Advice! Sell or rent? Tax burden?

Question

Im looking for advice on what to do?

I bought a condo for 80k in Dec.2018.

My original plan was to rent it out. (after calculations ill cash flow 500.00 monthly)

Ive been working on the property and i had a visitor the other day.

It was a R.E. agent asking to see the unit..i said check it out!

Long story short she came to me with an offer for 155,000.

I will have 10/12k in the renovation. (90k total)

Should i sell within 1 year and take the check or cash flow 500 per month?

How much will i expect to pay in taxes?

Will waiting until after 1 year significantly reduce the tax burden?

Thanks in advance.

Joshua Thompson · Answer

How much you'll pay in taxes would be hard to calculate with the information given. I'm sure one of the tax pros here can give you the max % and you can use that to be safe. As far as I know, because it's a flip I'm pretty sure you'll need to pay SE taxes (15.3%) and ordinary income tax (whatever your tax bracket may be) as well as any depreciation recapture you took in 2018 (this year tax return) which I would assume none because you were probably still in the process of renovating.

You also have to look at what you hope to achieve from investing in real estate. Do you want to make the flip money or build a portfolio with passive income?

Regarding your waiting one year, I believe (and anyone correct me if I'm wrong) if your intent is to flip the property you're still going to need to pay the SE tax. I'm pretty sure no matter what your flip will not be taxed at the capital gains rate but at the ordinary income rate. Not too sure on this one though.

You would also have to look at 5% of the sale price will go to the agent (unless you negotiate it out). However, no matter when you sell it a percentage will be going to the agent.

*Not a CPA, EA or tax professional. Maybe a few more years till then*

Basit Siddiqi · Answer

@Alex BreuerI don't see a scenario where you should be subject to self-employment tax since you mentioned your original intent was to rent it out.Short-term capital gains will be taxed at your marginal tax rate(this is something you can ask your accountant).Long-term capital gains(federal) is either 0%, 15%, or 20%. You may also be subject to the 3.8% net investment income tax.MN will also look for their share as Dave mentioned.With all that is said - no one here can answer how much tax you will pay without knowing your whole scenario. Your accountant should have this information.It looks like you still want to be in real estate after this deal. I would look to doing a 1031 exchange which will save you from having to pay the taxes. You can reach out to @Dave Foster about doing a 1031 exchange.

John Woodrich · Answer

@Alex Breuer talk to your CPA or whomever prepares your taxes, they will know your actual tax rates and tax situation.  In general if you sold within a year your tax rate will be 30%-40% (fed and MN) depending on your marginal rate.  There may also be SE tax consequences depending on your other income.

If you hold it a year your tax rate will be between 22%-30% (fed and MN).

Your tax savings will be roughly 10% if you wait a year, more if you have to pay SE taxes.

On a gain of $60,000 that is roughly $6,000.  Is that worth potential market or tenant risk?  Is the after tax amount enough to change your initial plans?

Alex Breuer · Answer

I would reinvest the money if i sell it. But as for finding another condo/property for 80k around here ..... very unlikely. I was just in the right place at the right time to get it for that price

Steve Vaughan · Answer

They may pay more.  First rule of negotiation is to always flinch at the first offer. Especially an unsolicited one out of the blue.

Express your tax concerns as a reason to tell them "Thank you, but you'll have to do better than that."

Theresa Harris · Answer

@Alex Breuer  If you sold, what would you do with the money?  Could you buy another condo in a similar $80K price point that would rent for a similar amount?

Michael Plaks · Answer

@Alex Breuer

You're asking a tax question when you're dealing with a business question first: keep or sell? I.e. do you want to make a one-time soup out of this chicken or keep her for years of breakfast eggs?

Only if you decided to NOT keep this property, then and only then you ask the tax question.

I love the point brought up by @John Woodrich which is routinely ignored when discussing the 1-yr hold: market risk. While trying to save 10% on taxes, you might lose the deal! Your potential buyer can any day:

• change his mind
• get divorced/fired from his job/sick
• die

The house can burn down or get flooded. The area can be affected by a natural disaster. And so on.

My standard advice to my clients: whenever you decided to sell and have the right buyer - close tomorrow, and deal with taxes later.

Once exception to this rule can be when your gain is big enough to warrant a 1031 exchange already discussed. Still sell ASAP, just make sure to engage an exchange intermediary, like @Dave Foster, before you sell.

Dave Foster · Answer

@Alex Breuer, waiting one year does indeed usually have monster impact on the taxes.  A sale at less than a year classifies it as ordinary income taxed at your ordinary income rate.  If you're in the middle of that it's 24-32%.  Then MN is going to want another 7 - 10%.  And you will probably have to pay self employment and there might still be the ACA 3.8% surcharge (not sure it that's still applicable or not).  In any event that equals - a truck load (industry term).  35-45% is not out of the question.  Which turns a healthy $75K gain into mediocre real quick.

You've got a couple of options however.

1. If you decide to wait past the year mark you could be eligible for capital gains treatment.  This eliminates self employment and that nonsense.  It changes the federal rate to probably 15% and then you're just left with the MN 7-10% on top of that.  So figure 25% ish.  That's a healthy drop.

2. Even better would be if you want to sell and reinvest to do a 1031 exchange.  Since you stated that your intent was to hold the property and you had an unsolicited offer for the property you would be eligible for a 1031 exchange.  The 1031 would defer all that tax and let you use it to purchase new investment property.

3.  Or hold the property and rent it.  $500/month on a $155K asset isn't the greatest return.  But maybe there's other factors that would still make that an attractive hold.

Advice! Sell or rent? Tax burden?

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