getting paid and avoiding taxes

13 Replies

I have been reading alot about taxes and 1031s but i never seem to see anything on how you pay yourself without having to pay the higher tax rates for gains and profits. My thoughts are that you can pay yourself off of the profits of a flip and invest the rest into the next one as a 1031 to keep business rolling. Is this what everybody does? Am I just asking the obvious? Or is there something that I am missing? Is there a podcast that would speak to this subject?

Im not an expert, but in a 1031, the profits must be transfered to another project of like kind within a 3 month period.

So you are not getting paid in a 1031.

Someone with more experience Ims sure while chime in.

Profit from a flip is taxed as ordinary income, including SS/Med, period. No way to change it. The only option I know of is of your entity is taxed as a sub S corp., pay yourself a reasonable salary, say $40-50k, taxed as payroll, and any profits above that would be taxed as ordinary income, but without SS/Med. A 1031 can't be applied to a flip.

I don't know that a "flip" as commonly understood, could ever be subject to a 1031 exchange.

A 1031 exchange has a number of rules. One is intent to hold. Flippers pretty much by definition have no intent to hold, IMO.

Another is the qualified use test. As I understand it, the guidance is that you need to have held the property for 2 years.

Flipping is (hopefully, if you think about it) not about capital gains at all. You don't want to be holding long enough to qualify. Flipping is essentially a job, leading to ordinary taxable income.

The good news on the SS is that if you have a job and then flip a house or two, you can get above the maximum withholding pretty easily. When that happens, you will get a refund of the excess SS tax paid.

So you cannot roll profits from a flip into a hold via 1031?

Originally posted by @Drew Poniewaz :
I have been reading alot about taxes and 1031s but i never seem to see anything on how you pay yourself without having to pay the higher tax rates for gains and profits. My thoughts are that you can pay yourself off of the profits of a flip and invest the rest into the next one as a 1031 to keep business rolling. Is this what everybody does? Am I just asking the obvious? Or is there something that I am missing? Is there a podcast that would speak to this subject?

There are very few ways to make money without paying taxes. 1031 just defers tax payment (which is very nice, but not tax-free). The business of flipping is not tax advantaged at all - if you're looking for tax advantage, then you probably want to look at buy and hold (passive income properties) or notes. One way you can "get paid" tax free with rental properties is by adding significant value then doing a cash-out refinance. If you buy for $100K and put $25K into a property and it's now worth $200K, you should be able to borrow between $150K and $160K. This will effectively make you $25-$35K and allow you to keep the property and rent it out. There is no tax on the additional money you borrow because it is a loan, not income/gain. The downside is that your cost basis is $125K so if/when you do sell, you may have to pay taxes on more money than what you receive from the sale (it should be LTCG though which is pretty low comparatively speaking).

Originally posted by @Terry Royce :
So you cannot roll profits from a flip into a hold via 1031?

That is correct - as @Richard C. pointed out, flipping is not in the same investment family as buy and hold. 1031 can only be used property where the intent is to hold long term (even holding onto a flip for 2 years will not help you unless you've converted to a rental).

Originally posted by @Terry Royce :
So you cannot roll profits from a flip into a hold via 1031?

You should talk to a tax lawyer or CPA of course. But I don't think so. Unless you owned the flip for a long time before flipping it. If you buy a place, fix it up in a few weeks/months, and sell it, that's inventory.

Originally posted by @Richard C. :
Originally posted by @Terry Royce :
So you cannot roll profits from a flip into a hold via 1031?

You should talk to a tax lawyer or CPA of course. But I don't think so. Unless you owned the flip for a long time before flipping it. If you buy a place, fix it up in a few weeks/months, and sell it, that's inventory.

Even if you do this and sell after 366 days or 700 days, it's still considered inventory. Profits will get taxed as LTCG (congrats you get a discount for taking WAY too long to flip it) but you will not be able to do a 1031 exchange.

Michael clearly knows this stuff and I encourage you to listen to him.

Here's how I look at rules and regulations, generally. If you want to have a general idea (not something you can go to the bank or court with, but a general idea) of whether what you are doing is OK or not, do this: Consider the intent of the rule.

Simplifying a bit, I would say the intent of Section 1031 is to treat the multiple, sequentially held properties as one "investment." To recognize that just because you switched from one property of a particular type to another property of a particular type, you have not ceased your investment activity and actually realized your gain.

Flipping doesn't qualify.

Again, if Michael says I'm crazy, listen to him. But that's how I look at it.

The requirement in a 1031 Exchange is to have the intent to hold for rental, investment or business use. Acquiring property to rehab and then sell or flip is actually holding property for sale (i.e. inventory in your real estate business) and does not qualify for 1031 Exchange treatment.

There are lots of opinions out there regarding holding periods. The Treasury Regulations do not have any requirement to hold for any specific time period. The Treasury Regulations only say that you must have the intent to hold for rental or investment. Holding for 12 months or 24 months certainly helps support your contention that you had the intent to hold, but if the auditor can show that you always had the intent to flip all along, then they holding period will not matter.

If avoiding taxes is what you are getting at, an LLC will require you to pay an additional 15% employment tax. In order to get around that, get an LLC and request an S-Corp Status its a 2553 form. You must file it before the first two months and fifteen days of the beginning of the tax year in which the election is to take effect.

The allows your business to function as an LLC legally however be taxed like an S-Corp. Check SBA.GOV and your local tax laws… Hope this is helpful

Craig

Thank you all, everything was very helpful.

The main question I had was how I would be taxed on a flip. (which I did not do that great of job conveying). I was thinking that if I profited from a flip that it would be considered more than just ordinary income.

My intent is not to avoid taxes just not to pay more than I have to.

The nice thing about business taxes vs personal taxes is that you pay personal tax when you receive the income. In a business, you make the money and then pay the tax AFTER deductions. A good accountant that knows the business can help you shelter it with deductions. You can also 1031 the profits as mentioned above.

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