Tax Help on Fix and Flips

45 Replies

Hey everyone, 

Wanted to hear the communities response to this;

Brand new r/e investor, going to do a fix and flip. Does anybody have any interesting tax strategies in respect to this whole process? (buying, selling and personal income wise).

I will be doing this in my personal name as a part time office clerk earning ~22k/year and want to get some income on the side. I'll be doing this in Brooklyn, NY if it helps.

Many thanks to this awesome forum and all its members!

Tom B.

Flipping houses is ordinary income and subject to your earned income tax rate. If you do flips via a sub S corp you may be able to pass some of the income through as dividends and avoid the 14% SS tax. 

Ned, that is horrible advice.  

S-Corp is a nightmare.  Banks won't lend you the money in an S-Corp.  If you need to refi they will make you take the property out of the corp.  This will trigger a taxable event. 

Putting property into an S-Corp vs cash also creates a gigantic headache.

Always use an LLC no S-Corp status. In an S-Corp you MUST pay yourself a reasonable wage. Thus, you will not escape SS taxes unless your making serious money with the business. Now if you have enough cash in an IRA of sorts you could buy and sell properties through that vehicle to defer taxes all the way to retirement. You could also use 1031 Exchanges to accomplish the same thing.

Ned, don't hand out tax advice if that is not your area of expertise.   

Originally posted by @Joseph Accetturo Can you comment here.


Ned, don't hand out tax advice if that is not your area of expertise. 

I could say the same to you. I didn't offer advice. I simply pointed out an option that "May" work. You on the other hand did offer advice without pointing out the potential pitfalls to Tom and other readers. 

Joseph, apparently this was your first post here. This can be a great forum to build your business but people will judge you on how credible you appear. There a LOT of very smart people here. You ought to get to know some of them before you start throwing around criticisms. 

LLC first, and later on C-Corp based on volume. If you are using your IRA, try a self-directed. Gives you the freedom to pull for investments, flip and put it + profit back. By self directing, you have to grow your own money.

@Tom Bud  

@Ned Carey  

The reason I don't move to a corp status to get out of the AMT is that the LLC allows me if needed to go back and capture tax's paid 5 years back in the event of poor years.. So for me personally when 08 HAMMERED US lenders I wrote off a bunch of bad debt took the loss's then went back 5 years and systimacally got almost every dime I paid in income tax's back to me so I was cashing 6 figure checks from Uncle for a few years.. came in handy in those dreaded years of 09 and 10.. so for that reason alone I keep my tax status were it is and pay my AMT... Just in case we have another melt down and I need to go back and grab tax's paid. But that's me and my comfort level.

If you are looking for side income and need the pace of a fix n flip then Ned is correct you may not use 1931 exchanges to mitigate taxes.

However if you can look at longer time horizon and become a buy and hold investor who occasionally sells a property then 1031 exchanges can be the most powerful tool in your arsenal for tax relief and enhancing ROI

Originally posted by @Joseph Accetturo :

Ned, that is horrible advice.  

S-Corp is a nightmare.  Banks won't lend you the money in an S-Corp.  If you need to refi they will make you take the property out of the corp.  This will trigger a taxable event. 

Putting property into an S-Corp vs cash also creates a gigantic headache.

Always use an LLC no S-Corp status. In an S-Corp you MUST pay yourself a reasonable wage. Thus, you will not escape SS taxes unless your making serious money with the business. Now if you have enough cash in an IRA of sorts you could buy and sell properties through that vehicle to defer taxes all the way to retirement. You could also use 1031 Exchanges to accomplish the same thing.

Ned, don't hand out tax advice if that is not your area of expertise.   

 My understanding about 1031 is that it cannot be used for "flipping", i.e. business property. It only applies to "investment" properties.

Winston, 

To be eligible for 1031 the type of real estate is irrelevant.  It is the use that is key.  The statute refers to qualifying property as being "...held for productive use in business or trade or for investment."  Fix n flip property no matter the type is considered inventory and when being held primarily for resale cannot be sold using a 1031.

Originally posted by @Dave Foster :

Winston, 

To be eligible for 1031 the type of real estate is irrelevant.  It is the use that is key.  The statute refers to qualifying property as being "...held for productive use in business or trade or for investment."  Fix n flip property no matter the type is considered inventory and when being held primarily for resale cannot be sold using a 1031.

 Right. A property used in business is business property, and a property held for investment is investment property..

@Dave Foster  

@Wilson Churchill  

One of my favorite deals all time was when I was buying Timber rights ( timber Deed)  and helping the timber land owner do a 1031 into an income producing property ( usually apartments).  These were great plays and very profitable for all involved.. I was able to buy the timber deed... then log the property and make my profit.. The timberland owner only sold their timber deed and kept the property that we logged and then replanted ( so in another 80 years their heirs can do it all over again)... I brokered the multi family deal ( since I am a broker in state as well and one reason I think a RE license is useful to have)

Love this play... But it was a tough one to explain to unsophisticated timber land owners many just flat did not believe we could do that... Most timberland owners when they have mature timber have basically a next to nothing basis in the standing timber remember it was just little 20 foot trees when they bought it in the 40's or 50's...

