Posted by JHyre in Ohio on January 16, 1999 at 07:43:29:
It depends. If your rehab houses are considered “inventory”, then you pay ordinary income rates no matter how long you hold them. If you are holding for investment, you pay the 20% rate after one year. Whether you are a dealer or an investor is a fairly subjective determination & depends on your individual “facts & circumstances”- which is why a professional generally needs to be consulted. Basically, if your business is the selling of rehabs, you are a dealer for income tax purposes. The number sold per year can hurt but never help you. That is, if you sell more than x-number of houses (some say 3), then you will be classified as a dealer. If you sell less than x, you may still be a dealer. To be a credible investor, I would hold my properties for at LEAST 2 years- that is not an IRS rule, just my personal gut feeling.
The reason corporations are useful for flips is: The ordinary income tax rate for corps with< $50k income is 15%, while most ordinary income rates (e.g.- your personal rate) are higher. If you immediately reinvest the after-tax proceeds, the corporation is more tax-efficient on a present-value basis EVEN IF you are eventually double-taxed (on the eventual distribution to shareholders). If you use strategies such as those hinted at by Kiyosaki or more fully explained in Bronchick’s books, you may even legally avoid (NOT illegally evade) double-taxation, making the corporation that much more efficient. You also have control over the amount of employment taxes paid, because you have a degree of control over the salary paid.
If, on the other hand, you are an investor, capital gains rates apply. C-corporations are generally no good then because they DO NOT GET THE PREFERENTIAL CAPITAL GAINS RATE- they pay the same ordinary rate and may be eventually double-taxed. Even though the 15% rate is slightly better than the 20% cap gains rate, the difference is not large enough to make use of a corporation worthwhile. A pass-through entity is a better tool for MOST invstors (that individual facts & circumstances thing again) because any income is passed through and taxed at the favorable cap gains rate. Also, passive investments are much less vulnerable to (self) employment taxes than are active investments, so you are less likely to need protection of c-corp against such taxes.
My explanation may have confused you more than it helped. If that is the case, send me your e-mail and I can send an Excel spreadsheet that demonstrates this theory with any numbers that you care to plug in. It’ll take a week, because I need to modify it for general use. I used it to figure out the best entity for Lonnie Deals.
Hope this helps,