1031 flips? and business structure

9 Replies

Hello BP! 

Two questions: can you 1031 a house that you have flipped into your next flip?

and also what business structure is best for someone who plans to do a few flips to build capital for B/H MFR properties?

I know LLC is the automatic answer, but why do people not use S or C corp? would they not provide lots of opportunities for tax deductions that an LLC cannot provide?

Thank you for any insight.

Also, if there are any helpful articles directly related to the subject please point me towards them! 

No.  1031 is only applicable to investments, not inventory.  Houses you own while fix and flipping them are inventory, not investments.

An S-corp or a LLC taxed as an s-corp is the best bet for fix and flipping. Maybe. It provides no deductions you can't take as just an LLC or sole proprietorship. What it does is allow you to take out some of the profits as distributions. Normally all profit from fix and flipping is ordinary income and so is subject to self employment tax. That's both halves of medicare and social security. If you make enough profits to pay yourself a "reasonable salary" you can have the s-corp distribute some of the profits as salary (subject to SET) and some as distributions (not subject to SET, though its still subject to ordinary income taxes.) So, if you have enough income from the fix and flips to exceed an "reasonable salary", then you may have some savings.

That assumes you don't have a day job.  If you do and the day job maxes out the social security income, then your flips won't generate social security tax.  Medicare is unlimited, but is the small piece of SET.

A C-corp is very unlikely to have any benefits and probably has significant negative implications.  A C-corp pays corporate tax on its income.  Then it distributed dividends to its shareholders.  When then pay tax on the dividends.  A C-corp can deduct certain fringe benefits (health, dental, some others) that others can't.  But unless your operation is quite large this probably won't offset the double taxation.

@Jon Holdman Thank you for the feedback! Ive seen the question on here in other posts but not towards flipping. So an LLC being taxed as an S Corp should work fine for flipping and the same LLC could do B/H's?

And also ONE other question, what version of quickbooks is best for real estate investors in both flipping and B/H?

I don't use quickbooks.

The real purpose of LLC's is asset protection. Unless you elect special tax treatment they have absolutely zero effect on taxes. If you are going to be generating a significant amount of revenue from fix and flips, doing it in a s-corp or LLC taxed as an s-corp might be beneficial. Realize you are not going to get away with paying yourself a $1 salary. So, if you're only making, say, $20K on fix and flips, a s-corp won't really help.

If you get to doing buy and hold you would want a different LLC because the s-corp doesn't help buy and hold at all.

Keep in mind that LLC's cannot get 30 year fixed rate loans. Only individuals. So, even if you want to hold your rentals in LLCs is likely you'll want the 30 year fixed rate loan more and you'll end up buying them in your own name.

If you want good tax and asset protection advice you need to find a good accountant (taxes) and attorney (asset protection) who you can discuss your personal situation and the deals you want to do with.

The rental Industry uses Schedule E.  

You get into C Corporations or S Corporations or even an LLC, and you pay big bucks in taxes, not to mention Attorney Fees.

If you are an C or S Corp, you can bet the eyes of the IRS will be watching you like a hawk.  And that is why you will need to have top notch attorneys to keep you out of trouble.

LLC's are for actually Landlords who are worth over a million dollars, maybe even more.

I don't know if this helps, but there it is. 

For you I would recommend Premier because of it's Inventory feature. Real Estate Brokers like to put their foreclosures in Inventory, using the build feature to keep track of their expenses and then doing a  COGS (Cost of Goods Sold) when they flip it.

I'm not an expert on Flipping but have worked with some Brokers, so I recommend Premier for you. 

Hi Caleb,, @Jon Holdman  is correct about technical aspect of 1031 exchanges.  You cannot do 1031s on property you hold as dealer as inventory.  1031 exchanges are properly done on property being "held for productive use in business, trade or for investment".  The key is "intent" not longevity or anything else.  There is no statutory holding period.  There are no statutorily required activities.  There is only the question of intent. 

Unfortunately (or fortunately depending on your psychological composition) this question of intent as test got even murkier with the recent Allen v. U.S. 113 aff’d2. d 2014-2262 (2014) decision.  Allen purchased property that he was going to use as inventory and immediately develop and sell.  Life intervened and over the course of the next 12 years he was undecided on his course.  Ultimately, 12 years after purchasing the property he sells it and does a 1031 exchange which is subsequently disallowed because he did not demonstrate that his intent had changed to hold the property.  There's a lot of nuance in this case.  Not the least is that the 1031 was not the audit trigger.  So there was something else going on that may have made the Service grumpy.  

But for you the rank and file investor what do you make of it?  If you eliminate the word flipper from your vocabulary and do things that demonstrate your intent to hold the property like - documentation to your professionals, long term financing, putting rentors in, not advertising for sale immediately, holding longer rather than shorter time frames...all of these are not conclusive evidence (neither was a 12 year hold period) but they help.

Why not use an alternative model to fix N flip.  Fix rent N sell after a while can be made to work as well as rent-fix N sell after a while depending on your bent. Both have the effect of creating a longer time horizon which can be used as part of your documentation of your intent to hold for productive use.  Investors are more willing to pay retail for investment properties that are juiced and fully retail rented.  Nothing says "bargain" like "could be great rental" or "under market rents".  For you particularly this can work as you stated your desire was to move into longer term holds anyway.

John is correct.  You would not qualify for 1031 Exchange treatment because your intent was to hold for sale and not hold for investment.  There are many forum discussions on Bigger Pockets regarding intent to hold that you might want to review to get different perspectives.

I disagree with Dave's comment regarding Allen vs. U.S.  I don't think it made the issue of holding for investment murkier, but rather supports what has been said all along.  It is not the length of time that you hold property that determines whether you had the intent to hold for investment, but rather your actual intent.  The length of time that you hold the property is just one part of demonstrating that you had the intent to hold (or not hold) for investment.  An investor's intent to hold for investment vs. sale is generally pretty easy to determine.  Allen made numerous arguments, but in the end, it was clear that his intent to was to hold for sale (i.e., development and then sale) and not for investment. 

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