Limiting Tax liability as a flipping company
Investor · Springfield, MA · Member since 2010 · 277 posts · 84 votes
Limiting Tax liability as a flipping company
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes@Matthew T.
Sorry for the long reply, but looks like decent amount of money is at stake.
- Yes, those houses you sold are inventories for you. So, the gain is an ordinary income(not the capital gain). Although the tax rate is same for the (STCG) Short-term capital gain and the ordinary income, the income from the flip sale cannot be classified as STCG because STCG has other benefits.
- You should elect to be taxed as S-crop. IDK when you started your LLC but there is a procedure that ou can retroactively elect to be S-corp. That way you will not pay SE taxes on your Net Income. You have to pay FICA tax on the salary you pay to yourself which should be less than 150k, I assume. Reasonable salary. You save a significant amount of tax this way.
Changing a deal status is not as easy. It is all based on fact and circumstances.Yes, classification of gain as capital or ordinary is determined property-by-property, so you can be both dealer and investor, but you will be a prime suspect for an audit.
The frequent buying and selling of real estate indicates the taxpayer is engaged in the trade or business of real estate sales. Taxpayers who can show that the time they devote to real estate activities is insubstantial compared to the time devoted to their normal occupation may be able to preserve capital gain treatment for the property they hold, despite some frequency in sales. Taxpayers who engage in more frequent real estate sales still may be able to prove that the sales represent an investment activity when compared to their primary occupation. This may be particularly true for professionals such as doctors, lawyers, and business executives. (This is not your case)
To determine if the taxpayer is a dealer generally three questions must be answered (per court cases):
(a) What is the taxpayer's trade or business? - Yours is not just rental, when you sell the rental house after 366days , IRS will look at if you were trying to funnel your dealer sale via rental activity to get Long term capital gain treatment
(b) Did the taxpayer hold the property primarily for sale in that business?
Determining if property is held primarily for sale to customers in the ordinary course of business is based on the facts and circumstances. Among the facts to consider are the-
- owner's original intent (nature and purpose for which the property is acquired);
- Per court case, the taxpayer's primary holding purpose over the entire course of his ownership of the property [Not just time of the sale]. I am not saying that original intent can never be changed, but what you are trying to do clearly shows that you are holding property 366 days just to avoid taxes. IRS will come at you.
- extent of improvements and advertising to increase sales;
- number, frequency, and substantiality of sales [this generally is the most important factor See (c) below
- duration of ownership;
- continuity of activity related to sales over a period of time;
- extent and nature of the efforts to sell the property;
- extent of subdividing and development to increase sales;
- use of a business office for the sale of the property; and
- character and degree of supervision or control over representatives selling the property
(c) Were the sales ordinary in the course of that business?
Sales are ordinary if they are normal for business, which may be based on their frequency and substantiality. Per court case, Frequent and substantial sales of real property more likely indicate sales in the ordinary course of business, whereas infrequent sales for significant profits are more indicative of real property held as an investment.
In your case, it will be frequent because you are planning to sell even more.
However, to get long-term capital gain treatment on the sale, if you have an actual investment property and you are a dealer too:
- Maintain separate book
- Document intent to hold the property as investment property in Minutes or other documents
- Report expense as investment expense on tax return
- Also, use separate entities.
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5 Replies
- 8yAshish AcharyaBusiness MemberCPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
@Matthew T.
Sorry for the long reply, but looks like decent amount of money is at stake.
- Yes, those houses you sold are inventories for you. So, the gain is an ordinary income(not the capital gain). Although the tax rate is same for the (STCG) Short-term capital gain and the ordinary income, the income from the flip sale cannot be classified as STCG because STCG has other benefits.
- You should elect to be taxed as S-crop. IDK when you started your LLC but there is a procedure that ou can retroactively elect to be S-corp. That way you will not pay SE taxes on your Net Income. You have to pay FICA tax on the salary you pay to yourself which should be less than 150k, I assume. Reasonable salary. You save a significant amount of tax this way.
Changing a deal status is not as easy. It is all based on fact and circumstances.Yes, classification of gain as capital or ordinary is determined property-by-property, so you can be both dealer and investor, but you will be a prime suspect for an audit.
