Self employment or long term investment income
Rental Property Investor · Dayton, OH · Member since 2022 · 103 posts · 49 votes
Tax season! We bought a property in 2022, remodeled and sold it in 2023, over a year after the purchase. We did most of the rehab work ourselves. Will the profit be counted as self- employment income or long-term investment income? Thank you for your input!
@Michael Plaks We bought it with the intent of rehabbing and renting it out as a rental. Later on decided to sell it. Will that be considered as capital investment?
...We already sold it so the long term capital gains is what we strive for.
First, if you already sold it after 8 months, you cannot "strive" for anything. You have ordinary rates, not long-term capital gains, no matter what the next step is.
And the next step is to determine whether it was business income or short-term capital gains. It does not change your income tax rate, but it does determine whether you owe a 15% self-employment tax in addition to income tax.
And the answer is case-by-case, there is no universal criteria. Your stated intention of renting it can play a role in this determination. But before you rush your decision, you need to realize one critical distinction: treating this transaction as a business allows you to deduct all business expenses against this income. For example, driving. Treating it as a capital transaction does NOT allow it!
The result is that treating it as a business can result in less taxes, even with the SE tax added to the mix. Besides, depending on your other income - such as your W2 job if you have one - it may be less than 15%. As I said, it is case-by-case.
Hey @Robin Evans,
To answer your question in a sentence: This will be "long term" income.
Let's say you finish a house flipping project within a year. In this scenario, you're subject to ordinary income tax. Here's a breakdown:
Project Details:
For instance, if your regular income is $50K, and you add the $20K from the house flipping, your total income becomes $70K. This places you in the third tax bracket, with a 22% rate. Additionally, there's a fixed self-employment tax.
Income Tax: 22% * $70K = $15.4K Self-Employment Tax: 15.3% * $20K = $3.06K Total Tax Due: $18.46K
Remember to account for any state taxes as well.
To defer taxes entirely, you could utilize a 1031 exchange, which allows you to reinvest the proceeds from the sale into a similar investment property, thus deferring the tax payment until a later date.
Example #2: Long-Term Capital Gains
Now, consider a scenario where you hold onto the property for over a year.
Project Details:
Since self-employment tax doesn't apply, you only need to calculate the long-term capital gains tax. Assuming you're in a bracket with a 15% rate:
Long-Term Capital Gains Tax: 15% * $80K = $12K
For tax purposes, we want to either defer it via the 1031 or do the long term capital gains route whenever possible. Best of luck this tax season!
Tax season! We bought a property in 2022, remodeled and sold it in 2023, over a year after the purchase. We did most of the rehab work ourselves. Will the profit be counted as self- employment income or long-term investment income? Thank you for your input!
This question does not have a simple answer. The fact that you held it for longer than one year does NOT determine the tax treatment. It only matters as step 2, AFTER you already determined that it was a capital gains deal, as opposed to ordinary business profit.
Step 1: Business or capital investment? If business, then ordinary rates + SE tax, even if longer than 1 year.
Step 2: If capital investment, then more then 1 year or less than 1 year? Different rates apply, and no SE tax.
The answer to Step 1 is not simple. You have to weight different factors. Since you did extensive work yourself for several months, it's more likely that the answer would be regular business income. But it can go either way and requires a longer case-by-case discussion.
Hey @Robin Evans,
To answer your question in a sentence: This will be "long term" income.
Let's say you finish a house flipping project within a year. In this scenario, you're subject to ordinary income tax. Here's a breakdown:
Project Details:
For instance, if your regular income is $50K, and you add the $20K from the house flipping, your total income becomes $70K. This places you in the third tax bracket, with a 22% rate. Additionally, there's a fixed self-employment tax.
Income Tax: 22% * $70K = $15.4K Self-Employment Tax: 15.3% * $20K = $3.06K Total Tax Due: $18.46K
Remember to account for any state taxes as well.
To defer taxes entirely, you could utilize a 1031 exchange, which allows you to reinvest the proceeds from the sale into a similar investment property, thus deferring the tax payment until a later date.
Example #2: Long-Term Capital Gains
Now, consider a scenario where you hold onto the property for over a year.
Project Details:
Since self-employment tax doesn't apply, you only need to calculate the long-term capital gains tax. Assuming you're in a bracket with a 15% rate:
Long-Term Capital Gains Tax: 15% * $80K = $12K
For tax purposes, we want to either defer it via the 1031 or do the long term capital gains route whenever possible. Best of luck this tax season!
Thank you for your input! We already sold it so the long term capital gains is what we strive for.
@Michael Plaks We bought it with the intent of rehabing and renting it out as a rental. Later on decided to sell it. Will that be considered as capital investment? It's just hard to prove our intent with documentation. We do all the rehab ourselves for our rentals but that doesn't make the rental income business income, right? Thank you for your input!
Hey @Robin Evans,
To answer your question in a sentence: This will be "long term" income.
Let's say you finish a house flipping project within a year. In this scenario, you're subject to ordinary income tax. Here's a breakdown:
Project Details:
For instance, if your regular income is $50K, and you add the $20K from the house flipping, your total income becomes $70K. This places you in the third tax bracket, with a 22% rate. Additionally, there's a fixed self-employment tax.
Income Tax: 22% * $70K = $15.4K Self-Employment Tax: 15.3% * $20K = $3.06K Total Tax Due: $18.46K
Remember to account for any state taxes as well.
To defer taxes entirely, you could utilize a 1031 exchange, which allows you to reinvest the proceeds from the sale into a similar investment property, thus deferring the tax payment until a later date.
Example #2: Long-Term Capital Gains
Now, consider a scenario where you hold onto the property for over a year.
Project Details:
Since self-employment tax doesn't apply, you only need to calculate the long-term capital gains tax. Assuming you're in a bracket with a 15% rate:
Long-Term Capital Gains Tax: 15% * $80K = $12K
For tax purposes, we want to either defer it via the 1031 or do the long term capital gains route whenever possible. Best of luck this tax season!
Thank you for your input! We already sold it so the long term capital gains is what we strive for.
understood! Congrats on the sale
@Michael Plaks We bought it with the intent of rehabbing and renting it out as a rental. Later on decided to sell it. Will that be considered as capital investment?
...We already sold it so the long term capital gains is what we strive for.
First, if you already sold it after 8 months, you cannot "strive" for anything. You have ordinary rates, not long-term capital gains, no matter what the next step is.
And the next step is to determine whether it was business income or short-term capital gains. It does not change your income tax rate, but it does determine whether you owe a 15% self-employment tax in addition to income tax.
And the answer is case-by-case, there is no universal criteria. Your stated intention of renting it can play a role in this determination. But before you rush your decision, you need to realize one critical distinction: treating this transaction as a business allows you to deduct all business expenses against this income. For example, driving. Treating it as a capital transaction does NOT allow it!
The result is that treating it as a business can result in less taxes, even with the SE tax added to the mix. Besides, depending on your other income - such as your W2 job if you have one - it may be less than 15%. As I said, it is case-by-case.
@Michael Plaks thank you for your input! If we don't treat it as a business, can we still deduct all the rehab/holding cost other than the driving?
@Michael Plaks thank you for your input! If we don't treat it as a business, can we still deduct all the rehab/holding cost other than the driving?
Labor, materials, insurance, interest, local property taxes - yes. Other costs - need to examine item by item, and many will be subject to your accountant's interpretation.