Two flips this year how to avoid self employment tax

Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes

I bought two properties this year and sold them for a profit. It is my understanding the profit from those flips will be treated as active income and subject to self employment tax. However I didn't even lift a finger to "flip" the property. All i did was buy the property and pay contractors for the work they did. All of my income this year was 1099 income from commissions except the two flips.

Are there any creative ways to avoid self employment tax on the flips by turning the profit from those flips into passive or portfolio income?

Thanks

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Dmitriy Fomichenko

Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes

@Rich Hupper,

Consider establishing Solo 401k plan, which can allow you to shelter up to $55,000 of your income per year into a retirement account. You could double the amount you can shelter if you are married and get your wife involved in your business.

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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
8y
if there is I am not aware of it..
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Jay Hinrichs
Okay thank you Jay.
That's too bad considering it is not part of my normal day to day business operations.
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
8y
Originally posted by @Rich Hupper:

@Jay Hinrichs
Okay thank you Jay.
That's too bad considering it is not part of my normal day to day business operations.
flipping is inventory.. the way others would do it.. is to buy it with the intent to rent it.. get them rented hold them a year or little longer then sell them but have one year on your tax return showing rental income and depreciation.
if its quick flips.. it just is what it is.. make good money pay your tax's
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Ashish AcharyaBusiness Member
CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
8y
Originally posted by @Rich Hupper:

Hi
I bought two properties this year and sold them for a profit. It is my understanding the profit from those flips will be treated as active income and subject to self employment tax. However I didn't even lift a finger to "flip" the property. All i did was buy the property and pay contractors for the work they did. All of my income this year was 1099 income from commissions except the two flips.
Are there any creative ways to avoid self employment tax on the flips by turning the profit from those flips into passive or portfolio income?
Thanks
If you made more than $40k, you might be able to avoid SE on anything above that with S-Corp.
Do you already have a LLC? You need to talk to a professional on how to and effective what date to get your s Corp based on the date of sale.
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Ashish Acharya
I do have an LLC. but it does not have an operating agreement yet. I will speak to the accountant.
@Jay Hinrichs I am guessing that would turn it into passive income?
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Dmitriy Fomichenko
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
8y
@Rich Hupper,
Consider establishing Solo 401k plan, which can allow you to shelter up to $55,000 of your income per year into a retirement account. You could double the amount you can shelter if you are married and get your wife involved in your business.
10 Reply
Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Dmitriy Fomichenko Yes I will definitely reach out to you about that as soon I can afford it.
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
@Rich Hupper
Generally a flip that you do (even if you pay others to do the work) is considered earned income and results in SE taxes. If you lend money to others who are doing the flip, your interest income on the other hand is generally passive resulting in no SE taxes.
As suggested, splitting wages and distributions with an S Corp can help and renting the property before selling can too. As far as the Solo 401k, some providers allow you get started with a very small fee upfront. You might want to call around and see what your options are.
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George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
8y
@Rich Hupper
You will want to find that sweet spot where contributing to the solo 401k makes sense since contributions will be based on net self-deployment income.
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Carl FischerPro Member
Rental Property Investor · Ambler, PA · Member since 2015 · 2k+ posts · 1k+ votes
8y
@Rich Hupper
Get a tax advantages plan now or look harder at your expenses if you aren’t saving money.
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Gilbert Dominguez
Investor · Detroit, MI · Member since 2016 · 211 posts · 144 votes
8y
Flipping is self employment and simply renting it before one year will usally also not fly. If you filp something which was already rented when you bought it and can show some consistency in intent and also rent for over one year then you can say your intention was always to purchase an investment and earn passive income otherwise it is in fact self employment even if you are not the one who does the work.
I believe the self employment tax is between 15% and 16% if you can hire yourself out as a management consultant to your LLC then you can claim under the new tax law a 20% deduction off of income off the top . You will still be subject to self employment tax but it will be neutralized by the 20% you get to deduct in the first place but I would consult an attorney on this matter. I am presently consulting an attorney on this matter as well. This would require the LLC either does not have anything left because of what is pays you or you will show very little earnings by the LLC and most of the earnings by you , the Business Consultant.
Either way you have to show it was always your intent to rent the place so that you would earn rental income in order to get out of the self employment tax. Check out the new tax law changes thanks to Donald Trump. Maybe the guy is not 100% bad after all, heheheheh :)
You cannot ever put the place up for sale before you claim it as an investment otherwise the IRS will be of the opinion that you simply rented the place out because you could not sell it and it was always your intent to sell it. (self employment tax due, thank you).
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Gilbert Dominguez this is interesting. thank you for bringing it to my attention. Self employment is 15.3% on top of the 25% bracket I will be in this year.... 40.3%.
@Justin Windham Thank you
@George Blower thank you
@Carl Fischer thanks
Does anyone in this thread have an issue getting financing if you are self employed. I have had multiple lenders telling me my net income is not high enough despite my great credit and almost non existent debt.
Is anyone aware of a legal entity that does pass income through to the owners and would avoid self employment tax that way?
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Caleb Heimsoth
Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
8y
@Rich Hupper. Pretty sure rental income doesn’t have self employment taxes
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Caleb Heimsoth yes I hoping the flip income would be considered because I did not invest any time of my own into renovating it, everything was sub'd out. It is also not part of my normal course of business.
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Caleb Heimsoth
Rental Property Investor · Durham, NC · Member since 2016 · 7k+ posts · 7k+ votes
8y
Originally posted by @Rich Hupper:

