Taxes (not Enough Help In Tax Forum)
I am looking to flip properties, and am under the impression that a 1031 exchange will not work.
What is the best way to avoid the largest amount of taxes on a rehab and what are the typical tax costs? (assuming only a $10,000 profit)
Thank you in advance
[addsig]
Why do you think a 1031 won't work for you??
The big tax burden is capital gains = 15%. The only way I know to lower your tax is to lower you profit....not the best alternative in my mind.
This topic hasn't been replied on for a while, but I couldn't help but ask a couple questions on it.
1. If wspinden is flipping properties, he/she probably hasn't held the property long enough to qualify for a 1031 exchange, correct?
2. If wspinden is flipping properties, then by nature the income from flipping will be reported on schedule C, not D, correct? Even if it was considered a capital gain, it would probably be a short-term cap gain, and still therefore taxed at ordinary rates, correct?
Rentalman hit the nail on the head. The IRS likely will consider rehabbing as trade or business income and tax it at ordinary rates. How can you minimize tax?
Sole Proprietership: self employment tax (15.3%) plus ordinary income tax
single member LLC: self employment tax (15.3%) plus ordinary income tax
S-corp: NO self employment tax but still ordinary income tax.
I use an S-corp for flipping properties.
Good luck
Quote:
S-corp: NO self employment tax but still ordinary income tax.
I use an S-corp for flipping properties.
Then my question is, how do you pay yourself? As we know, being able to withdrawl money from an S-Corp w/out having to pay taxes on dividends is a major advantage of an S-Corp. But, do you pay yourself a paycheck, even if it is minimal?
My interpretation of earnings from S-Corps is this. Taken from Kleinrock's TaxExpert:
"S corporation shareholders may be tempted to characterize payments as distributions with respect to stock, rather than as compensation, in order to avoid the payment of employment taxes on compensation income. If an S corporation tax return shows no compensation payments to shareholder-employees, the IRS may attempt to recharacterize the purported dividend payments as salary. On the other hand, if the S corporation pays reasonable compensation, additional amounts should be classified as a distribution with respect to stock."
See Radtke v. United States, 895 F.2d 1196 (7th Cir. 1990); Spicer Accounting, Inc. v. United States, 918 F.2d 90 (9th Cir. 1990); Rev. Rul. 74-44. 1974-1 C.B. 287.
wspinden,
By the very nature of the activity, flip property is considered stock-in-trade, or business inventory. As such, your flip profits are taxed as ordinary income -- not capital gains -- regardless of your holding period.
If you are doing this as a sole proprietor or from within a single member LLC, Your "business" income is reported on Schedule C and Schedule SE.
A 1031 like-kind exchange can only be used for your investment property or your business property. Investment property is defined as property held for the production of income or for future appreciation. Business property (for the real estate investor) is the real estate that houses your business such as your office building. Because your flip property is stock-in-trade, it does not meet the investment or business property criteria to participate in a 1031 exchange.
In my opinion, the best way to avoid the largest amount of taxes on a rehab is to hold it as long term rental property. Once it is established as an investment property, you can use a 1031 like-kind exchange to "sell" and acquire a replacement (rehab) property. Repeat the process -- rehab, rent for a couple of years, exchange for another rehab. Typical tax cost for this strategy is zero because all your taxes are deferred until you sell the replacement property in a taxable transaction.
You need to explain what you mean by "(not enough help in the Tax Forum)". I am puzzled why you would come to the Tax Forum with a negative subject title. Did you mean to post your question in another forum instead? Did you previously post your question with no reponse?
Perhaps you did not notice that there are five pages here, with around 200 separate topics posted. Several of the topics have already addressed your very question. I admit that I am biased, but let me assure you that in this forum you are getting much more help than you paid for.
DaveT,
Great advice! It is also worth mentioning that during the time you do use the property as a rental, that rental income is not subject to SE tax, where as if you bought and sold in an inventory like fashion, that income would be subject to SE tax.
I would agree with myfrogger. Use a S-Corp for your flipping activities. Pay yourself a reasonable (grey area) salary as the manager and take the balance of your profit as ordinary income without the SE tax. I would hold my long term rentals in a separate entity, such as an LLC, so as not to inflict my long term sales to dealer stautus rules.