I'm trying to better understand how CG works.
I lend 100K to my LLC. Purchase a home via the LLC for 70K. 30K expenses ( includes rehab, travel, realtor expenses etc). I sell the home for 140K. Payback 105K to myself. 5K interest.
How much is my CG exposure?
I'm thinking 25% of the 70K you made on the property, but i'm only 25% sure.
There is no capital gain treatment for flipping the house. Gain is taxed at ordinary income rate.
Also, the lending of money to you entity and getting it back has no tax implication. You dont get taxed on the principal amount. You will have interest income that will be taxed at the ordinary rate.
There is no CG exposure.
Hope that helps
You should look at this in a separate few steps:
1) You fund your LLC (shareholder contribution) with $100k
2) Your LLC spends $70k on inventory (the house), and puts in an additional $30k to improve the inventory. Your LLC now has inventory worth 100k (note that no expenses have occurred yet for tax purposes)
3) You sell the inventory for $140k so your LLC recognizes $40k in ordinary income. This 40k will flow to your tax return and you will pay taxes on it at ordinary income rates.
4) You take out $105k from your LLC (shareholder distribution). Note that this would likely not be a taxable event.
If you were to draft loan documents then you would record interest expense of 5k on your LLC (which would be tax deductible), but then you would have to record interest income of 5k on your tax return (which would be taxable to you).
It would be much more simple to do steps 1-4 than to legally create a loan.
Just consider the money you put in a contribution (rather than a loan), and the money you take out as a distribution (rather than a repayment).
Of course, talk with your tax professional first to make sure there isn't an outside detail I am missing that might change this for your situation.
@Brian Zaug, @Ashish Acharya thank you for your responses.
@Alan Rohrer you answered some of the questions I had in mind after Ashish's response.
Interesting to know that I can make a contribution and take back that same amount as a distribution from the LLC without a tax implication.
I thought creating the loan was an easy way to get back the funds, but now I know it's not.
Truly appreciate the responses.
In most cases, your LLC will not even file a separate tax return, making it simpler.
You really just have steps 2 and 3, for tax purposes. You don't have to think in terms of contribution/distribution. The LLC is essentially a separate pocket on your jeans, but it's still your jeans. You're moving money from pocket to pocket, but the money stays on you. No tax consequences for those transfers.
Thank you @ Michael Plaks.
Don't forget to count the expenses(costs) that you pay at closing to decrease your ordinary income on sale(Title fees, transfer taxes and real estate agent commission).
@Basit Siddiqi, thank you for your response.
Just to be clear, out of the 40K recognized as profits to the LLC, I can deduct all closing costs thus reducing the tax burden to me when it moves as ordinary income to my return?
What other expenses can be deducted? SE Tax, is it mandatory to take?
You should be entitled to take the closing costs as a deduction for a flip.
You calculate gain as selling price less selling costs less cost basis.
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