Rental Property Investor · Waikoloa, HI · Member since 2014 · 32 posts · 2 votes
Hello All,
I just got back my K1 from the accountant on a property that I purchased in 3/2013, rented out and then sold in 6/2014. The K1 has all of the profit listed on line 1 as ordinary business income and does not seem to reflect long term cap gain tax benefits. Can anyone tell if this profit should have been reported somewhere else to acquire the 15% cap rate tax rate for this money? Thanks in advance!
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
11y
@Brian Klingbail what was the purpose of renting it out and was that documented?
I think the fact that it remained on market for the duration of the hold kills "investment" intent unfortunately. Your advisors should be implementing strategies with you that avoids subjecting you to a grey area like this.
Real Estate Broker · North Richland Hills, TX · Member since 2013 · 1k+ posts · 607 votes
11y
I'm not a CPA, so don't take this as an authoritative answer, but my impression is that in most cases a real estate asset held at least one year should be eligible for capital gains treatment. I'd reach out to the accountant and request it be re-categorized or explain why it wasn't listed as a cap gain.
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
11y
@Brian Klingbail what was the intent upon purchasing the property? Did you intend to flip and sell it quickly? When was it rented out? Can you demonstrate investment intent?
Your accountant is either confused (quite common) or thinks you can't demonstrate investment intent. In either case, it should not be a surprise to you. This is why it's critical for real estate investors to use real estate savvy CPAs.
Thank you very much! We purchased it from a foreclosure auction. The short time frame associated with the foreclosure buying process left us unclear on intent at the time of purchase. Initially we were going to simply flip it, but then the market began trending in a direction that supported holding it for a year. Our CPA who prepared the K1 indicated that because most of our other deals were flips this particular investment should be viewed the same. Does initial intent trump the length of hold in regards to changing tax status of long term cap gain to ordinary income?
No problem! Your CPA is wrong. While it's true the IRS may look at your typical business transactions as part of the facts and circumstances, intent is evaluated property-by-property. Simply classifying this transaction as a flip because you "flip other properties" does not indicate in and of itself that the intent for this property was also to flip.
Intent can change over time. Your original intent may have been a flip, but if that changed to an "investment" intent due to market changes, then that's perfectly acceptable. The question then becomes: how well did you demonstrate investment intent?
Obviously renting the property out is a point in your favor. Did you also model the property's cash flow and appreciation potential over a long hold period? Do you have investors and partners who are lending you money on a short term or long term basis? Did you hire a property manager? Did you perform landlord duties? Did you actively market the property or did a deal fall into your lap?
Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
11y
The fact the accountant assumed the worst case scenario for you, instead of Letting you know the option and risk of claiming long term cap gains would concern me. I don't want an accountant that will structure my return to pay the MOST in taxes without consulting me.
Intent becomes the gray area. This deal was split between three investors. The property was listed and marketed a few months after ownership took place and then remained on the market for the duration of the hold. It was rented out for 5 months during the ownership. The investment capital was funded based on return at time of final sale. I managed the property myself from time of purchase to final sale. My management was billed back to the company and is reflected in the K1. I simply advertised the property at my place of employment for the renters. I might still have the flyer, but no other measures were taken. Thank you again for the continued assistance!
This was my dilemma as well. Rather then simply filing the profit as ordinary income, I would have really liked to see it as long term cap gain if possible. As an investor, that taxed money is vital to continued growth and I would obviously like to hold on to as much as possible. What would you say the risk would be with filing a property that was held for well over a year, but that did not have clear intent at time of purchase? Thank you for your insight!
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
11y
@Brian Klingbail what was the purpose of renting it out and was that documented?
I think the fact that it remained on market for the duration of the hold kills "investment" intent unfortunately. Your advisors should be implementing strategies with you that avoids subjecting you to a grey area like this.
Rental Property Investor · Waikoloa, HI · Member since 2014 · 32 posts · 2 votes
11y
The neighborhood had been trending in an unfavorable direction and the property had been sitting for a few months so we decided that renting it was a smart play. All rents were documented and are apparent on appropriate tax forms. We also utilized a lease as well. So in your opinion, this would indeed fall into ordinary income and not long term (or short term) cap gain tax?
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
11y
@Brian Klingbail I can't render an opinion without seeing and understanding all the facts and circumstances. You could very well classify it as an investment property if there are underlying facts we can lean on to substantiate the position. But without knowing whether or not those facts exist, I can't say either way.
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
11y
I will also add in here the question of what other activities your business has under that same entity? Mostly flips or rentals? This is when you should consider a parent company that holds a rental and a flip business.
What would you say the risk would be with filing a property that was held for well over a year, but that did not have clear intent at time of purchase? Thank you for your insight!
The risk is you get audited and they disallow your deduction. This could mean added interest and penalties. Personally I would document in any way I could both, the rental intent.and my reason for changing my mind and selling after a year.
More and more it sounds to me that you did not have the intent on renting. My guess is the IRS might look at it the same way.