Income Tax for Real Estate Developer

United States · Member since 2018 · 7 posts · 2 votes

Hello Guys,

Let's assume I managed to purchase a land for $ 100 k and I build a 10 unit apartment complex ( construction cost = $ 900 k), and let's say it takes me 2 years to complete the project (The ROI is 100%). Then I decide to sell 5 units of this project and I net $500 k after all expenses, but I decide to keep the other 5 units for more than a year. As far as I'm aware, I have to pay regular income tax on the $ 500k. After a year, I decide to sell the rest of the units and I net another $ 500 k. Can I pay capital gain on this $ 500 k or I still have to pay regular income tax on it? (which is going to be about 20% based on my income tax bracket)?

Please clarify this scenario for me.

Thank You

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Michael PlaksPro Member

Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes

@Navid T.

This is a great question, but it does not have a simple answer. It really needs an in-depth discussion with a tax expert specializing in real estate.

There is a major distinction between a developer and an investor for tax purposes:

Developer buys, subdivides, maybe builds and sells. He pays what you call regular income tax PLUS 15% self-employment tax (Soc Security/Medicare). Combined, it can be anywhere between 15% and 40%. Will be eligible for the new 20% deduction.

Investor buys, waits for time-based appreciation, usually rents, and ultimately sells. She pays long-term capital gains of 15% and no SE tax. (For full disclosure, the 15% can go up to 24% for higher-income folks.) In addition, she pays 25% on the depreciation recapture. Not eligible for the new 20% deduction.

The trick is determining whether the second part of your deal qualifies for the investor treatment. It is a grey area with many gotchas and a long history of litigation between taxpayers and the IRS. There're also some tax planning strategies designed to fortify your investor position. Like I said, this is not for a quick online answer.

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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
8y
@Navid T.
Where did $900k come from -you or a loan? When were the units you sold completed? you need to sit with your accountant and get the specifics laid out. Are you the developer? Contractor? Etc all that applies as to when and what income you use. Your numbers tell me you didn’t make any money thus you owe no taxes. You put in a million and you got back a million. What am I missing?
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
@Navid T.
This is a great question, but it does not have a simple answer. It really needs an in-depth discussion with a tax expert specializing in real estate.
There is a major distinction between a developer and an investor for tax purposes:
Developer buys, subdivides, maybe builds and sells. He pays what you call regular income tax PLUS 15% self-employment tax (Soc Security/Medicare). Combined, it can be anywhere between 15% and 40%. Will be eligible for the new 20% deduction.
Investor buys, waits for time-based appreciation, usually rents, and ultimately sells. She pays long-term capital gains of 15% and no SE tax. (For full disclosure, the 15% can go up to 24% for higher-income folks.) In addition, she pays 25% on the depreciation recapture. Not eligible for the new 20% deduction.
The trick is determining whether the second part of your deal qualifies for the investor treatment. It is a grey area with many gotchas and a long history of litigation between taxpayers and the IRS. There're also some tax planning strategies designed to fortify your investor position. Like I said, this is not for a quick online answer.
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Navid T.
OP
United States · Member since 2018 · 7 posts · 2 votes
8y
Can you explain the new 20% deduction ?
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
Originally posted by @Navid T.:

Can you explain the new 20% deduction ?
Most businesses get to deduct 20% of whatever is left after all deductions, including depreciation.
For the majority of landlords, it will change absolutely nothing, as they show losses after depreciation.
Interest and capital gains do not count.
For a wholesaler, here is an example.
- All assignment fees for the year are $100k.
- Marketing is $20k.
- Driving is $15k.
- Supplies, cell phone etc $3k
- Home office $2k.
- His 20% deduction is $12k (20% of what is left)
- His actual tax savings are maybe $4k.
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · Sarasota, FL · Member since 2017 · 5k+ posts · 3k+ votes
8y
Originally posted by @Navid T.:
Hello Guys,
Let's assume I managed to purchase a land for $ 100 k and I build a 10 unit apartment complex ( construction cost = $ 900 k), and let's say it takes me 2 years to complete the project (The ROI is 100%). Then I decide to sell 5 units of this project and I net $500 k after all expenses, but I decide to keep the other 5 units for more than a year. As far as I'm aware, I have to pay regular income tax on the $ 500k. After a year, I decide to sell the rest of the units and I net another $ 500 k. Can I pay capital gain on this $ 500 k or I still have to pay regular income tax on it? (which is going to be about 20% based on my income tax bracket)?
Please clarify this scenario for me.
Thank You
@Michael Plaks gave you good info.
Without knowing the status of the project, I would like to add that you might be able to save some taxes if you sell your land to a closely held S-corp.
if you dont do that, the appreciation in the land will be taxed as ordinary. However, if you plan carefully, and sell the land to s-corp that will build the apartment, the appreciation in the land will be treated as capital again.
I am giving you toned downed and a very general tip. It needs to be discussed in detail with you professional. Dont forget to bring it up because of most professional miss this.
Good luck.
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Michael PlaksPro Member
Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
8y
Yeah, @Ashish Acharya ventured into those tax planning strategies I vaguely referred to.
Slightly dangerous without a thorough discussion, which is why I stopped at the door.
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