@Caleb Heimsoth yes I hoping the flip income would be considered because I did not invest any time of my own into renovating it, everything was sub'd out. It is also not part of my normal course of business.
If you elect to have your llc taxed as a S-Corp I believe profits aren’t taxed unless you take the money out of your llc as a distribution.
Consult a cpa
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Vinay H.
Cambridge, MA · Member since 2017 · 268 posts · 247 votes
8y
You avoid self employment taxes by booking gains in an LLC and distributing profit as dividends to shareholders.
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Vinay H.
So if the llc does not distribute profits to the owners it won't have to pay self employment tax?
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
Originally posted by @Rich Hupper:
@Vinay H.
So if the llc does not distribute profits to the owners it won't have to pay self employment tax?
No, this is not true since LLCs are pass-through entities. Ditto with S Corps, but income can be split between wages (with SE tax) and distributions (without SE tax). A CPA can help you with this.
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Justin Windham would you happen to know of any entities which are not pass throughs?
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
@Rich Hupper
C Corporations
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Vinay H.
Cambridge, MA · Member since 2017 · 268 posts · 247 votes
8y
Originally posted by @Justin Windham:

Originally posted by @Rich Hupper:

@Vinay H.
So if the llc does not distribute profits to the owners it won't have to pay self employment tax?
No, this is not true since LLCs are pass-through entities. Ditto with S Corps, but income can be split between wages (with SE tax) and distributions (without SE tax). A CPA can help you with this.
LLCs can elect to be taxed as C Corp
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
Originally posted by @Vinay H.:

Originally posted by @Justin Windham:
Originally posted by @Rich Hupper:
@Vinay H.
So if the llc does not distribute profits to the owners it won't have to pay self employment tax?
No, this is not true since LLCs are pass-through entities. Ditto with S Corps, but income can be split between wages (with SE tax) and distributions (without SE tax). A CPA can help you with this.
LLCs can elect to be taxed as C Corp
That's true.
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Justin Windham
Thank you. So when it comes to lenders lending to entities without a personal guarantee the only entity that can achieve this is a C corp?
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Justin WindhamPro Member
Banker · Nationwide · Member since 2015 · 4k+ posts · 1k+ votes
8y
@Rich Hupper
No, not necessarily. Whether a lender will require a personal guarantee is not solely dependent on the borrower entity type. For example, many self-directed IRAs and Solo 401k plans receive non-recourse loans without the accountholder or participant signing a personal guarantee.
Usually the LTV is limited on deals in which the lender will not require a personal guarantee. Not all lenders offer these programs, however.
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Rich Hupper
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Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
Thanks @Justin Windham
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