Our IRA adviser is trying to convince us that capital gain taxes will eat up our profits and want us to keep our funds in the IRA or transfer them to a 401K instead of closing these accounts and investing them in our business. How do Capitol Gain taxes work with fix and flips, or properties held by an LLC that are sold prior to 1 years of ownership?
1031 Exchange for greater than one year
For less than one year the capital gains taxes are the same whether it is stocks, etc.
Why will the capital gains taxes kill you? They are the lower than income tax rates. I'd rather pay the top capital gains tax than top income tax. This may change in the future where cap gains are taxes the same as income.
If you have capital losses, they wi reduce your capital gain
Well, of course your fund manager wants to keep your money! Tell them taxes don't eat up net profits, they are applied to gross profits and then you have net profits after taxes....LOL
Yes, holding less than a year you'll have gains and you'll have social security taxes if you're in the business of flipping houses. I don't mind paying taxes that are due, it's an indication I'm making money! It's a cost of doing business.
Now, the best use of funds is another question, I'd bet that the average flipper makes more than the interest earned on either of those accounts under management, so let your tax advisor guide you as to the use of funds, not the guy holding your money. :)
Thank you all for such a quick response!!!
I believe BP is one of the best resources we have in our tool box.
capital gains taxes don't apply to flips. Taxed at ordinary income tax rates, plus SS/MED taxes.
I was about to write what @Wayne Brooks said. Capital gains don't come into play at all on fix and flips. You'll wish they did. Its worse than that. The profits on fix and flipping (and wholesaling, property management, developing, brokering, etc.) are all just ordinary income. Taxed at your marginal tax rate. Also subject to both halves of "self employment tax" which is social security plus medicare.
Yes, this does eat into your profit. Same as if you were running any business. Your business model must account for taxes.
Seems like a simple math problem: if even after any penalties for taking your money out of the tax-advantaged accounts early plus taxes on the gains in your business, you can earn a better return than on the investments within the IRA then that sounds like a win.
LT Capital Gains are what, 15%? So yeah, capital gains will eat up 15% of your profits, but at least there are profits! Would you rather have 85% of something or 100% of nothing? I never understood the "don't do that because you'll have to pay taxes on it" argument. By all means avoid theft of your property by government, er "taxes", at all costs, but don't not make the decision to seek higher returns because you'll have to pay taxes on them. Your adviser just wants to keep that money under management, thus the inherent conflict of interest with most investor-adviser relationships.
I think your big tax hit will likely be liquidating your IRA. Transferring from an IRA to a 401K is a bit weird and contrary to the usual advice, since it mainly will limit your options. Unless the goal is to borrow against the 401K.
Assume your marginal tax rate is 30% between federal and state taxes your 100K IRA balance is 60K factoring in the 10% penalty.
Let's say you get 10% return on your investment, so that is 6K. Wait you have to pay taxes(30%+15%(self-employment rounded down)) - that just turned into 3.3K.
So after one successful flip you are almost 10% behind leaving it in your 401K(the after-tax value is 70K). It would basically take 3 successful flips - just to break even.
I realize that a lot of flips make more than 10%, but a lot also make a lot less.
Real estate in general is tax-advantaged, but flipping is not. Cashing out 401Ks is probably the worst tax move possible.
Buy property this year. Slap some paint on the walls. Rent for 12 months. Do your retail remodel and sell the property 12 months and 1 day later - this would be a way to avoid ordinary income and FICA since after 12 months the deal is considered long-term hold. At this stage you will have cap gains, but much less than earned income taxes in the alternate scenario...
That advice is coming from a poor person. I hope you owe millions in taxes. That would mean you could send me a nice birthday present. Your advisor should be pushing you to be successful.
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