Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
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?
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.
Boston, MA · Member since 2017 · 95 posts · 29 votes
8y
@Andrew Flora I’m in a similar situation with my flip profits and can’t rent it out cuz that wouldn’t make sense with my hard money financing and inability to convert to conventional financing since I don’t have w2 income. The only way I can see is a self directed solo 401k to defer some of the taxes and then eat the rest of the tax hit....
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
8y
Passive income doesn't mean you didn't 'lift a finger', passively sitting in your pajamas while stroking checks to contractors. Funniest thing I've read in a long while.
Passive income is when the asset earns the income. Not you. By improving it and selling for more quickly as inventory, you earned it.
Rentals are passive because the property is generating the income, even if you're like me and DIY. I may not have a passive day some days because I 'lifted a finger' but my income is passive.
Anyway, SE taxes can be mitigated like people so generously mentioned. Maybe have an LLC taxed as an s-corp and separate earnings and dividends.
Investor · Detroit, MI · Member since 2016 · 211 posts · 144 votes
8y
I forget which election will not demand you pay self employment tax, but it's either the S Corp election of the C corp election for taxation as an LLC. Look it up, you should find an explanation.
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
8y
@Gilbert Dominguez "I forget which election will not demand you pay self employment tax, but it's either the S Corp election of the C corp election for taxation as an LLC."
You're still paying FICA through an S Corp. One of the defining characteristics of an S Corp is that owner-employees must be paid 'reasonable compensation' and issued a W-2.
That said, the self-employment tax savings comes from the disparity between reasonable compensation and total net taxable income without considering reasonable compensation.
@Rich Hupper An S Corp or C Corp might make sense. Speak with a tax CPA/EA who will discuss your facts, circumstances, goals, current net income level, and projected growth.
Investor · Detroit, MI · Member since 2016 · 211 posts · 144 votes
8y
@Eamonn Mclroy, thank you for chiming in and elaborating. I actually just looked that up a few days ago because I have the same concern over self employment tax but I did not recall all of the details. I am a management consultant to an LLC and I was actually researching the new tax law with regards to my capacity in running a manager managed LLC and for some reason I decided to also look up self emploment tax regarding LLC members and I came across this issue.
Real Estate Agent · Jacksonville, FL · Member since 2015 · 1k+ posts · 1k+ votes
8y
I may be stating the obvious, but accounting for every detail is worth the time. It will lower the amount of tax you pay as you will account for making less.
1. Miles and travel looking at properties.
2. Up front expenses - inspections
3. All costs from suppliers and vendors
4. Property tax
5. Insurance
6. Mortgage interest points, fees,
7. Did your kids help?
8. Selling fees, RE agent, closing help
I thought about depreciation, but you would have to recapture it upon sale. It might be a good strategy if you cross years.
Rental Property Investor · Fort Collins, CO · Member since 2008 · 168 posts · 105 votes
8y
@Rich Hupper They'll be taxed at the ordinary income tax rate. The KGB looks at rehabbing and selling like a business and not an investment like a rental property...unless I've been doing something wrong! haha
OR you've been talking to a RE guru pitching you on how to flip with your IRA or something...
Real Estate Broker · Dayton, OH · Member since 2010 · 245 posts · 186 votes
8y
Geez, there's a lot of misguided advice on this thread. For starters, you can't 1031 a short-term flip. @Rich Hupper the accountants who have responded here have given you a good starting point. Ditto for the comments about contributions to retirement plans.
I'll echo what @Eamonn McElroy said, albeit more bluntly: No one can give you a solid answer without looking at your entire financial picture and future goals. Anyone who claims they can do so otherwise is full of it. The old adage about getting what you pay for extends to free advice - and often free advice turns out to be the most expensive kind.
Pay a CPA who also invests in real estate (and by "invest", I mean they've done more than buy a couple rental houses) for an hour or so of their time, and then set up the appropriate structures. Also, do it now, because if you wait until tax time, some of your options for the 2018 tax year will be gone.
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
8y
@Christina Carey "Also, do it now, because if you wait until tax time, some of your options for the 2018 tax year will be gone."
Good advice, however it's unlikely that a CPA will take on a new client consulting engagement before 10/15 at this point in time. We're well focused on wrapping up 2017 tax year compliance work right now. Might be worth it to reach out now with the expectation of a late October or early November consult.
Broker / Investor · Tewksbury, MA · Member since 2008 · 1k+ posts · 351 votes
8y
@Andrew Flora thats a great point too. The only thing is I am not sure I would be able to get a cash out loan on the property. The two flips I did were single families. Do you know if there are any lenders that look only at the property for the guarantee on the loan? Or do all lenders want a personal guarantee as well?
@An Duong this is my problem I need to pay back my lender as soon as the property is finished.
@Steve Vaughan thanks for the comment, i can't tell if you are being condescending or not...
Boston, MA · Member since 2017 · 95 posts · 29 votes
8y
@Rich Hupper The good think about solo 401k is that you can borrow against it penalty and tax free to fund your deals. (Typically 50k or 50% of the solo 401k balance whichever is smaller)
@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.
Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
8y
Hard to rely on any tax or legal advice that is free. Your tax calc of 40% is probably short - you are not including state taxes...
There are ways to structure things to limit the amount of SE tax one pays on flips, but there are administrative costs to doing so also. Corporate return, quarterly payroll returns, payroll deposits, annual reporting, etc. Talk to your tax adviser and they should be able to talk you through the cost/benefit. We all want to save money on taxes but sometimes it doesn't make sense. At the same time this isn't a good area for an internet warrior to work on their research skills in hopes of avoiding professional fees...
Sounds like you have some banking questions also. Banks aren't going to consider a flip as normal income until you prove that it is normal income though a couple of years of experience. This also requires paying taxes on all income.
Attorney · Fort Worth, TX · Member since 2015 · 372 posts · 176 votes
7y
You may want to discuss with your CPA converting your entity for flips (you did do your flips in an LLC or other liability shielding entity, right?) into being taxed as an S-Corp. It won't shelter all of the gains from SE tax, but may shelter a portion of the gains.
You also should not be doing flips in an entity that holds your rentals and vice versa as they often should elect different tax regimes.
Rental Property Investor · Seattle, WA · Member since 2018 · 129 posts · 163 votes
7y
@Dmitriy Fomichenko
Is the 55K limit based on NOI or gross proceeds?
I thought all gains an rental income that a solo 401k owns is tax deferred. Only distributions are taxed as normal income?
Solo 401k Expert · Anaheim Hills, CA · Member since 2012 · 18k+ posts · 6k+ votes
7y
@Account Closed
For 2018 Solo 401k contribution limit is $55,000 (plus $6,000 catch up for those who are over 50 making total $61,000). Contributions are based on net compensation.
Yes, you are correct, all gains and incomes from passive investments are tax deferred until distribution.
Distributions from Roth 401k are tax-free if you meet the criteria.
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
7y
@Account Closed
With a Solo 401(k), depending on your salary and age, you could contribute $55,000 per year or $61,000 for those 50 or older in 2018.
Solo 401k contributions are based net- income from self-employment.
The business owner acts in both capacities in a solo 401k plan: employee and employer. As such, the business owner can make both contribution types: employee and employer.
The annual solo 401k contribution calculation depends on the type of entity sponsoring the solo 401k plan.
If the entity type is a Sole Proprietor, the starting figure for calculating the annual solo 401k contribution is line 31 of Schedule C(after deducting one-half of self-employment tax).
If the entity type is a C-Corporation, the starting figure for calculating the annual solo 401k contribution is income.
If the entity type is an S-Corporation, the starting figure for calculating the annual solo 401k contribution is W-2income.
If the entity type is a Partnership, the starting figure for calculating the annual solo 401k contribution is line 14 (after deducting one-half of self-employment tax).
The self-directed 401k contribution deadlines are based on the type of entity sponsoring the solo 401k.
If the entity type is a Sole Proprietorship, the annual solo 401k contribution deadline is April 15, or October 15 if tax return extension is timely filed.
If the entity type is an LLC taxed as an S-Corporation (calendar year), the annual solo 401k contribution deadline is March 15, or September 15 if tax return extension is timely filed.
If the entity type is an LLC taxed as a Partnership (calendar year), the annual solo 401k contribution deadline is March 15, or September 15 if tax return extension is timely filed.
If the entity type is a Partnership (calendar year), the annual solo 401k contribution deadline is March 15, or September 15 if tax return extension is timely filed.
If the entity type is an S-Corporation (calendar year), the annual solo 401k contribution deadline is March 15, or September 15 if tax return extension is timely filed.
If the entity type is an C-Corporation (calendar year), the annual solo 401k contribution deadline is April 15, or October 15 if tax return extension is timely filed.
Correct that gains from investments will flow back to the solo 401k and grow tax deferred, or tax free in the case of a Roth solo 401k designated account.
Distributions would be tax free if taken from the Roth solo 401k designated account provided you are age 59 1/2 and have had the Roth solo 401k designated account for at least 5 years.
Contractor · Atlanta, GA · Member since 2018 · 32 posts · 14 votes
7y
@Rich Hupper What did you do with the profits? If it was already spent on personal living expenses, then you already determined the taxation. If you still have it, spend it with a strategic deduction in mind to offset the tax liability.
Perhaps you would know the answer to this question. Why not elect the llc as a c corp. Do not pay the owners a dividend or a salary. It is my understanding C corps are not pass throughs. Pay federal and state taxes but avoid the self employment tax. All I want to do is reinvest the profits into real estate anyways. Wouldn't this also be beneficial from a borrowing stand point to show the LLC had profits and paid taxes?
Accountant · Atlanta, GA · Member since 2015 · 1k+ posts · 1k+ votes
7y
@Rich Hupper "Why not elect the llc as a c corp. Do not pay the owners a dividend or a salary."
Subchapter G.
If the personal holding company tax (IRC Sec 541-547) doesn't bite you the accumulated earnings tax (IRC Sec 531-537) will.
The IRC strongly disincentivizes C Corporations to accumulate earnings & profits in excess of bonafide business needs. C Corps are currently designed to distribute earnings either via salary or dividends.