Here’s how the law reads : “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.”
Rehabs that weren’t held as a rental for a period of time clearly don’t fit that definition. Typically you would want to hold the property for at least a year, or on the advise of my CPA, two years. As a matter of fact, it’s even possible that the seller-carried note would be fully taxable as well under dealer rules…depending on your entire situation.
None of this will come to light of course unless you’re audited. But if your accountant blessed this particular move, I’d be looking for another accountant. He is badly misinformed in my opinion.
If I made 15k on a property I just rehabbed, and then reinvested that money in another property, do I owe a capital gains tax on it? And once I do sell the property, say in 3 to 4 months after purchase do I lose any tax advantage I had, or is it carried over to the next property?
Re: capital gains and tax advatages - Posted by Jim Holmes
Posted by Jim Holmes on March 04, 2000 at 01:57:52:
Mike,
Had to post. I just closed a rehab and took back a 2nd in a note of $16,200 (80/20 buyer’s loan). I’m deferring capital gains through a 1031 exchange. I put both the note and $13,800 in cash into the exchange. The rules make you take all cash (profit and injected money) from the sale into a designated escrow holder to be released when you close on an identified exchange target property. You pay a fee for the exchange company to hold your money.
The result is since the tax is deferred, the government is giving us an interest free loan that we can use to leverage other property as long as the amount of the property we are buying equal or greater value than the property sold.
In my case, I found a seller that would take my $16,200 note as part of a carry back as long as I guaranteed the note. By doing this I deferred the gain on the installment of the note. I’m using the 1031 cash to put down on a four-plex.
It is true that the profit on a rehab or other investment property held less than 12 months will be taxed as ordinary income. That is, your profit will be taxed at the same rate as your earned income.
However, only “investment” property held for more than 12 months qualifies for the capital gain tax rate of 10% or 20% depending upon your tax bracket. A rehab property that you purchase to resell for profit is not “investment” property. Instead, the IRS will classify this property as “dealer realty” or “inventory” and the profits will be taxed at your ordinary tax rate regardless of how long you actually held the property. That is why you so often see on this board the suggestion that your rehab and flip property should be purchased and sold through a C-Corp to take advantage of a more favorable tax rate.
The “rollover” exemption that deferred capital gains on the sale and replacement of your principal residence was repealed in 1997. This was replaced with the $250K/$500K exclusion if you satisfy the 2 of last 5 years ownership and use rules.
On the other hand, if you sell “investment” property (for example, your long term rental property) capital gains taxation on the profit can be deferred if you use a 1031 exchange to acquire a replacement investment property.
Suggest you consult a tax professional for guidance in your specific situation.
Any gain on a rehab or other investment property held less than 12 months will be taxed as ordinary income. That is, you’ll pay income taxes at your regular rate upon the gain.
If the property is held for more than 12 months, the capital gain is taxed at the capital gain tax rate of 20%.
The “rollover” exemption you refer to, rolling the gain into another property, applies only to the sale of your personal residence. If you own and occupy the property for 2 out of the last 5 years, there is no tax on the gain.
It’s highly unlikely that the 1031 rules will permit deferral of tax on a rehab. The 1031 exchange functions from “intent”. Assuming your “intent” was to buy, rehab, and resell…you would not qualify for a 1031 exchange.
I’d have your CPA recheck the 1031 rules. If audited and not found within the rules, you will incur penalties and interest on the unpaid tax…which could be significant.
Re: capital gains and tax advatages - Posted by Jim Holmes
Posted by Jim Holmes on March 05, 2000 at 23:56:08:
J,
This is a disconcerting post. Your the first person that told me this information. I did intend to rent the property, but once I looked at market value after remodeling I decided to flip it and put it up for sale. The 1031 was an afterthought before closing. Hmm. I’ll talk to my accountant. Thanks for the heads up.