Tax Help on Fix and Flips

Property Manager · Brooklyn, NY · Member since 2014 · 10 posts · 0 votes

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.

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Ned CareyPro Member

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Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes

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Kevin E.
Investor · Jackson, TN · Member since 2014 · 11 posts · 11 votes
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Thank you, @Bill Exeter and @Jay Hinrichs
So flipping is an active investment that brings in UBIT issues when done within an IRA, got it. I understand using a Solo 401k mitigates the UBIT taxes, but are there additional considerations when operating an active flipping business within a Solo 401k?
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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@Kevin E.
Not sure Bill will know.. but if I was making a guess retirement accounts are retirement accounts and they may be treated the same
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
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@Kevin E.
Solo 401k plans are exempt from UDFI tax (type of Unrelated Business Income Tax assessed on leveraged real estate inside of a retirement account), however, if you Solo 401k is involved in an active business - UBIT would still apply.
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Kevin E.
Investor · Jackson, TN · Member since 2014 · 11 posts · 11 votes
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Thank you for the information @Dmitriy Fomichenko , that is helpful. UDFI is a type of UBTI. Now I know where do direct my research.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
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@Kevin E.
UBTI would still apply with Solo K Plans.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
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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.
Joseph,

We have a few issues with your comments.
First, Banks WILL lend to S-corps.
Second, You are correct on possible taxable events. Much of that is subject to financing situations and increase in Fair Market Value.
Third, It is NOT a gigantic headache.
You must pay a reasonable salary which has many different definitions and is dependent upon how much work and time is invested into the even itself.
Fourth, You can consider a solo 401k that you can contribute wages into as well as matching contributions. (This can be done as a sole proprietor as well)
Fifth, Investing in a flip inside and IRA can be a trouble as you can run into UBIT issues AND you can run into a problem of the TP needed actual cash and money personally not in retirement.

NOW, my BIG issue with your statement and you as an accountant even posting on a real estate investment board should know this as Tax 101. You CANNOT use a 1031 exchange for Flips. I will tag @Bill Exeter , Our 1031 expert here to agree with me.
[email protected]224-381-2660
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
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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.
Incorrect. It is entirely about intent.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
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Originally posted by @Steven Hamilton II:

Originally posted by @Joseph Accetturo:
NOW, my BIG issue with your statement and you as an accountant even posting on a real estate investment board should know this as Tax 101. You CANNOT use a 1031 exchange for Flips. I will tag @Bill Exeter , Our 1031 expert here to agree with me.
Yep, I agree. Properties acquired and held for sale such as rehabs/flips, developments, condo conversions, etc., are generally not going to qualify for 1031 Exchange treatment unless you actually complete the project and then hold them for rental/investment purposes as opposed to held for sale.
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Gregory H.
Real Estate Agent · Philadelphia, PA · Member since 2013 · 451 posts · 369 votes
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I think the moral of this thread has been, if you are investing in Providence, RI ... you know one accountant not to use ...
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
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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.
Joseph,
You need to be careful how you phrase your comments. 1031 Exchanges are about proving intent, but not intent to hold for a period of time. You must have the intent to hold for rental, investment or use in a business. The code, regulations and rulings have no required time period. They only require intent to hold for investment purposes. If you get audited, you must be able to demonstrate that you did in fact have the intent to hold for investment purposes as opposed to holding for sale such as rehabs/flips. There are cases on the books where the taxpayer's holding period was well over ten (10) years, but their 1031 Exchanges were disqualified because they were holding for sale (e.g., development) and not holding for investment.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
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@Jay Hinrichs
Yep, the Starker family in the Pacific Northwest changed our industry forever. I copied a quick historical piece that we have on our website below that summarizes the Starker family's contribution to delayed exchanges;
Starker Family Case Sets Precedent
The tax court cases and corresponding decisions, including an appellate decision from the 9th Circuit Court of Appeals resulting from the now famous Starker family tax-deferred like-kind exchange transactions, changed the tax-deferred like-kind exchange industry forever. The Starker family litigation stemmed from two delayed tax-deferred like-kind exchange transactions where T.J. Starker and his son Bruce Starker sold timberland to Crown Zellerback, Inc. in exchange for a contractual promise to acquire and transfer title to properties identified by T.J. Starker and Bruce Starker within five (5) years. The Internal Revenue Service disallowed this arrangement, contending, among other things, that a delayed exchange did not qualify for non-recognition treatment (i.e. deferral of income tax liabilities).
These tax court decisions were significant in numerous ways and set the precedent for our present day non-simultaneous, delayed tax-deferred like-kind exchange transactions.
The Starker family cases demonstrated to the investment community that non-simultaneous, delayed tax-deferred like-kind exchanges will qualify for non-recognition treatment, which provided Investors (Sellers) with significantly more flexibility in the structuring of tax-deferred like-kind exchange transactions.
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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@Bill Exeter
Thanks Bill, I of course had heard of the Starker exchange.. But then I find myself doing a deal with the Starker family... We just had an odd ball little property out in the woods 20 miles from Corvallis OR>.. We sold it to them so they could square up one of their sections.... I have done a handful of 1031's with Timber Deeds as they subject of the exchange its a super way for Timber land owners to reposition from one slow growing asset to monthly cash flow asset.. However it was a tough sell because of most Timberland owners in the PNW that are not professionals are every day farmers and you talk tax planning and it kind of goes right over there head.. then they go to their bookkeeper who never heard of it etc etc. But the one's I did were super for all parties involved.
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Joseph Accetturo
North Providence, RI · Member since 2015 · 14 posts · 1 vote
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@J Scott: 60/40 split is not "reasonable." It has nothing to do with the percentage on income you pay in distributions vs. wages. There is a reasonability test the IRS and Tax Courts use and it has to do with a reasonable WAGE for services performed, the type of job and company and the hats you wear within the company.
I gave him the ONLY reasonable option for anyone with 22k of income per year in this situation even at a stretch. Facts are he has NO options. Did any of you actually look at the facts he presented. Dodging taxes is not what he needs to be worrying about.
Facts: Earns 22k per year. Lives in Brooklyn, NY. He's got no money! No bank is going to loan him money in an LLC, it would become a business loan he would need actual capital to buy property, the rates would be through the roof. Electing S Corp status with such little income and available capital is silly because it offers no real benefit at this point. He's probably thinking of getting a HUD Loan and pretending he is going to live in the property and then trying to flip it.
I think you guys are looking at it from the standpoint of a seasoned real estate investor with plenty of capital making a few hundred thousand a year of net income. Take your personal situation out of the equation. He is not you. His circumstances are completely different than a real estate professional with year of experience an hundreds of thousands if not millions in capital.
Sorry I kicked the nest but your S-Corp status idea really is horrible for a brand new real estate investor in this particular situation. In fact it's a bad idea to use any entity type with no assets, no capital and nothing to lose. I didn't feel the need to go into every thought I had on how I arrived at the only possible solution to answer his silly to begin with question.
@J Scott: My start up real estate clients go through this all the time. This is my personal experience. New real estate investors have no track record and need to personally guarantee everything there is no benefit in spending the money to create an LLC and pay fees associated. If he loses on this one his very first deal he's filing for bankruptcy. If you want REAL tax advice that actually pertains to your situation you need to go to a CPA and PAY them. They will get all of the details from you and offer you the proper advice based on your situation.
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J ScottPro Member
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Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
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Originally posted by @Joseph Accetturo:
I gave him the ONLY reasonable option for anyone with 22k of income per year in this situation even at a stretch. Facts are he has NO options. Did any of you actually look at the facts he presented. Dodging taxes is not what he needs to be worrying about.
Actually, your response appeared to have nothing to do with his situation personally.
You made some very blanket statements...allow me to quote you:
The first sentence might be directed at the OP, but it doesn't sound like it. It sounds like a blanket statement of your beliefs.
The second statement is just flat-out wrong. I've refi'ed properties in a corporation using bank loans.
As for the third statement, that's clearly not directed at the OP, as you used the word "always," yet you have no idea what his future situation will be.
It sounds to me that either you've realized you were wrong and are now changing your story, or your original comments were poorly written and misleading. Either way, don't blame the rest of us for calling you out on what you wrote.
Which brings me to this statement of yours:
If you really had any experience here, you'd know that many (most?) portfolio lenders (banks) will ONLY lend to a business entity...they will not lend to an individual. And given the large percentage of investment loans that are portfolio loans, this mean that not only is your advice bad, but it it would be impossible to implement in many situations.
As for my needing to visit a tax professional...trust me, I'm not smart enough to do my own taxes...
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Joseph Accetturo
North Providence, RI · Member since 2015 · 14 posts · 1 vote
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Originally posted by @Wilson Churchill:

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.
In the original question the person is not a real estate professional. While he "thinks" his intent is to be a flipper and a professional real estate developer, he can do what is necessary to not "intend" since he has no prior track record of flipping properties. His question and intent was how to avoid taxes on this one transaction, his first. In full disclosure, I do not know all the facts nor does anyone else. Each case is unique. Don't let anyone tell you different. Using a 1031 requires planning. Don't use a thread of strangers as advice to live or die by.
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Joseph Accetturo
North Providence, RI · Member since 2015 · 14 posts · 1 vote
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@J Scott I did make those comments. I shouldn't have said they WON'T lend. The better question would be WHY would you borrow like this as a newbie. I wrote my response pretty quickly and without any proofreading.
Not changing the story. He's not a real estate professional. He's never done it before. Why on gods green earth would he approach the bank in a way that required commercial rates and lending standards?
Clients transfer properties in and out of LLC's to get better rates and standards since there are different sets of rules and rates when lending to an llc vs an individual.
I do believe Bill said "in general" which means exceptions exist.
Again you are applying your personal situation as a real estate PROFESSIONAL to this guy's one time attempt at flipping a property. It must be nice living in a black or white world. I do hope that someday I can join you.
"As for my needing to visit a tax professional...trust me, I'm not smart enough to do my own taxes..."
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Joseph Accetturo
North Providence, RI · Member since 2015 · 14 posts · 1 vote
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My job is to assess the situation and come up with the best plan of action for a particular situation. That is how I think about an analyze every question. I need to be aware of loopholes an scenarios that do or don't pertain. It is to help my client dance ever so close to the edge of wrong while keeping them on the side of right. Any bozo can plug numbers into tax software and process tax returns. Everyone always assumes their situation and circumstances pertain to everyone else and they don't. No two situations are the same. I am the exact guy you want as your CPA.
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
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@Joseph Accetturo
no dog in this hunt... and agreed stricktly speaking most banks will not lend to a Corp ... they will lend to corp with PG or LLC with PG at least every loan I have gotten for the last 30 years went this way.. not a big enough fish to get loans without PG.
But its tax season what are you doing on BP ? LOL
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J ScottPro Member
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Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
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Originally posted by @Joseph Accetturo:

Not changing the story. He's not a real estate professional. He's never done it before. Why on gods green earth would he approach the bank in a way that required commercial rates and lending standards?
It sounds to me as if you're not familiar with portfolio loans and how they work. Many new investors use portfolio loans to get started in this business -- underwriting guidelines are simpler and more geared towards the hard asset as collateral, with rates that are relatively close to conventional.
Personally, about 30 of my first 50 deals were funded using portfolio loans. For real estate investors, it's the best financing method out there, in my opinion.
If you're going to work my real estate investors, you really need to be familiar with portfolio loan products.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
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Originally posted by @Joseph Accetturo:

My job is to assess the situation and come up with the best plan of action for a particular situation. That is how I think about an analyze every question. I need to be aware of loopholes an scenarios that do or don't pertain. It is to help my client dance ever so close to the edge of wrong while keeping them on the side of right. Any bozo can plug numbers into tax software and process tax returns. Everyone always assumes their situation and circumstances pertain to everyone else and they don't. No two situations are the same. I am the exact guy you want as your CPA.
Joseph,

I'm going to be honest you haven't shown anyone here a knowledge of the industry. Please be careful about giving out incorrect information. You are welcome to go through some of my old posts to educate yourself on taxation of real estate investments.
[email protected]224-381-2660
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