Thanks for the trip down memory lane.  A 1031 worthy of the Starker name :)

@Dave Foster  

  ya know I always wondered about the starker exchange is that related to Starker timber here in Oregon ????

1031 is about intent.  You have to prove you intended to hold the property for a certain period of time.  You don't actually need to do it.  Some cases show 2 years as investment qualification.  But it is arbitrary.  I'd say 1 year since after one year the gain becomes long term.  

@Joseph Accetturo  

  my timber clients averaged 50 plus years so they made the test  :)

@Joseph Accetturo  If it takes a whole year to do a simple fix & flip, there probably won't be much gain to shelter from taxes anyway.

People always want to make money and look for tax loopholes.  There are none.  When you make money you pay taxes.  Be thankful you pay taxes because it means you made money.   Tax loopholes were not created for people fliipping 50k properties.  They are for billionaires selling multi-million dollar properties that take years to unload.

Originally posted by @Joseph Accetturo :

Ned, that is horrible advice.  

S-Corp is a nightmare.  Banks won't lend you the money in an S-Corp.  If you need to refi they will make you take the property out of the corp.  This will trigger a taxable event. 

  

Not sure where you're getting your information, Joseph...

I've used local banks to purchase and refinance about 50 flip properties in my S-Corps (technically, LLCs with an S-Corp tax election).  In fact, the banks I work with -- those that make portfolio loans -- typical REQUIRE the loan to be in the name of an entity.  My first-hand experience indicates that the information you provide above is incorrect.

Additionally, by doing so, I've saved self-employment tax on about 40% of the total income earned in those S-Corps (I typically pay 60% of the total income in salary and distribute the other 40%).

I'm not a tax professional, but I've used and have spoken with many accountants, CPAs and enrolled agents over the years, and they all pretty uniformly give this recommendation...at least until larger volume suggests using a C-Corp instead.

@Jay Hinrichs  That's right.  Starker was the basis for the modern day deferred exchange.  You're a part of tax history!  I"e got to dredge memory but I think the case surrounded he and his son selling timber land but left the money in escrow with the buyer who then purchased numerous pieces for the Starkers over the next 18 months or so.  Went all the way to court of appeals with both sides prevailing at some points.  And voila - we now have real estate for real estate, the 45 and 180 day rule, the title requirements, the need for QI and the valuation requirements.

Not sure I agree with @Joseph Accetturo  stirred up a hornet's nest here but listen closely and you'll hear the market speaking to you.  

@Dave Foster  

  Thanks Dave.... I sold a piece of property to Starker I had a little odd ball piece and they wanted to square up one of their sections.. very well to do Oregon timber family.

The timber deed 1031 is still alive and well just there is very few folks that are aware of it outside of the industry and the power it has for land owners who have sat on timber holdings for years have no basis in the stand of trees and pay massive tax when they finally log it.  The 1031 allow them to cut the tree's roll all that tax deffered money into an income producing property.. it was sweet.. but hard to convince old farmers who are so afraid of paying tax in the first place.. or live in their old shacks and are sitting on a few million dollars of timber and do nothing with.. it.. REmainder trusts also work well for timber

Originally posted by @Joseph Accetturo :

1031 is about intent.  You have to prove you intended to hold the property for a certain period of time.  You don't actually need to do it.  Some cases show 2 years as investment qualification.  But it is arbitrary.  I'd say 1 year since after one year the gain becomes long term.  

 Good analysis of the issue.  But even here you've got to be careful.  One recent case where an exchange was denied the property had been held for 12 years but the intent to hold had never been established to the tax court's satisfaction.  \

The mantra in the QI business for a long time was "one year and one day" precisely because of what Joseph says about capital gain and because that met two other timeline criteria that had been mentioned in other court cases "two tax years, and two calendar years".  One year and one day always involves two calendar years and two tax returns.  Unfortunately people began to believe that this was the rule and it is not.  The issue is not time it is intent.  Show  intent and you are probably fine.

But remember what Mark Twain said - ""No man's life, liberty, or property are safe while the legislature is in session"

@Dave Foster  

But remember what Mark Twain said - ""No man's life, liberty, or property are safe while the legislature is in session"

   Amen to that statement

While we newbies have you long-time experts on the line...

Since the intent to fix and flip is a tax-intensive enterprise vs the intent to hold for rental and 1031 exchange, would it therefore generally make sense to

  • buy your rental properties with post-tax non-retirement funds and
  • invest in fix-and-flips within an SD-IRA / Solo401k as long as all the work is hired out?

I've never done a flip, more of a buy and hold guy. Is it even possible to make a profit while avoiding the self-dealing limitations?

@Kevin E.  

have to be cognizant of the ubt on your IRA in a flip scenerio

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here