Tax question for flip house with sweat equity partner

4 Replies

Hoping someone might be able to suggest ways to solve the following tax question:

My business partner and I have an LLC that we have bought a rental duplex, with the aim to buy several more. In order to build cash reserves for next rental down payment we are doing the flip strategy.

We closed on a single family property last November in the name of our LLC and we were intending to use a contractor for the carpentry. But my partner knew a guy who was interested in doing all the carpentry for "free" in return for a percentage of the profits after all rehab, carrying and closing costs were paid. It has worked out well as this builder does very high quality work and the property in is in a good neighborhood in a great market. We should come out with about $70-80k profit. However, our challenge now lies in how to to make sure we close on this properly so that we have the lowest tax burden possible - both my partner and I (in the LLC, as we build a reserve for more flip properties or rental properties) and our sweat equity partner (who really doesn't want to be paying income and self-employment tax, etc.)

1. Could we potentially roll this into a 1031 exchange (including our sweat equity partner rolling his share so that he isn't facing a large income tax on the work on this property)?

2. Could the profit be considered capital gains since the intent was for this to be an investment from the get-go?

3. Does anyone have any other ideas that might work well in this scenario?

Thanks!

Originally posted by @Shaun Wilson :
Hoping someone might be able to suggest ways to solve the following tax question:

My business partner and I have an LLC that we have bought a rental duplex, with the aim to buy several more. In order to build cash reserves for next rental down payment we are doing the flip strategy.

We closed on a single family property last November in the name of our LLC and we were intending to use a contractor for the carpentry. But my partner knew a guy who was interested in doing all the carpentry for "free" in return for a percentage of the profits after all rehab, carrying and closing costs were paid. It has worked out well as this builder does very high quality work and the property in is in a good neighborhood in a great market. We should come out with about $70-80k profit. However, our challenge now lies in how to to make sure we close on this properly so that we have the lowest tax burden possible - both my partner and I (in the LLC, as we build a reserve for more flip properties or rental properties) and our sweat equity partner (who really doesn't want to be paying income and self-employment tax, etc.) Look into Joint Venture Agreements. You can establish one with the contractor for each home, basically the same contract over and over and each one ends when the property sells. Talk to an attorney

1. Could we potentially roll this into a 1031 exchange (including our sweat equity partner rolling his share so that he isn't facing a large income tax on the work on this property)? Can't 1031 a flip

2. Could the profit be considered capital gains since the intent was for this to be an investment from the get-go? You said your intent was to flip, which will be ordinary income plus self employment tax

http://www.biggerpockets.com/forums/48/topics/47202-do-i-have-to-pay-self-employment-tax-on-flips-

3. Does anyone have any other ideas that might work well in this scenario? Like others, you work as 'ready, fire, aim' . Your best best is to talk to a CPA before acting, let them know what you plan to do and structure the business accordingly.

Thanks!

I'm not sure what you can do at this point, I am interested to see what others say.

Agree with @Bryan H. , no 1031 and no cap gains available. If your LC is taxed as a Sub S you can save some on the self employment taxes. Your equity contractor just needs to be paid, and 1099'd. He can't expect "tax free" earnings.

Hi Shawn,

I think as long as you are 'flipping', you will have to pay regular taxes.

As Bryan said, find a good real estate investment CPA. He can't do much for this deal, but he can guide you on how to structure future ventures.

One caveat of 1031 exchange is that the entity selling one property has to be the exact same entity buying the new property. You may need to rearrange the ownership before putting it on the market.

Best of luck,

Jim

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