Rehab Profits Vs. Stock Market Losses
After much time educating myself, I will soon be starting in the rehab business and I am trying to understand the tax situation... Is the profit from flipping property after a rehab considered Short Term Capital Gain if flipped within one year?
If so, can carryover losses from prior year stock trades be used to lessen the tax on profits from Rehabs?
If I am totally wrong with this, then does Social Security and Medicare have to be paid from profits made in rehabs?
Thanks in advance to all. This site is the best. You are all my great mentors.
Glenn
Glenn,How do you plan to structure your business? Will you operate as a single propietor,partnership, or a corporation (C or S)? My advice is to find an accountant and attorney who are also rei's. They understand what you will need better.
if you hold property less than a year the profit from sale of home will be taxed at ordinaty rate anything over 1 year is considered capital gains which the rate stands at 15% right now. as far as losses from the stock market again it all depends what you did with the stock did you hold it over a year or did you sell less than a year...
MichaelChandler: Thanks for the response. When I start out I plan to just buy in my own name and rehab then sell. Later as my business grows I may start an LLC. But since I will be doing it in my name I was wondering if the gains can be applied my stock market losses.
lp1: Thanks to you too. Your response was very informative. Most of my stock market losses are short term (less than a year) losses. Of course I hope to turn around any rehab in less than a year (actually shooting for about 3-4 months turnaround). So if those gains are short term, I was hoping I could have my short term stock losses offset the Real Estate gains.
Glenn-LI,
As a sole proprietor, you report your income and expenses from your rehab business on Schedule C. You calculate your self-employment taxes on Schedule SE. By the way, it does not matter how long you hold your rehab property, since profit on the sale is ordinary income -- not capital gains (consequently, the long and short term capital gains holding periods do not apply).
Your rehab activities are independent of your stock market activities reported on Schedule D. Your Schedule D loss allowance will continue to be limited to $3000 against active income and excess losses will continue to be carried forward to the next tax year.
Thank you Dave. That cleared things up for me. I may as well start an LLC sooner since there is no advantage in doing the rehab as a sole proprietor.
Real Estate owners who own multiple properties usually consider themselves real estate investors. Accordingly, when they sell their properties, they treat the profit on the sale as capital gains. The Internal Revenue Service, however, may view the real estate owner not as an investor but as a real estate dealer.
What's at stake?
If the IRS classifies the real estate owner as a dealer, the tax results can be disastrous. Instead of paying tax at a capital gains rate of 15%, the seller may be faced with an ordinary income tax rate as high as 39.6%. As a dealer, two other common techniques for tax deferral would not be available - installment sale reporting and tax free exchanges. The provision prohibiting use of the installment sale method of reporting gain can be particularly harsh. A dealer receiving a very small downpayment and a note would have to recognize all of the gain in the year of sale.
Being classified as a dealer does have some advantages. Losses on sales of dealer held property are treated as ordinary losses and not subject to the limitations on capital losses. Additionally, interest expense on dealer held property can generally be deducted from ordinary income and is not subject to investment interest limitations.
What are the factors that determine whether someone is an investor or dealer?
As one might guess, investor/dealer status has been a heavily litigated area over the years. The key question is whether the property is being held primarily for sale in the ordinary course of business. If it is, the taxpayer will be treated as a dealer with respect to that property. It should be noted that someone can be a dealer with respect to some properties and an investor with respect to others.
Typically, the courts and the IRS consider the following factors in determining if a property was held for sale to customers in the ordinary course of business:
The purpose of acquiring the property and the purpose for holding at the time of sale
How long the property was held
The number and frequency of sales
The extent of the taxpayers efforts to sell the property
The use of a business office to sell the property
The degree of control and supervision by the taxpayer over any representative trying to sell the property
The extent of improvements to the property
A high number of sales over an extended period with active continual taxpayer involvement indicates dealer status, as does the taxpayer maintaining a sales office and making extensive improvements to the property. Conversely, infrequent sales with little taxpayer involvement support investor status.
so if you are in the rehab business then you'd be taxed ordinary rate..and Dave T. you are correct....i missed the rehab part in the posting...[ Edited by lp1 on Date 02/12/2004 ]
Wow this is wonderful. I didn't expect to learm so much in such as short time and I am deeply greatful to all, especially lp1 for the details.