How to I avoid paying so much on taxes on my first flip

Question

I have finally gotten my first property under contract and should close the end of the month or by mid Oct. It will take me less then a month, I hope and pray to rehab. The question I have is how to avoid paying the big chunk to Uncle Sam. Is 1031 exchanges even done if I only have the ownership for a short time? I know that I want to start the BRRR method but I was thinking maybe 1 or 2 more flips before I do. Thanks in advance for any advise.

Kyle J. · Answer

A typical flip (held primarily for resale) wouldn’t qualify for a 1031 exchange. Flips are generally taxed as ordinary income subject to self-employment taxes.

Congrats on getting your first property under contract though!

Dave Foster · Answer

@Stacey Vilardi, You've got a good game plan put together. However 1031 won't be available for you until you purchase a property with the intent of holding. Until then the properties you are buying primarily to resell will not qualify for 1031. So flip away if you're trying to build a war chest. And once you buy your first hold property that one will be eligible for a 1031 when you decide to sell.

But it might be worth your while to see how the numbers would run on a rent and refi of this first one. You may be too leveraged to get much bang from a rehab and refi. But it also might surprise you what you can get if you rehabbed it and rented it and then refi'd using your rental income in addition as a qualifier - especially if you factor in the massive taxes flipping gets you. That jump starts your Brrrr career and would also make that property qualify for 1031 in a a year or so.

Stacey Vilardi · Answer

That is excellent information Rob. I don't think I cam with this project but definitely think about it for future ones.

Rob Massopust · Answer

Hmm, that is the rub. That is the problem no one looks into that. I call it the 2 year flip. Always have a back up plan.

1031 you most likely want to hold for about 14 months, a 2 year timeframe on paper maybe not a full 2 years but has 2 year calendar dates. ie June 2019 to Nov 2020

If you can not rent out the property for 2 years thats tough. What about owner occupy, or family.

If you are a broker or real estate professional you can qualify to deduct passively up to $25k per year on RE activities.

https://loopholelewy.com/loopholelewy/01-tax-basics-for-startups/passive-activity-rules-01e-rental-real-estate.htm

Also depending on how much you make you can deduct alot of expenses, look at accelerated depreciation that might help.

You have to look at least a 1 year hold that will reduce you some and is the debt service more or less than the tax hit.

Stacey Vilardi · Answer

Thanks Jake

Jake Thomas · Answer

Flipping houses comes with a tax bill, no way around it. Make sure you account it for it with your final numbers. The TV shows always show how someone makes $100K on a flip but never talks about the almost 40% tax bill they will incur. Paying taxes is a sign you are doing well in you're well in your business. Maybe look into switching to an S Corp to save on your tax liabilities.

Stacey Vilardi · Answer

Hello Bob. It unfortunately is not an option with this particular property. It has to be owner occupied for 2 years before the association would even consider allowing you to rent. Then it is up to the board if they allow you to rent. Thanks for your input

Stacey Vilardi · Answer

Hello Dave. Thank you for the information. My game plan is exactly that. I think I will be able to start to buy and hold by next year. I intend to have 10 within 3 years in my portfolio. I went to the accountant today and I believe my business plan is within reach. I have my why and I am committed.

Bob Norton · Answer

@Stacey Vilardi You could consider renting your rehab for a period of time to reduce your taxes. If you rented the property after rehabbing it, then you would be considered a landlord instead of a dealer and save on SE taxes. If you sold the property after you owned it for 366 days, then you would only be taxed as long-term capital gains. Furthermore, if you rented it for a period of time, then you would most likely qualify for a 1031 exchange.

Stacey Vilardi · Answer

Thanks Wayne.

How to I avoid paying so much on taxes on my first flip

How to I avoid paying so much on taxes on my first flip

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