Tax question re: rehabbing - Posted by JD in CO


#1

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,

John Hyre


#2

Tax question re: rehabbing - Posted by JD in CO

Posted by JD in CO on January 14, 1999 at 21:20:16:

I have talked to a couple agents about how I would be taxed if I rehab a house and I can’t get a straight answer. So, I’ll ask here.
If I buy a house for $50000, spend $3000 rehabbing and then resell it for $65000, am I taxed on $15000 or $12000?
Is it taxed as capital gains or regular income?
Does it matter how many I do a year?
Thanks in advance for any help. If you have anything else to add, positive or negative, about rehabbing, please let me know.
JD in CO


#3

Re: Tax question re: rehabbing - Posted by Dave T

Posted by Dave T on January 14, 1999 at 22:41:10:

Your profit on the deal is 12000 and is taxed as ordinary income. Capital gain limits usually don’t apply to flips because the holding period is less than 12 months.


#4

Re: Tax question re: rehabbing - Posted by PBoone

Posted by PBoone on January 14, 1999 at 22:00:00:

This is really a good reason to find a great accountant
You would be taxed on the 12,000. The percentage of tax paid will be dependent on you INTENT. You can do as many rehabs as you wish but after 3 it is possible to be considered a DEALER which means a complete loss of investor priviledges and there are many.
What we do is Rehabs are done by the CORPORATION 15% tax bracket on goods sold. Our rentals or ones we INTEND to hold go into the LLC 20% tax bracket on capital gains.
Pat


#5

Re: Tax question re: rehabbing - Posted by Laure

Posted by Laure on January 15, 1999 at 04:40:11:

Is your corp. a C or S ?? What percentage can the corp contribute to your IRA? You said the LLC is taxed 20%… do you have to hold the property for 2 years to get that rate?

Thanks,
Laure :slight_smile:


#6

Re:IRA question re: rehabbing - Posted by Bud Branstetter

Posted by Bud Branstetter on January 16, 1999 at 01:26:29:

The corporation can not contribute to your IRA. The Indivual retirement account is set up for earned income of an individual.

The corporation can have a pension plan that takes profits and defers it. The amount depends on the plan implemented. But generally it is more than an IRA.


#7

Re: Tax question re: rehabbing - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 15, 1999 at 11:21:15:

Laure,

To get 20% cap gains rate, you must hold for 18 months. Flips NEVER qualify for cap gains treatment- NOT EVEN the first 3 per year. It is the INTENT TO QUICKLY RESELL that makes the rehab “inventory” and therefore ineligible for capital gains treatment. Codeheads should refer to Section 1221(1).

Dunno the answer to your IRA question off the top of my head- maybe one of the pension/deferred comp people can give you a quick answer.

John Hyre


#8

Re: Tax question re: rehabbing - Posted by JPiper

Posted by JPiper on January 15, 1999 at 14:22:42:

The holding period was changed to 12 months from 18 months.

JPiper


#9

I looked it up… - Posted by JHyre in Ohio

Posted by JHyre in Ohio on January 15, 1999 at 14:37:29:

and you are of course correct. Good catch.


#10

Re: I looked it up… - Posted by Laure

Posted by Laure on January 15, 1999 at 18:48:34:

Ok, so let me get this straight. I but a property. Fix it up. Rent it. After I have owned it for a year, I only pay 20% tax on the gain when I sell?

Thanks “guys”,
Laure :slight_smile:


#11

Re: I looked it up… - Posted by Laure

Posted by Laure on January 15, 1999 at 18:50:06:

Also, is this only in a LLC? or is this outside of a LLC also?

thanks,
Laure :slight_smile: