need a solution rehab tax problem - Posted by patrick

Posted by JHyre in Ohio on March 02, 1999 at 07:15:41:

JPipers “quitclaim” solution strikes me as workable. There is still some small risk of reclassification as wage income, but good documentation should minimize that risk (e.g.- transfer made in exchange for liquidity of the note, NOT to compensate you…). Distribution from the corp is then dividend, not wage, income. If you intend to immediately distribute, use S-Corp, pay yourself a small (but “reasonable”!) salary and distribute the remainder subject to one (not two!) level(s) of tax and avoid most of employment tax bite.

John Hyre

need a solution rehab tax problem - Posted by patrick

Posted by patrick on March 01, 1999 at 13:50:51:

Recently bought a rehab unit together with another investor via his corpation which I am not a part of, we fixed it up cosmetically to resell or flip. the profit we expect to be about 22k which will stay in his corporation until I recieve my 1/2.

The question is, what is the best way to receive it as to protect myself from capital gain and keep as much as I can?

Any help will be appreciated
my email is:

Re: need a solution rehab tax problem - Posted by JPiper

Posted by JPiper on March 01, 1999 at 18:44:34:

I’ll look forward to an answer to this one along with you. However I can’t resist giving an opinion…keep in mind I’m not a tax expert.

In my view, the bad news is that since you receive your money from the corporation, that it will be taxed as ordinary income…and therefore not only subject to ordinary income rates, but also subject to self-employment taxes.

If the money were left in the corporation, then it would be subject to corporate taxes, which could be lower than individual taxes, depending on the rest of the corporation’s income. Also, as long as it’s in the corporation it would not be subject to self-employment taxes.

However you don’t own a part of the corporation. One possible solution to this might be to form your own corporation, have your partner’s corporation quit claim an interest in the property comensurate with your % interest, and at the same time execute a note back to corporation for the cash that the corporation has already spent on the property…due upon sale of the property.

Now your proceeds of the sale would come to your corporation. If you pay it out to yourself, you still experience the same consequences as above. But if you hold the money in the corporation it would be subject to a lower tax, and you may have write-offs to use to offset against the income at the corporate level.

In no case are the proceeds of the sale going to be treated on a long term capital gain basis unless your holding period is longer than 12 months.

The other factor to consider is whether the cost of incorporation will exceed the possible tax savings. That’s going to depend on who incorporates you, and your state filing fees.


Thanx J Piper - Posted by Patrick

Posted by Patrick on March 02, 1999 at 13:39:18:

Thank you J Piper for your thoughful insight. it is much appreciated.


Re: need a solution rehab tax problem - Posted by JHyre in Ohio

Posted by JHyre in Ohio on March 02, 1999 at 07:04:13:

Ick! Since you are flipping, no way you get cap gains rates.

Getting the cash to you would have been simpler had you owned 1/2 of corp up-front. Getting money out of someone else’s corp is more complicated than getting it out of your own. If the corp makes a payment to you for your services, you get a Form 1099 and ordinary income subject to (self) employment taxes. If you owned part of the corp, you would receive dividends. Dividends are ordinary income but NOT subject to employment taxes (dividends are NOT wage income in most cases), so that would have been more efficient than your current situation.

The current problem is GETTING an interest in the corporation so that a dividend distribution can be made. If you receive stock for your services, the stock will be treated as wage income to you- putting you back into ordinary taxes rates and employment taxes. You could pay a nominal amount for a half-interest in the corp and than distribute. In form, this is correct, but upon audit, the IRS would look to the substance of what was done and recharacterize the dividend payment as wage income- IF you are audited and IF the auditor is quick enough to catch what was done. I cannot encourage you to play the audit lottery- the choice is yours. Other solutions (e.g.- IRC 368 tax-free reorg for Codeheads) are not worth the complication and expense. You could have the corporation loan you the proceeds and ratably forgive the amount over time- this option would have to be carefully structured and is probably not worth the expense of involving a professional. The tax on such a payment stream would be deferred in manner similar to an installment sale. If you trust your buddy, let him keep proceeds from this one and you get made whole + interest on the next deal AFTER you have gotten a piece of the corp, formed a new one, etc.

By the way, corporations are useful tools for flipping businesses IF the funds are reinvested in the corp at a high rate of return and distributions are made far into the fututre or done via certian limited loopholes (e.g.- loans, certain fringe benefits). If you flip properties but immediately distribute proceeds, corporations are no better than- and often worse than- LLC’s or S-Corps. The advantage of corp is primarily from a combination of low bracket (15% for first $50k) and present value of deferring distribution.

NOTE: Codeheads- Congress is contemplating providing S-Corps with same benefits with respect to fringe benefits as are currently enjoyed exclusively by C-Corps. I’ll keep you posted.

John Hyre