Tax-Free Profit? - Posted by T.B. Komatsu

Posted by Soapymac on January 25, 1999 at 06:25:55:

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Tax-Free Profit? - Posted by T.B. Komatsu

Posted by T.B. Komatsu on January 25, 1999 at 01:36:39:

Hello!

I was wondering, let`s say that you have purchased a distressed
property and want to act as the General Contractor.

You get your estimates from sub-contractors (carpet, roof, etc.)
then mark up their totals by 100% (your profit for acting as G.C.)
and go to the loan officer at your local bank.

The loan is approved and you walk away with a tidy tax-free profit?

Is this legal?

Thanks and I look forward to your answer!

Re: Tax-Free Profit? - Posted by Baltimore BirdDog

Posted by Baltimore BirdDog on January 28, 1999 at 11:40:18:

T.B.-

All you are talking about is using G.C. estimates to take out a rehab loan against the equity in a property, doing the work yourself (or hiring subs) and taking the difference between the loan amount and the cost of your subs as profit for your time and effort. I don’t know if 100% is a reasonable markup, but it is legal and tax-free because it’s borrowed money. Russ Whitney got his start this way and describes it in his book, “Building Wealth.”

If you’re considering rehabs, however, may I suggest another track? Personally, I don’t have the course yet (shame on me!), but I’ve heard nothing but good about Ron LeGrand’s rehab course. Check him out on this site. When borrowing money, rather than going to a bank, you probably want to find a hard money lender in your area that will loan you money based on the “subject to” or after-repaired appraised value of the house. While these loans are expensive, they sure beat giving a money partner 50% or more of the deal. With the proceeds, you can buy the house and fix it up. Just be sure to get good estimates for repair costs and after-repaired market value (btw, the hard money lender will probably have a feasibility consultant who estimates these for a few hundred bucks, or for market value, have a Realtor friend do comps and, for repair estimates, find a handyman or contractor (possibly retired?) who will inspect the property with you for a small fee after you tie it up with an offer to purchase.

Finally, if you have no experience in rehab and want to learn the R/E ropes first, check out Jackie Lange’s articles and try flipping properties. Even LeGrand recommends not rehabbing or landlording for the first year in the biz. Hope this helps!

-Jeremy

Re: Tax-Free Profit? - Posted by Dave T

Posted by Dave T on January 25, 1999 at 19:42:41:

I am not sure what your real question is. The posts below answered from a GC perspective, let me answer from the tax perspective.

You asked if the GC fee you would add on to your rehab subcontractor’s estimates is tax free. Remember that no business profit is tax free. If you are a general contractor by trade and file a business tax return, then your GC fee is taxable income to your business.

If you are not a GC by trade, and you wish to act as your own GC for a rehab you purchase, then the difference between the bank loan and the purchase price is your rehab fund. After you pay your subs, anything left over is your “fee”. Since this is borrowed money, and eventually has to be paid back with interest, it is not taxable income to you.

It is however, a portion of the equity in the home you rehabbed. When you eventually sell that home, any profit you get from the sale will be taxable.

Hope this answers the rest of the question.

Let Me Rephrase that… - Posted by T.B. Komatsu

Posted by T.B. Komatsu on January 25, 1999 at 17:56:49:

First, a BIG thanks to those of you who took the time to read and answer my question.:slight_smile:

I left out the most important fact, and that is that I would, before the purchase of the home, set up a company that would act as General Manager and Property Manager (that would be me). All subs would be paid in full and, as a legitimate G.M. and Property Manager, I would see to those duties diligently.

I guess my question really then is, would the bankers frown upon a R.E. investor who acts as his own G.M. and Property Manager?

Thanks again to everyone!

Re: Tax-Free Profit? or pay to the GC! - Posted by Doris - Va.

Posted by Doris - Va. on January 25, 1999 at 17:16:13:

I think we must have read the same R.E book.

