Capital Gain & Adding a Tax Specialist and Lawyer to the team

9 Replies

I have an LLC that will be doing an all cash purchase of a 3 br 1 bath SFH. We are going to be fronting the cost to acquire the property but the GC that I have used for several years is going to cover the cost for rehab. Then we're going to split the profits on the sale of this flip 50/50 (Purchase in Nov 2020 and List in March or April 2021).

I've never done a flip, which is why doing this deal makes a bit more sense because he has experience flipping and I'm investing out of state (technically, I'm out of the country right now).

My main obstacle at the moment is how to factor in capital gains taxes. There are 4 investors in this LLC and the property is being purchased by the LLC so I'm assuming that we'll have 100% of the tax burden and the GC won't have any. Is that correct? How would you all structure the dividing of profits after sale without knowing what the capital gains implications are?

Last thing, we're small and just getting started. We've decided it's time for a tax specialist and lawyer to join the team. How do you all factor those team members in from an expense point of view? What's a good price? Any recommendations?

Thanks,

Josh
 

1) flip profits are not capital gains, they are ordinary income

2) of course the contractor pays taxes on his share of profits, since the llc won’t be keeping them, everyone else pays on their individual profit realized. 

Hi Wayne, thanks for the clarification on that part. 

Regarding the GC, I think on paper it's going to look like it's all us because we're going to have a separate contract or side deal with him. When the property is purchased and sold, it'll be done so by our LLC.

In our case, non of us are taking the profit as income but rather rolling it into the next deal so do you know how better that would work?

@Joshua Sokolow

As its been stated, flip profit is active income subject to self employment taxes.  The IRS considers it that you've sold a piece of "inventory" as opposed to an investment property.  This is why some people don't consider flipping is investing.

If you've been doing your own rentals, flipping isn't much different. You just cutout the whole landlord part :)

Meanwhile, you've got it all hosed up:

First, you really should be doing your short term investments separately from your long term investments entity-wise because of liability partitioning.  Consult your qualified professionals.

If you really are going to be splitting the profits with the GC, then you need to form an entity with him. Even if you want to use your current LLC (call it Sokolow LLC), then make a Flip LLC with Sokolow LLC as one member and the GC as another member (it doesn't matter whether he uses his personal name, his gC compnay, or he makes another). Then, your operating agreement will spell out his cut (personally think 50/50 even if his rehab profit is included in this as it should be). Thus, the profits are nicely, cleanly divided. I'm sure you've been experiencing this with your current investments with the 4 of you investors.

As for the qualified professionals...  They shouldn't be working for a cut of the deal.  They are just expenses, and should be expensed accordingly to your entity.

So, wait, you've been doing your own investments without any professional assistance?  I'm not an accountant or a lawyer, but direct message if you want to chat.  I'd be happy to chat to give you some more info so that you can be better informed when you do speak with some qualified professionals.

Good luck.

Thank you to both Bob and David for your replies. It's really helpful to see several perspectives here.

Yes, across 3 properties, we've been doing our own accounting/taxes, but each property we add and certainly as more investors come on, the more complex and complicated it's become.

@Joshua Sokolow

Well, be careful how/when you add investors. This is how multi-layered LLC's (not Series LLC) can be important. Like what I described above with the GC... Instead, each of you might have your own LLC. You create a LLC as your purchase a property to hold Title -- easy way is to name the LLC the street address. Then, each of your individual LLC's is a member of the LLC holding Title. Each Operating Agreement can be customized, if necessary, for the deal. If additional investors come along, they can be included in future deals per LLC. Of course, consult some professionals about this. I have no idea where you are investing and especially as an expat if there are other issues.

Also, check out what happens when you have "too many investors."  I've read posts on BP about this sort of thing becoming a syndication, a fund, etc. which is all regulated by the SEC.  Not trying to fear monger, but something to make you aware or you should run the question by your pending qualified professionals.  In my case, I don't have any other investors so nothing with which I am personally experienced.

Good luck.

Local laws apply, so what works might change on where you are doing this.

Flipping is taxed as a dealer, as stated above, but is ultimately irrelevant. 

Payment to the GC is an expense, like paying commission to a RE Agent for sale of the property, so has no effect on the LLC's "profit". You should properly define "net profit" to get all expenses of "buying", "holding", and "selling" deducted from the contract price.

The real danger is papering the agreement between the LLC and the GC. What happens if the GC fails to perform? Runs out of money? Hides defects that the future buyer sues on later? Your construction contract w/ the GC needs to be comprehensive because ambiguity favors the GC.

@Joshua Sokolow

As others have mentioned - flips do not generate capital gain income, it generates ordinary income.

Regarding how the income is split - how has the GC agreed to be paid? Is he being paid a fee for his work? or is he getting a percentage of the profits from the sale.

Thanks for the advice everyone. My partners and I have a better idea of how to move forward.

Basit, it's going to be a 50/50 profit split.


I really appreciate all of your time in replying to my post! - Josh