Income taxe planning on owner financed wholesale/flips

Tax, SDIRAs & Cost Segregation
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Income taxe planning on owner financed wholesale/flips

Mike W.
Member since 2019 · 11 posts · 1 vote

New to the board here but have been reading for years. I am a seasoned (25 year) real estate investor and broker. I have searched this forum for answers and discussions but have not found anything so here goes...

For all of you wholesale real estate guys who specialize in owner financing, especially the land guys who now are so common, how do you handle your income taxes on the sale? My CPA has always indicated that as a land dealer, I lose the ability to 1) 1031 and 2) treat the sale as an installment sale for tax purposes. In other words even if I owner finance for 3-5 years, I have to pay the entire tax nut in the year I sell.

In this case, just as an example, if I buy a 15,000 lot for $1000, sell it for $6,000 and owner finance it, I will owe taxes on roughly $5000 in profit or $2000-$2500 in taxes. If I get little down payment and low monthly payment as many of the land wholesalers do, my annual cash flow will be negative  potentially depending on payment amount and when I start getting payments and when taxes are due.

My question is this, are all you  owner financing wholesalers  paying the income tax in the year of sell even if owner financed and how do you handle this unless you are starting out with a ton of cash?

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    7y

    @Mike W.

    Land/real estate is considered inventory to dealers.

    Inventory does not qualify for installment sales.

    You would have to change your intent to get the benefits of installment sales/1031.

    [email protected]917-280-8544
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  • Mike W.
    OP
    Member since 2019 · 11 posts · 1 vote
    7y

    I am very well aware of the rules thus the reason I asked the question.

    Are the guys who claim to be doing 5,10,20 deals per month and owner financing them really doing that many deals,  they cash heavy to start with, or are they ignoring the tax rules, This is my question.

    In my experience, I cannot get ahead of the tax curve if I keep owner financing with low down payments especially considering I have to pay for marketing, closing costs, etc.  Even if the deal closes in January, assuming payment of estimated taxes, the is a revolving door of first year properties that I owe taxes on and not enough cash flow to cover them on top of everything else. Nobody every mentions this which is why I am wondering if the owner financing guys are really doing as many deals as they say.

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  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    7y

    @Mike W.

    No one is going to admit ignoring the tax rules. Even if they are ignoring the tax rules shouldn't mean that you should start ignoring them.

    Are you able to increase the low down payment? Would you be better off doing a lease-option?

    [email protected]917-280-8544
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  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    7y

    @Mike W.

    Bad news: the problem is very real, as the tax law does prohibit installment sale treatment for "inventory" property. Inventory is not clearly defined though, so there's some room for debate. Multiple deals per month is clearly inventory.

    More bad news: I'm at war with OF gurus and their CPAs who pretend this is not a problem, based on their irresponsible position of "the IRS never raised this issue in my XX years of doing this." They cannot provide any court case supporting their position. While I can show court cases where the IRS won.

    Good news: in your situation, it's NOT an issue. Dealers of unimproved residential lots are an exception. You ARE allowed to use installment sale treatment.

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  • Mike W.
    OP
    Member since 2019 · 11 posts · 1 vote
    7y

    Basit Siddiqi, No, I have no intention of following the herd on tax treatment just because they say it can be done. I have always been a stickler on tax laws, in fact, I am probably overly conservative. I am a long term investor, not a flipper or wholesaler. I prefer lease income over gains. That being said, I occasionally let something go that does not meet my long term criteria anymore and since I am an active, licensed broker, that pushes me even closer to "dealer" status even though on volume alone I don't think I qualify but that is neither here nor there as I am not going to change that status.

    What I am interested in Michael Plaks, is the devinition of "unimproved residential lots". I am not aware of this distinction as far as installment treatment and would like to learn more. When I do sell land, it is generally larger acreage tracts, 10-100 acres+. I assume this would not qualify for the exemption you are referring to? I would like to be able to mention it to my CPA if there is any way you could point me to specific language in the code that could help me.

    Thanks for your assistance!

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