Keeping money in my pocket vs. paying the tax man

10 Replies

Is there any way to avoid paying personal income tax when flipping a house?

Could you hold it for longer than 365 days and only be subject to longterm capital gains tax?

Alternatively, could you fix it up and call it your temporary residence and then buy a place of equal or greater value?

Is there any difference between putting the property in your personal name vs. a business entity's name?

Thanks in advance!

How long you hold it is irrelevant.  Intent is what counts.  If you buy it with the intent of fix and flipping it the profits are ordinary income, subject to income tax and SET.  Capital gains taxes never come into play.

If you live in it for two of the five years before you sell you can exclude gains up to $250K for a single taxpayer, $500K for married filing jointly.  But as a residence many things you might spend for a fix and flip would not add to your basis, so your gain would be higher.

Personal name or most entities won't make a difference.  What might is to use an s-corp.  If you have enough income from these deals, using an s-corp would allow you to distribute some of the profits as salary (subject to SET) and some as distributions (not subject to SET).

But bottom line is fix and flipping is a business and you're taxed just like a shoe store or other business.

@Jon Holdman   IF a person bought, fixed, and then HELD (rented out) a property for say 2-5 years, and then sold it, would that capital gain (I realize rental income is completely different) then be realized tax wise as a Capital Gain instead of Ordinary Income? If so, from what I have read here on BP (maybe I am assuming) that IF that is a Capital Gain, there would be NO S.E.T.?  (for those not familiar Self Employment Tax which is both halves of SSI, Medicare/caid, etc..... roughly 15-17% or so).

Thanks, Dan Dietz

Jon is right on the money.  It is all about your intent to hold for either sale (rehab/flipping) or for investment (rental).  You must have the intent and be able to prove intent to hold for rental or investment in order to qualify for 1031 Exchange treatment should you be audited.  The amount of time that you hold the property helps prove intent, but it is not the only factor.  There are cases where the individual held for 12 years and another for 20 years, but the IRS disallowed their 1031 Exchange because their intent was to develop and sell SFRs and not hold for investment.

@Daniel Dietz   its all about intent.  If you bought it to fix and flip, couldn't sell and so rented it, it won't matter how long you hold it.  Its inventory and the gains are ordinary income.  So you cannot structure a business to buy, fix for rental, hold a few years, fix for sale, and sell.  That's just fix and flipping and the gains are ordinary income.

Conversely, if your intention was to hold, but you got an offer you couldn't refuse shortly after buying the property it would be capital gains.

@Daniel Dietz  Welcome to the world of nuance.  The worst thing that can happen to you is to get locked into an I can - I can't strategy based on on a parital fleshing out of a scenario.. So make sure you discuss thoroughly with your finance and legal professional before eliminating or choosing a definitive course of action. 

@Jon Holdman  gives you both sides of an identical scenario.  You buy and then later sell.  In one scenario your intent was to hold for productive use and you later sold it - that would probably qualify for the 1031 exchange.  In the other your intent was to fix and then sell but it took you some time to sell - that would probably not qualify for the 1031 exchange.  He's right.  It's all about the nuance of what you demonstrate by your behavior.

Holding time is not the gold standard for 1031 exchanges but depending on your business model the holding time absolutely can be used to change recognition of gain from ordinary income to a capital gain - talk to your accountant to see where you would fall.

Most industry professionals are not overly concerned with holding periods of greater than one year qualifying appropriately for 1031 exchanges.  And you are allowed to change your intent - you just need to document and demonstrate it well. 

In the most recent case that @Bill Exeter  is citing the exchange was not disallowed because the defendants intent when he purchased his property was to sell not hold.  It was disallowed because over the 12 years that he held the property he never satisfactorily demonstrated that his intent had changed from developing and selling the lots to holding for productive use.  When you read the case, he was continually trying to develop and sell the property throughout.  Hard to say you "changed your mind" when your behavior doesn't change isn't it :)

Be bold Be thorough and use your professionals and their accumulated wisdom.  As Supreme Court Justice Learned Hand described it - Taxes are an enforced exaction not a voluntary contribution!  Pay what you are required to and not a penny more.

@Jon Holdman  undefined

Is right on the mark. If you are unsure how long you will hold the property I would be careful   with the loan contract. You can live in the property for 2yrs and avoid capital gains. Plus if you are primary residents than you interest on the loan is cheaper. 

The 1031 exchange option is you have 90 days after the close on the flip to invest into another property equal or greater in value.

For a 1031, 45 days to identify replacement property (up to three possible replacements) and 180 days to close.

That's right @Wayne Brooks.  The clock actually starts with the closing  of the sale.  You have 45 calendar days to create your potential identification list and a total of 180 days from closing of sale to closing of purchase.  180 days seems like a long time but it is usually the 45 days that trips people up because after day 45 the list is set in stone and you have to purchase a property on the list to complete the exchange

However, there are a couple of twists on the 45 day list.

1. If you name three or fewer properties it does not matter how expensive they are (keeping in mind that you're still going to have to close on an amount equal to or greater than your net sale in order to fully defer all tax).

2. But you can name more than 3 potential properties as long as their total value does not exceed 200% of what you sold.

3. And this one is the most quirky twist of all - If you have to name more that 3 properties and if their total value is more than 200% of what you sold then you can still complete your exchange by purchasing at least 95% of the value of the list.  

It can get a little complicated but still very much worth the tax deferral power.  One piece of guidance I can give based on our client's experiences is that it is even better to go under contract for your purchase before closing the sale of the old property.  The date of contract is irrelevant.  Only the closing of the sale must preceed he closing of purchase.

Originally posted by @Brian Johnson:
The 1031 exchange option is you have 90 days after the close on the flip to invest into another property equal or greater in value.

Hi Brian,

I wanted to correct some information here. 

You have 45 calendar days to identify your potential replacement properties and you have an additional 135 calendar days after the 45 day ID period to complete your 1031 Exchange by acquiring and closing on your replacement property, which equates to a total of 180 calendar days to ID and close.

The equal or greater in value reinvestment requirement is based on the net sale price of the relinquished property. 

Thank you Bill,

I have never done a 1031 E and just was told word of mouth 90 days.

I am glade to get more information on the topic.

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