The frequent buying and selling of real estate indicates the taxpayer is engaged in the trade or business of real estate sales. Taxpayers who can show that the time they devote to real estate activities is insubstantial compared to the time devoted to their normal occupation may be able to preserve capital gain treatment for the property they hold, despite some frequency in sales. Taxpayers who engage in more frequent real estate sales still may be able to prove that the sales represent an investment activity when compared to their primary occupation. This may be particularly true for professionals such as doctors, lawyers, and business executives. (This is not your case)
To determine if the taxpayer is a dealer generally three questions must be answered (per court cases):
(a) What is the taxpayer's trade or business? - Yours is not just rental, when you sell the rental house after 366days , IRS will look at if you were trying to funnel your dealer sale via rental activity to get Long term capital gain treatment
(b) Did the taxpayer hold the property primarily for sale in that business?
Determining if property is held primarily for sale to customers in the ordinary course of business is based on the facts and circumstances. Among the facts to consider are the-
- owner's original intent (nature and purpose for which the property is acquired);
- Per court case, the taxpayer's primary holding purpose over the entire course of his ownership of the property [Not just time of the sale]. I am not saying that original intent can never be changed, but what you are trying to do clearly shows that you are holding property 366 days just to avoid taxes. IRS will come at you.
- extent of improvements and advertising to increase sales;
- number, frequency, and substantiality of sales [this generally is the most important factor See (c) below
- duration of ownership;
- continuity of activity related to sales over a period of time;
- extent and nature of the efforts to sell the property;
- extent of subdividing and development to increase sales;
- use of a business office for the sale of the property; and
- character and degree of supervision or control over representatives selling the property
(c) Were the sales ordinary in the course of that business?
Sales are ordinary if they are normal for business, which may be based on their frequency and substantiality. Per court case, Frequent and substantial sales of real property more likely indicate sales in the ordinary course of business, whereas infrequent sales for significant profits are more indicative of real property held as an investment.
In your case, it will be frequent because you are planning to sell even more.
However, to get long-term capital gain treatment on the sale, if you have an actual investment property and you are a dealer too:
- Maintain separate book
- Document intent to hold the property as investment property in Minutes or other documents
- Report expense as investment expense on tax return
- Also, use separate entities.
INVESTOR FRIENDLY CPA®4.9242 Reviews - 8yLance LvovskyPro MemberAccountant · Fort Lauderdale, FL · Member since 2013 · 1k+ posts · 753 votes
One tax planning strategy is having the LLC that flips properties elect to be taxed as an S Corporation. Did your CPA not recommend that as an option?
- 8yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
First, there're two principal strategies: stay a dealer and minimize dealer taxes or try to get out of dealer status.
While staying a dealer, you have two available strategies, both working forward, not retroactively to 2017:
1. S-corporation + W2 payroll. It is relatively simple, and it can reduce your self-employment (Soc Sec / Medicare) taxes. However, the potential savings are relatively small (less than $10k), especially under the new law.
2. C-corporation. It offers much greater opportunities for tax planning, because it reduces income tax, not self-employment tax. However, it absolutely requires professional setup, and it limits your access to the profits. With your big plans for 2018 - I'd certainly go this way.Now, if you want to get out of the dealer status - it gets tricky, with tons of legal issues, as illustrated by @Ashish Acharya. Holding properties as rentals before selling is one of the specific strategies, and there're more. All of them require that you work with a REI-specialist accountant.
Of course, these strategies can be combined, but it gets more complicated. Then, you can insert retirement funds into the picture for even more complex but more rewarding setup. All depends on how much hassle and cost you're willing to endure, because all of them require you being disciplined and following formalities.
- Investor · Springfield, MA · Member since 2010 · 277 posts · 84 votes8y
Can you elaborate more on the advantages of setting things up as a C-corp for 2018?
Thank you.
- 8yMichael PlaksPro MemberTax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
Originally posted by @Matthew T.:
Can you elaborate more on the advantages of setting things up as a C-corp for 2018?
Thank you.
Only briefly, because it's a loaded topic.
1. You can set up corporate benefits, paying for some of your expenses pre-tax
2. You can redirect large amounts into retirement plans
3. Whatever is left, is taxed at only 21%
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