Tax strategy advice for flipping/wholesaling

Tax, SDIRAs & Cost Segregation
5yFollow

Tax strategy advice for flipping/wholesaling

Jessica Parker
Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes

Hi fellow BP'ers! So My husband and I are at the very beginning stages of getting our investing career going! We just created an LLC to flip and wholesale out of. We don't need any of the money we will be making from wholesaling or flipping as our current business provides more than enough income to live off of. So we plan on reinvesting everything!

If we re-invest all profits that we make from flipping and wholesaling, will we have zero tax liability for that portion of income at the end of the year? 

We have a plan on moving to the South here in the next couple years...so would we then be able to take whatever our capital is up to at that point and put it all into buying properties in cash or use the money as down-payments on multiple properties and completely avoid any tax?    We would then plan on Refinancing properties to pull our money back out after we rehab them.  I'm just wondering, is this a good tax strategy?  Will we in essence be able to avoid all taxes on that income doing this? 

0Reply
36 views

Most Popular Reply

David M.
Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
5y

@Jessica Parker

Hmm..  In think you need to get a hold of the basics.  The "reinvesting" thing is more of a 'business strategy' than a 'tax thing.'  Think of it this way:  assuming you've invested stocks before, if you purchase then sell some stock for a profit, you have a profit.  If you take that profit and buy some more stock, you still have a profit to report to the irs.  The fact that you purchased more stock doesn't change that for tax purposes.  It just means you don't have any cash because you "reinvested" it.

The concept of "taking money/profits out of the business" only really makes any sense if you have a C Corp.  Most people don't use C Corps because of the double taxation.  All the other legal entities / tax status' are pass through entities.  In this manner, the profits/losses are passed directly to the owners who then have to report those profits/losses on their personal tax returns.

S Corps can be useful to save on the self-employment tax.  However, you really need to making a good deal of income since you have to pay yourself a "reasonable salary" first, then take the rest as dividend/distribution.  Meanwhile, you have more reporting/filing (i.e. more accountant fees) when you have a S Corp.

You mentioned "inventory."  When you are flipping or wholesaling, the IRS considers you to be in the business or trade selling inventory. That is why all the income is active, earned income subject to self employment tax.  If you are investing, e.g. buy and hold rentals, then by definition you have a passive investment which is passive profits/losses and capitals gains/losses when you sell.

1031 like-kind exchanges are only valid for passive investments.

There is a whole bunch here.  I'd be happy to chat with you about all this and any other ideas you have so you are better educated before spending time and money with an accountant.  Just send me a direct message.

Take care, and good luck.

2Reply
See this reply in the discussion

19 Replies

Jump to latestLatest
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y
    Originally posted by @Jessica Parker:

    If we re-invest all profits that we make from flipping and wholesaling, will we have zero tax liability for that portion of income at the end of the year? 

    No, sorry, you will owe taxes. Reinvesting does not cancel taxes. There're some ways to mitigate your tax impact but not erase it. 

    1Reply
  • Tiffany Watkins
    Flipper/Rehabber · Vancouver, WA · Member since 2020 · 22 posts · 3 votes
    5y

    Hey @Jessica Parker I don’t know a lot about taxes but I understand that Michael is correct. Taxes can be mitigated using certain strategies, such as a 1031 exchange. You can look into that but I plan on consulting with a CPA that is knowledgeable in real estate. Also, in my personal opinion, if the interest rates are still low when you move, it might be a more lucrative option to finance the properties with 20% down and invest your cash in other places (stock market, gold, etc.) depending on the rate of returns you could get. 

    1Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Michael Plaks Darnit...I guess I was looking at it in a business stand-point with the houses being inventory like any other product.  Well that's a bummer, I had a feeling it was too good to be true! lol So when you say there are ways to mitigate your tax impact...Are you speaking about 1031 exchanges?  We are thinking about going the S-Corp tax status route to try and save us a bit of money there, with the not having to pay 100% of the self employment tax...

    0Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Tiffany Watkins Thanks for the tips! We currently have a CPA but she is not well-versed in Real estate...so I will definitely need to find another CPA for our real estate dealings! When it's time to move, hopefully we will be able to get several places and then do the BRRRR Strategy to pull all of our money back out! Definitely not a bad idea to diversify a little bit though!

