Taxation for private lender on fix and flips

Tax, SDIRAs & Cost Segregation
8yFollow

Taxation for private lender on fix and flips

John Pauler
Investor · Somerville, MA · Member since 2015 · 34 posts · 7 votes

I am looking for help on tax implications for two flips I invested in passively with slightly different terms. For both of these, I was completely passive, simply supplying the capital and waiting for my return. 

FLIP 1:  20% fixed interest. Deal closed January 2018 and was paid out 13 months after initial investment (120% of initial investment) . 

FLIP 2: pro-rated share of upside created. Deal closed January 2018 and was paid out 14 months after initial investmen (117% of initial investment). 

I am pretty sure I will get hit with taxation at ordinary income rates for FLIP 1, because this is a simple interest structure, but am not sure about FLIP 2. My original thought was this would be a capital gain, but the more I read about it, it sounds like the IRS never treats flipping as a capital gain, but rather as a business activity. My question is whether that changes when you are a passive investor, and not the one driving the project. 

Can anyone with more expertise weigh in on this, specifically answering...

1. How will these two flips be taxes?

2. Is there anything you would recommend in the future for more favorable tax treatment? 

Thanks for the help!

0Reply
35 views

Most Popular Reply

Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
8y

Profit from fix and flips is ordinary income.  Fix and flips aren't investments, so no capital gains involved.  Both your deals will be taxed as ordinary income.

If you have a complex tax situation like this you really need a knowledgeable accountant.  There are probably expenses incurred during these deals that you can offset at least a bit of the income.

2Reply
See this reply in the discussion

7 Replies

Jump to latestLatest
  • Ryan Detig
    Nederland, TX · Member since 2016 · 109 posts · 92 votes
    8y

    @John Pauler  I am not a CPA.  I would talk to one of those guys.  Did you ever own the property, or was this just a personal loan?

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    8y

    Profit from fix and flips is ordinary income.  Fix and flips aren't investments, so no capital gains involved.  Both your deals will be taxed as ordinary income.

    If you have a complex tax situation like this you really need a knowledgeable accountant.  There are probably expenses incurred during these deals that you can offset at least a bit of the income.

    2Reply
  • John Pauler
    OP
    Investor · Somerville, MA · Member since 2015 · 34 posts · 7 votes
    8y

    Thanks @Jon Holdman. That's what I was thinking, but good to hear it from someone more knowledgeable. Appreciate the response! 

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    8y

    @John Pauler

    It is ordinary income on both. But the mechanics depend on how it was set up. As in - was there a partnership arrangement or a lending arrangement.

    Capital gain only applies to rental properties or properties held for appreciation.

    Opportunities for tax savings may or may not be there. It can only be discussed case by case, after understanding your entire financial and business situation. So get with one of us tax experts from BP.

    2Reply
  • John Pauler
    OP
    Investor · Somerville, MA · Member since 2015 · 34 posts · 7 votes
    8y

    Thank you @Michael Plaks! 

    0Reply
  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
    8y

    @John Pauler , 

    Flips are always ordinary gain.  So, if you were just a limited partner in the partnership or shareholder in the S-corp, when the entity prorates the gain and gives you your portion, the gain will still come to you are the ordinary gain. 

    However ordinary gain can be passive if you didn't not materially participate in the activity. Being a passive investor or active investor has no implication on the tax you pay on the gain. Both passive gain or ordinary gain are taxed at the same rate. ( passive gain does not mean  capital gain)   

    Passive gain is only useful when you have a passive loss because the passive loss cannot be deducted from ordinary income ( there are some exceptions). So people passively invest in the entity to produce passive income to deduct their passive loss. If you just have a passive loss, the loss is suspended.

    So, in future,  maybe get a rental that give you passive loss (mostly rental do give passive loss if carefully planned)  so that you can deduct against your passive gain. 

    [email protected]941-914-7779
    INVESTOR FRIENDLY CPA®4.9242 Reviews
    WebsiteView Page
    TaxMD® | Tax Planning Software
    WebsiteView Page
    1Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    8y

    @John Pauler

    "Flip 1" - What kind of agreement did you have with the flippers. If you had a loan agreement set up and you did not have a right to the gain on the flip - This might be considered interest income.
    Interest income is taxed at ordinary tax rates. 
    Depending on the state that the flip was done - the Interest income might be sourced to the state where the flip was done.

    Flip 2 - This income should be subject to ordinary income. Depending on how the partnership or S-corp was set up - you may not be subject to self-employment tax since your involvement was passive.

    [email protected]917-280-8544
    Basit Siddiqi CPA4.880 Reviews
    View Page
    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free