House flip scenario. Will I fall in a tax pitfall?

4 Replies

I bought and rehabbed a house, planning to hold as a rental. 

I have since decided to sell. I have an option to sell on a land contract and I am trying to figure out the tax implications. 

From what I understand, I will be taxed normal income on the interest income, capital gains on the down payment and principal payments.

Question 1: Will the down payment be taxed at normal rates as it's within a year? Even if it makes up for expenses?

Question 2:  Since I will receive the balloon payment after a year, will the whole balloon be taxed at normal capital gains rates? Am I at risk for normal tax rates because of selling under a year?

I have heard the suggestion of leasing for a year before switching to seller financing, but I don't want to if I don't need to.

Thanks for any advice.

Not sure on the land contract or balloon payments.

If you do not own a property for at least a year, your fear should be being taxed as "ordinary income" instead of capital gains. If you own the property for less than a year, the IRS will consider you to "flip" homes for a living and therefore tax your income as salary income (higher bracket than capital gains).

If you're talking about being taxed on your down payment, you may want to do some research to understand "cost basis" in a property. 

Simplified example:

Purchase price : $100k

Downpayment: $20k

Capital Improvements: $10k

Sold price: $150k

You paid into the property $30k (which is your cost basis) and Profited $20k which would be taxable income.

$20k to be taxed on Ordinary income rate (dependent on your other income sources) AND subject to self-employment income tax (consult with a CPA). Probably about 25%-50% tax rate dependent upon your bracket.

Assume 25% tax rate (low) - your profit $15k

NOW, there are ways around this but they need to be done in advance in terms of setting up proper entities to avoid this type of heavy tax burden upon sale if you plan to do this again. Consult with a real estate knowledgable CPA.

Let's say you hold onto the property for a year and rent it, and then sell it 12 months exactly later. Capital gains rate is subject to income but maxes out at 20%. If you fall into the 10-15% tax bracket, you pay no capital gains tax.

@David Augustyn ,

Have you done any flips recently, if yes how many ? 

If you are considered a flipper, IRS might look at this transaction sale if one of your flips. 

Installment sale is not allowed for flipping properties. 

I know you had intention to hold, but IRS will collaborate your intention with your past activity. 

@David Augustyn

Short-term capital gains do not get a preferential tax rate.
Short-term capital gains are taxed at your effective tax rate.

Long-term capital gains rate are 0%, 15% or 20%. Add an additional 3.8% tax if you are in the 20% long-term bracket.

capital gain portion of the balloon payment will be considered short-term if the deal was closed within a year of your purchase.