    0Reply
  • Michael PlaksPro Member
    Tax Accountant / Enrolled Agent · Houston, TX · Member since 2014 · 5k+ posts · 6k+ votes
    5y
    Originally posted by @Jessica Parker:

    @Michael Plaks Darnit...I guess I was looking at it in a business stand-point with the houses being inventory like any other product.  Well that's a bummer, I had a feeling it was too good to be true! lol So when you say there are ways to mitigate your tax impact...Are you speaking about 1031 exchanges?  We are thinking about going the S-Corp tax status route to try and save us a bit of money there, with the not having to pay 100% of the self employment tax...

    Business inventory works the same way. If you're selling wine and reinvesting all profits into buying more wine, you still pay taxes on the reinvested profits. Same with flipping houses.

    1031 exchanges are for rental properties, not for flips. Some of the strategies for flippers are choosing one of the two corporate entities, setting up benefits and retirement plans, and doing deals inside retirement plans. S-corps are not necessarily helpful, it depends. Sometimes they can actually be counterproductive.

    I'm biased of course, but in real estate business you probably need a real estate accountant.

    2Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Michael Plaks Yes, Oh ok, I totally see what you are saying!   

    Good to know all this!  I have so much to learn still! It can really be a bit overwhelming at times!  

    I most definitely need to see if I can find a good real estate CPA!  Thanks so much for your advice! 

    1Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Jessica Parker

    Hmm..  In think you need to get a hold of the basics.  The "reinvesting" thing is more of a 'business strategy' than a 'tax thing.'  Think of it this way:  assuming you've invested stocks before, if you purchase then sell some stock for a profit, you have a profit.  If you take that profit and buy some more stock, you still have a profit to report to the irs.  The fact that you purchased more stock doesn't change that for tax purposes.  It just means you don't have any cash because you "reinvested" it.

    The concept of "taking money/profits out of the business" only really makes any sense if you have a C Corp.  Most people don't use C Corps because of the double taxation.  All the other legal entities / tax status' are pass through entities.  In this manner, the profits/losses are passed directly to the owners who then have to report those profits/losses on their personal tax returns.

    S Corps can be useful to save on the self-employment tax.  However, you really need to making a good deal of income since you have to pay yourself a "reasonable salary" first, then take the rest as dividend/distribution.  Meanwhile, you have more reporting/filing (i.e. more accountant fees) when you have a S Corp.

    You mentioned "inventory."  When you are flipping or wholesaling, the IRS considers you to be in the business or trade selling inventory. That is why all the income is active, earned income subject to self employment tax.  If you are investing, e.g. buy and hold rentals, then by definition you have a passive investment which is passive profits/losses and capitals gains/losses when you sell.

    1031 like-kind exchanges are only valid for passive investments.

    There is a whole bunch here.  I'd be happy to chat with you about all this and any other ideas you have so you are better educated before spending time and money with an accountant.  Just send me a direct message.

    Take care, and good luck.

    2Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @David M. Thank you so much!  That definitely helps and makes sense! 

    At what income does an S-Corp make sense?  I'm debating if I should go ahead and file for S-corp status now or if I should hold off. I'm hoping once we start flipping we will be doing at least 2 our first year...then hopefully it will expand to more after we get our feet wet.  

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Jessica Parker

    Yeah, there isn't exactly an easy answer to that...  Its a cost/benefit analysis.  It'd be easier talk to talk about it over the phone...

    In short, you are really just saving the 15.3% FICA/SE tax (having brainfart right, but as I recall its both sides).  For the sake of argument, let's just say you determined the "reasonable salary" you pay yourselves is $30k a piece.  So, the first $60k you have to pay FICA/SE and payroll taxes.  Then, lets say you have a total of $160k of profit, so $100k isn't subject to payroll.  So, you'll save about $15k in taxes, but you have the filing/preparation fees related to having a S Corp thatyou'll be having an accountant take care of.

