Tax question about rental vs flips

[John D.]

Good Morning,

I thought I saw a thread here several months ago relating to what can and can't be deducted on rental properties vs. flips.  Unfortunately, I cant seem to find it now.

I have a home that I initially intended to rent out in 2017 but later decided to sell it.  I'm wondering if and how that affects the deductions I may take.  The property in in New Jersey. 

Thanks for the responses and have a great day!!

[Sam Grooms]

First, you'll want to speak with your CPA, because each one has a different comfort level of what they're willing to do. 

Have you sold the property already? If not, wait 12 months from the purchase date to sell it. Also, do you have any sort of documentation showing your intent was a rental when you bought it? It's tricky since you never placed a tenant in there, but that goes back to what your CPA is comfortable with. 

As for specific deductions, the only difference in deductions I can think of between a flip and rental would be depreciation, but you recapture that anyway. So I don't see a difference there, especially over a 1 year period. 

You should be able to deduct every expense for the property, and just pay LTCGT on your gain (not profit, since it's not a flip!), if you hold it for a year and have proof it was meant to be a rental. That being said, while I am a CPA, I never practiced as a tax CPA. So again, consult with one/your's. 

[Carl Fischer]

@john 

@John D. 

If you haven’t had it for a year -long term capital gains will not be in effect if you sold it already you will pay ordinary income on profit above the basis in your property.

 Long-term capital gains is actually measured from the point where any rehab was completed on the property. When it  was ready to rent—that may have been when it was purchased if no rehab was required. Proof of intention to rent as mentioned is important. Get an opinion from  @Brandon Hall  and @Lance Lvovsky as well as your own cpa

[Lance Lvovsky]

Thank you @Carl Fischer for the mention!

@John D. please do not hesitate to ask any questions.

[Basit Siddiqi]

@John D.

flipping income and rental income are two totally different income types filled out on 2 different forms on your tax return. They are also taxed and treated differently as such the income and expense methodology may be different.

You may have to reach out to an accountant and mention information such as

1. When was the property purchased
2. Was the property ever advertised for rent and also suitable for an individual to live in the house?
3. When was the property sold(if it was sold).

The answers to the above questions may dictate how it will be reported on the return.

[Michael Plaks]

Originally posted by @Carl Fischer:

Long-term capital gains is actually measured from the point where any rehab was completed on the property. When it  was ready to rent...

That is incorrect, Carl. Depreciation and all other deductions do start from the in-service date, which is after rehab. Holding period for capital gain, however, is measured from the original acquisition date.

[John D.]

@Sam Grooms @Carl Fischer @Lance Lvovsky @Basit Siddiqi @Michael Plaks

Thank you all for your insight.

I want to be sure I am getting the right info from my CPA.  In your professional opinion, could you share with me what your course of action might be in this scenario:

Property was purchased in June 2017 and took 2 months to rehab. It was listed on the MLS from Sept 15 thru Dec 15 for sale but was also listed for rent from Sept 1 through year end and was suitable to be occupied. The property has not been sold and is still listed for rent.

Thanks again!

[Carl Fischer]

@John D.

 I really don’t have enough information to help you such as -the price, your actual situation, what you really want, and what your goals are.  if it was me and I’m a “buy and hold” guy this is what I would probably do -It sounds like you wiant to sell. I would lower the rent, get a good renter, have a clause in lease that says tenet will have 60 days notice to leave if sold. Keep advertising for buyer, may sell to tenant, maybe do owner financing or contract for deed. You can barely get it sold by June so I think LTCGT will apply. 

[Michael Plaks]

@John D.

Are you asking for suggestions re: exit strategy - or about tax treatment? If tax treatment - then it really depends on your CPA's approach and your situation. There is room for interpretation. 

It can be considered a rental property placed in service Sept 1, eligible for deducting holding cost and depreciation. It can also be considered a flip property still unsold, not eligible for any deductions until sold. No way to decide without an extended discussion of details.

[John D.]

Thank you again @Carl Fischer and @Michael Plaks

In this instance, I will be selling the property...not renting.  I am just looking for the best way to minimize any type of tax implication.  The home was purchased on June 9, 2017.

Purchase price of home-$38K

Repair Cost-$50K

ARV-$120K (conservatively)

In the future, I plan on purchasing properties strictly as rentals and plan on my next purchase shortly after finalizing the sale of this one.

I appreciate you taking the time to assist me with information on this.

Thank you again and please let me know if any more specific info is needed.

[Carl Fischer]

@john 

@John D.

Your welcome. I look at like this you will have 38k + $50k +$12k closing costs = $100 k this you make $20k. It is either LTCGs or ordinary income and I’m not sure what tax bracket your in so the difference may not be that much either way. I also don’t know what the new tax laws will do to your situation. @Michael Plaks usually has great answers so seriously consider his  suggestions. Good luck

[Michael Plaks]

@John D.

If you sell within 1 year, you either have a short-term capital gain on an investment property or self-employment income on a flip. You pay more taxes on a flip. The income tax rate is the same. But on a flip, you pay 15% self-employment tax. (You also get a 20% deduction under the new law which partially mitigates the hit from SE tax.) Nothing you can do to lower the tax on a flip.

After discussing this with your CPA and having his blessing to treat it as an investment property and not a flip - the only thing you can do to reduce taxes is to wait until June 10th to sell it.

However, there is a business risk far more important than taxes: your buyer may not wait. Sell as soon as it makes sense business-wise. Only if you're close to June you may want to alter the timing, but you will still be running a huge risk by delaying closing.

If your CPA approves the non-flip treatment, you might also consider some advanced techniques to defer capital gain taxes - like installment sale or 1031 exchange, but there's not enough profit in this deal to make it worth the hassle.

PS. Thank you for the compliment, @Carl Fischer

[John D.]

Thank you again for sharing your knowledge gentlemen!