What happens when buy & hold becomes a flip?

Question

We purchased a house last week that we intend to rehab and then rent. However, if someone wants to buy it before we get it rented, we are not averse to making a quick chunk of cash. So what are the tax consequences of selling a property less than 1 year after purchase?

The property is owned by an LLC,(not S-corp) and the sole members are Hubby and me.

Sylvia B. · Answer

I intend to! :-D

I have an appointment with my accountant on Thursday, and this is one of the things I want to discuss with her. I just wanted to see what the BP group had to say.

J Scott · Answer

I'm not a tax professional, but this is my interpretation based on discussions with my CPA and discussions we've had here on BP...

Intent is key in this situation.  If you intended to flip it (regardless of whether you did or not), you're going to pay ordinary income taxes.  If you intended to rent it out (regardless of whether you did or not), you could pay capital gains (short or long-term, depending on hold time).

In theory, if your sincere intent was to hold it as a rental, and then you flipped it instead, you *MIGHT* be able to convince the IRS of that and pay short-term capital gains instead of ordinary income taxes.  That said, you may find it difficult to convince the IRS that was the case unless you actually took steps to turn it into a rental (advertised for tenants, took applications, etc).

It's probably worth getting the opinion of a tax professional.  While you might get away with paying capital gains, it may also increase your risk of audit, which may not be worth the trade-off.

Again, I'm NOT a tax professional, so get professional verification of everything I'm saying before you listen to me...  :)

Sylvia B. · Answer

That would probably be counter-productive in our case. Normally this LLC has only passive income - rents. All income passes straight through to our personal 1040, and moving money in and out is simple.

Our other LLC is an S-corp, which is our retail business. This one makes most of our income, but getting money out of it is a little more difficult. First, it rents the building it's in from our property LLC. In addition, we draw out equity distributions in an amount equal to what we pay ourselves as employees. That last amount is subject to SSDI & unemployment taxes. That can be both costly and time consuming.

I think the way we have things set up is avoiding the most taxes possible at this time, but if you have suggestions I'd love to hear them.

Patrick T. · Answer

Hi @Sylvia B. It sounds like you know what sub-s is.  So you probably understand that if you changed your LLC election to sub-s (which can be done) you could avoid some taxes.  That could be a long discussion, but it is an option.

Sylvia B. · Answer

Okay, any other issues?

Alan Russell · Answer

If you own the property for less than one year it is taxed as regular income instead of as capital gains.