The question is - do you hire a Gen. Contractor to
rehab your property? He will get estimates from
his subcontractors - total it up and add on a
healthy profit (maybe not 100%) on top as his
profit (read: his paycheck). Certainly the thought
would come to our entreprenurial (sp?) minds that
perhaps we should be the Gen. Contractor. Maybe to
make it more “legit” we should even set up a
separate company to do the rehabs. Therefore when
we get those estimates from our subcontractors or
"handypersons" - we can add that profit to the
total estimate we will submit to the bank for the
rrehab loan. So - either way - what is the
difference as long as the numbers are reasonable.
Besides you can get a contractor’s discount for
materials too. That way the profit stays with you.

Of course if you are looking to rip-off the bank
and pocket the money - baddddd! But- I didn’t read
that into your post.

I see nothing wrong with setting up side businesses
like rehabbing and property management which can
handle your own properties and take on other’s work
as well.

Just my opinion. Best wishes - Doris -Va.

Re: Tax-Free Profit? - Posted by Tim Pannabecker

Posted by Tim Pannabecker on January 25, 1999 at 07:28:28:

K.B.

I am not quite sure what your question is… But, getting a loan on property is a good way to free your equity without triggering a taxable event. However, just “walking away with a tidy tax-free profit” is a fraud, a fellony, and Baaad business (needlesss to say you won’t get another loan from that bank). If you meant walking away with a tidy profit to your local property management company that is gooood. Like Soapy Mac said if you buy right (the first rule of rehab) you may be able to get a “hard money” or equity based loan. These loans do not even consider the bids nor your credit or income. And you can have as many of this type of loan as you want (fannie/freddie loans have limits on the amount of loans one can have).

Best of ethically business to you,

Tim

TINSTAAFL… - Posted by Soapymac

Posted by Soapymac on January 25, 1999 at 06:23:48:

That Depends…on how dumb the banker is…and how much you can get for the house.

Your subcontractors will automatically put mechanic’s leins on the house if you do not pay them. When you do pay them, have them sign a lein release.

Whether or not the banker will go for it is something else again. On what basis is he making the loan to you? Your credit…or the value of the home?

Will the value of the home…when rehabbed…support the cost of your loan PLUS what you paid for the house? The banker is going to look for some security somewhere along the line. And When you sell the house, and pay back the loan, you are paying the money back, anyway.

Tax free money? Maybe. Just remember…

(TINSTAAFL) “There Is No Such Thing As A Free Lunch”

Cordially,

Roy MacLean
"Soapymac"
If you want to contact me, take the word “nospam” out of my e-mail address.

TINSTAAFL… - Posted by Soapymac

Posted by Soapymac on January 25, 1999 at 06:20:59:

That Depends…on how dumb the banker is…and how much you can get for the house.

Your subcontractors will automatically put mechanic’s leins on the house if you do not pay them. When you do pay them, have them sign a lein release.

Whethter or not the banker will go for it is something else again. On what basis is he making the loan to you? Your credit…or the value of the home?

Will the value of the home…when rehabbed…support the cost of your loan PLUS what you paid for the house? The banker is going to look for some security somewhere along the line.

Tax free money? Maybe. Just remember…

TINSTAAFL) “There Is No Such Thing As A Free Lunch”

Cordially,

Roy MacLean
"Soapymac"
If you want to contact me, take the word “nospam” out of my e-mail address.

Thanks Jeremy! - Posted by T.B.

Posted by T.B. on January 28, 1999 at 22:25:55:

Thanks!

Re: Let Me Rephrase that… - Posted by Doris -Va.

Posted by Doris -Va. on January 25, 1999 at 18:25:34:

That sounds much better!!!

Seems to me I read that if you apply for a loan specifically for rehab. work - the bank wants to see the estimates from the subs but only a total estimate if from a real Gen. Contractor. The want to pay the check to the G. C. - not to you.

If you are the Gen Contractor - you will get the check but they usually hold back 10% until they get a sign-off from the subs that they have been paid in full. If you act as your own G.C. they might want to see your subs estimates - which would make it difficult to add on a G.C. profit but if you are set up as a separate company, they might only want the total estimate for the work.

Of course this depends on the banker and your relationship with him. I think you have a good idea there.

Best wishes = Doris -Va.