Capital Gain into a New Rental

7 Replies

Hi BPs,

If I flipped a property, and use the entire gains from the sale to buy another property but that second property I decided to do buy and hold.

Do i still have to pay taxes on the capital gains from the first property?

Yes if it was simply a flip it is taxed as ordinary income. Buy and hold will give you tax advantages not available for flips.

@John Thedford thank you for your respond. 
I was informed that if we use capital gains from an investment property (buy a property and sell it) if we use that money to buy another investment property. We can wave the taxes. So that's not how it works?

You should note as well for the future- that it is not automatic. Unless you are doing a direct exchange (pretty rare these days) you will need to be working with a qualified intermediary PRIOR to closing on the sale of your property. If you have any questions on 1031's how they work, and the process, feel free to reach out. Considering the benefits of a 1031 the process is actually quite simple and painless. 

@Flavio Espinal

You got some good advice thus far.

As mentioned, the sale of the "flip" will result in ordinary income subject to federal income tax and self-employment tax. It will escape state income tax if you flipped the property in a state that does not charge an income tax.

@Flavio Espinal , The 1031 exchange is the process you are thinking of that allows you to defer tax from the sale of an investment property into a new investment property.  

But you've got two issues here.  First the sale of your flip would not have qualified for a 1031 exchange.  Property that qualifies for a 1031 exchange is property you purchase with intent of holding for productive investment use.  Flips do not count.  So you have to pay the tax on the sale of that old property.  And since it was a flip you'll not be paying capital gains rate.  you will be paying ordinary income tax on the profit which will probably include self employment as @Basit Siddiqi said - Yikes.

Your other issue is that even if the property you sold wasn't a flip you can't DIY a 1031.  You have to use an unrelated 3rd party called the qualified intermediary who documents the 1031 process.  And that QI must be in place prior to the closing of your sale.  

So the takeway for you is that first you want to make your flip qualify for 1031 treatment.  And the way you do that is to not think of it as a flip.  Think of it as a property you want to hold.  And treat it that way.  Instead of fix n flip - fix n rent n revaluate in a bit.  Once you've demonstrated your intent and then decide to sell and buy another property you need to contact a qualified intermediary before you sell your old property.  Then you'll be able to do a 1031 exchange and defer all of the tax and depreciation recapture.

If that slows you down too much you can modify that strategy only a little bit and "voila" you are now a BRRRR investor. Buy rehab rent refinance (use that for your next rehab) and 'r'eally evaluate when the time is right to sell and 1031 that property into another.