I own a real estate flipping business, so all of my profits are taxed as ordinary income (and at a high rate). I thought it could be beneficial if I bought a mixed use property and rented the commercial space to my flipping business as office space. I am in the SF Bay Area so costs are high. Could this be a feasible way to find a way to buy a primary residence and decrease my tax liability by charging myself a fair market value for the commercial space, thereby converting my profits into equity in the mixed use building instead of having to pay high capital gains taxes?
Is anyone familiar with the pro's and con's of this sort of a strategy? Or any pitfalls I might be missing while this is in a very early stage of an idea?
just to be clear when you say use this as a way to buy a primary residence are you referring more to saving money in taxation or using this commercial property as your residence as well? if the later, that's not going to be kosher.
as a fellow bay area resident I feel your pain. have you considered moving from flips to BRRR -- if you hold the property for at least 1 year then you will be taxed via long-term capital gains. so basically you rent the place out for a year after the rehab, collect the rent and then sell. but since you've refinanced after the rehab you get much of your money back out. then you can 1031 exchange the purchase of your next property and defer the gains...
I'm no CPA, but if you're interested in doing projects that involve longer holding periods and it's your primary form of income you may be eligible for real estate professional status which has huge tax benefits
You can rent property to a business you own from a different business you own but I'm not sure if there would be any real tax savings as you'd probably just be moving funds from one balance sheet to another.
Why not? I'd just make sure you charge market rate I guess. If you can use >50% of the building, you should apply for a SBA loan.
@Matthew Bailey Yes, you can rent the commercial space to your flipping entity for office space and reduce your overall tax rate (by converting active income to passive rental income).
I’m not a CPA but I have seen many tax returns of my clients whose businesses that they own themselves through an entity (corporations/ partnerships etc) pay rent to another property that the client owns.
@Matthew Bailey I wanted to chime in and agree with what has been said. I have seen a lot of my clients (SBA lending) do this with great success. It's actually a great way to get into real estate and grow your wealth as a self employed individual. Basically, business owners buy a property with an SBA loan since they can do it with very low money down (10% or even less, depending on the situation/business) and then once in the property they fix it up (with SBA loan money) and then in a few years, they refi with conventional financing, which frees up your SBA maximum loan limit to be used on another property. I don't know the tax implications, but I do know it can definitely be done while creating tremendous wealth.
Thanks so much to everyone who chimed in!
@Bob Norton thanks for your insight! I’d envision it would work like this: A 770sqft office space rents for $2,700/month in my area, that’s $34,000/year. Therefore 34k of my flipping business’ profit could be written down as rent so instead of being taxed at the highest tax bracket I can then apply rental deductions like insurance, mortgage interest, landscaping/cleaning costs, property taxes etc. That also should allow me to get $250k capital gains on the property tax free because I live in it.
If anyone can gut check that I’d appreciate it. I fully understand nobody is acting as a CPA or attorney, I will of course do due diligence and hire those people before jumping in. But this seems feasible to me? Anyone see any holes? Or more advantages I’m missing?
@Joshua Nackenson to be clear this isn’t a commercial property, it’s a mixed use property. Partial commercial, partial residential. Much like 514 S Murphy Ave, Sunnyvale, CA. You can look that up, see the law office in front, the residential in back. (There’s actually two residential units in the back)
Assumptions: I would charge market rent. Split my insurance/property taxes/interest deductions appropriately for the split of the property.
Just double check that your setup doesn’t qualify as a self-rental— or whatever the specific term is...
I get the specifics confused... basically, if your rent a property to yourself, the irs considers the income as active while your rental deductions as passive, so you can’t offset each other since in different buckets.
But, maybe if you use two different entities or if you are just one of the tenants it’s okay..
Like I said, I do get a bit confused on the specifics. If I find them I’ll let you know
First, If you have not incorporated your flipping business, you need to look into that immediately. Becoming an S-corp will save you thousands of dollars in self employment tax. I highly recommend 'The Tax and Legal Playbook' by Mark Kohler. (no affiliation) If saving taxes is your goal, that will be huge, but its also a very good investment to own the property and rent it to yourself and others. This is usually done as an investment on the personal side, while your business (preferably an S-corp) pays rent to you. Your tenants also pay rent to you, not your business. This is income is then reported on the K-1 as a long term investment.
I would recommend investing in RE syndications. With the cost segs and bonus depreciation they take advantage of, you will receive massive negative K1's. I have had great success with Ashcroft Capital. The -K1's have been a game changer for us.