on putting it up for sale within the next few months. Any ideas on capital gains, how to get around it, or where I can find out information on how much the capital gains maybe when I do sell it. Thanks in advance for any help.
I have bad news and bad news:
There are no capital gains taxes from your buy-rehab-sell for profit strategy.
Your profit will be taxed as ordinary income at your marginal tax rate, and self-employment taxes also apply.
There is a silver lining to this cloud. No one ever went broke paying taxes on their profits.[ Edited by DaveT on Date 01/13/2004 ]
Actually, that is not entirely correct. You can rent it out for a year and then sell it. At that point you only pay long term capital gains if I am not mistaken. You can also lease/option it and at the end of the option it would be capital gains also.
[addsig]
Taxes depend on a lot of factors and without knowing the entire situation and being able to ask questions, it is only possible to give general answers to a question. That is why everyone should go seek competent advisors. There is a way around the self employment tax issue too. It just depends on all the factors.
Quote:Actually, that is not entirely correct. You can rent it out for a year and then sell it. At that point you only pay long term capital gains if I am not mistaken. You can also lease/option it and at the end of the option it would be capital gains also.telemon,
Let's make sure that we are talking apples and apples. The context of the original question was buy-rehab-flip. In this context, the property is dealer realty. Profit on the sale of dealer realty is ordinary income regardless of the holding period, and possibly subject to self-employment income taxes as well.
If you change the context of the original question to buy-rehab-flip on lease option, you are still engaged in a dealer activity. It may be harder for the IRS to spot your pattern of activity and it may take a while for them to recharacterize all your property sales as dealer dispositions, but it is a definite possibility with a huge income tax penalty to sweeten your experience.
If you want to change the context of the question, to a buy-rehab-and hold for rental use, then I agree that capital gains tax treatment could apply if the property were eventually sold.[ Edited by DaveT on Date 01/14/2004 ]
I'm supposed to be closing on the purchase of my first rehab property at the end of this month. I plan to fix/flip, too, since I need my working capital back. So I've been trying to find a solution to this question as well. The idea I've gotten from various books and articles I've read is this:
You form an S-corp to do the rehab. You can pay yourself a reasonable salary from the profits of the deal, then pay out the rest as dividends. The salary portion is subject to self-employment tax, but the dividend portion is not. Does anyone have any comments on that? (I know, not legal advice, per se. Just curious as to whether that is the way anyone approaches it.)
Hmm... I just saw someone posted a similar response in another thread. No definitive answer there.
http://www.thecreativeinvestor.com/ViewTopic18789-23-7.html
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The floggings shall continue until morale improves.[ Edited by thuntermi on Date 01/14/2004 ]
thuntermi,
It is my understanding that, if you take a "reasonable" salary, the S-Corp pays its share of the payroll taxes while your share is deducted from your earnings (just like a payroll check). The S-Corp takes an expense deduction for your salary and for its share of the payroll taxes. The balance of the S-Corp net earnings can then be distributed to the shareholders (you are probably the only shareholder) as a dividend.
Your salary from the S-Corp is ordinary income to you taxed on your personal income tax return at your marginal tax rate.
The dividend is also ordinary income. I am not clear whether the S-Corp pays tax on the dividend distribution on its Form 1120S then makes a tax free distribution, whether the dividend passes to the shareholders as a pre-tax distribution and the shareholders declare the dividend as ordinary income on their Schedule B, or whether the dividend is taxed both on the corporate tax return and again on the individual tax return.
I am not up on corporate tax rules, so perhaps thowell will weigh in on this question.
Thanks, DaveT. That makes a lot more sense of things.
Oy! Corporate taxes, too. That was something that I hadn't really considered, but it certainly makes sense. And that gets me thinking -- are there any state business taxes for something like this? I wouldn't be surprised. I thought I was gonna maybe skip talking to a real accountant / tax advisor, and just figure it out myself with the resources online (including official gov't sites). But the more I learn the more complicated it seems to become. I guess I'm gonna have to shell out the few bucks to get some help in making sure I choose wisely.
[addsig]
The S-Corp dividends are passed through to the shareholder and is subject to regular income tax rates on the personal return. The strategy of using an S-Corp for your quick turn activities is to avoid the self employment tax on the entire profit. DaveT is correct that you need to take a "reasonable" salary and pay your payroll taxes on that salary. The balance of your profit bypasses the SE tax but not the income tax. The S-Corp will have the "Dealer" status rules imposed against it but your long term rental activities, hopefully held in an LLC, will not be affected and will recieve long term capital gains treatment. I hope this helps.