    The point is you really need to seriously be making a consistent, fair amount of profit to make it worthwhile for the S Corp.  Furthermore, it depends on what you think you can "get away with" for a reasonable salary.  $30k is basically min. wage.    I somehow don't think that would be reasonable, but I've never done this or seen it done.  I think $50-$60k is median salary/wage in the US.  Again, that means if each of you is doing that, you don't start saving on the FICA/SE taxes until after your first $100k-$120k.  Meanwhile, you have greater accounting/filing costs associated with the S Corp.

    Furthermore, what sort of REI will you be doing in the long run? Its usually not advisable to hold property long term in a S Corp. Don't forget, you can always elect S Corp taxation (N.B. S Corps aren't legal entities---they are a tax status elected by a legal entity such as a LLC or C Corp) later. So, get started and if you are making money, you can elect the status in the middle of the tax year.

    Work it out with a qualified professional or two on the details.

    Good luck.

    1Reply
  • Basit SiddiqiBusiness Member
    Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
    5y

    @Jessica Parker

    Flipping and wholesale are activities that normally generate ordinary income. 
    You mention that you and your husband make decent income to live off of, without knowing all your details, this may make the income you generate from wholesaling/flipping at the higher tax brackets.

    An S-corp may or may not make sense.
    S-corp normally is used to help by saving on self-employment taxes.
    If you and your husband make above the social security base($137,700 in 2020), then the tax savings from the S-corp will only be the medicare portion.

    [email protected]917-280-8544
    Basit Siddiqi CPA4.979 Reviews
    View Page
    0Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Basit Siddiqi Thanks for the reply!  I'm still unsure what will be best for us, I'm leaning towards S-Corp status..but not sure how much we will generate our first year if it will be worth it or not!  Luckily with our current business we have a lot of write offs that help bring down our taxable income! 

    0Reply
  • Don Ireland
    Holts Summit, MO · Member since 2016 · 63 posts · 9 votes
    5y

    @David M. But there is no need to put BOTH of them on payroll which should cut the SE Tax in half. Correct?

    0Reply
  • Don Ireland
    Holts Summit, MO · Member since 2016 · 63 posts · 9 votes
    5y

    @Jessica Parker you don't have to make that determination up front. Leave it as pass through until you've started earning enough to justify it.

    Go on YouTube and do a search for Kohler S-Corp. Mark Kohler does LOTS of videos and talks about this kind of stuff.

    1Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Don Ireland

    Hmm...  my understanding is each shareholder of a S Corp must be paid a “reasonable salary” per irs rules.  The exception is if they are a “silent partner” which I thought had to have less tha 5% holding or something...  

    So, one spouse would have to take a bona fide “silent” role to achieve what you are asking, assuming both are owners of the company being taxed as an S Corp to my understanding

    0Reply
  • David M.
    Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes
    5y

    @Don Ireland

    Oh, and LLC and S Corp are both considered pass through entities.

    0Reply
  • Don Ireland
    Holts Summit, MO · Member since 2016 · 63 posts · 9 votes
    5y

    @David M. Thanks for clarifying that for me. As to the pass thru issue, I know S Corp is pass through. I guess I should have said sole prop.

    0Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Don Ireland as of right now we are considered a single member LLC which in the state of Washington, being married allows us to do that. So not sure if that is more beneficial than s-corp would be? Because, I think, if i understand it correctly.. we'd just be taxed as one person?

    0Reply
  • Jonathan Tavarez
    Flipper/Rehabber · Laurel, MD · Member since 2016 · 139 posts · 109 votes
    5y

    @Jessica Parker If you have the cash to buy properties and you are trying to find a way to grow and keep as much off that money without getting kill with taxes you should focus on rentals and not flips or wholesaling.  With rentals you can write off many expenses plus depreciation, something you don't get with flips or wholesale, specially if you are already in a high tax bracket.  Get a lawyer and an accountant with a real estate background (there are plenty of them here in BP) and a good realtor, from there build a solid strategy before you start buying.  Best of luck!

    1Reply
  • Jessica Parker
    OP
    Realtor · Navarre, FL · Member since 2014 · 156 posts · 55 votes
    5y

    @Jonathan Tavarez Thanks for the reply! We are kind of trying to get out of our current business and go full time in real estate, I figured the fastest way is to start flipping! We definitely have long term goals of buying rentals and using the BRRRR strategy!

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free