lets talk taxes

Rehabbing & House Flipping
13yFollow

lets talk taxes

James Friedrichsen
Dover, DE · Member since 2012 · 26 posts · 0 votes

Ok investors, I've been trying to wrap my head around all these different taxes that rehab/flipping businesses are subject to....cant anyone put the different types into laymans terms or at least point me in the right direction. I want to understand these so I can have my ducks all in a row. Thanks

0Reply
30 views

Most Popular Reply

Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
13y

Fix and flipping (and wholesaling) is exactly like a retail store. Or, more accurately, like a manufacturing business. You buy raw materials (junky houses, building materials), put in labor, and then sell your finished product. The net income (the price you sell it for less all costs) is taxable. Because this is a self employeed business, you're subject to three taxes:
1) Federal income tax - this is just ordinary income
2) State income tax, if your state has one - same as for federal. Life gets more complex if you live in one state and rehab in another. You'll pay tax in both.
3) Self employment tax - this is medicare and social security. From a regular job, you pay half and your employer pays half. Since you're self employed, you pay both halves. There are ways to organize your company than can turn some of the income into dividends and avoid this tax on the dividends. But it assume you're making more than would be a reasonable salary for the job you're doing.

Rentals are taxes on net rental income. The $1000 from a rental in your example, Anthony O is the revenue. From that you subtract all your expenses, the interest you pay and depreciation. If that's a positive number (it should be, on good rentals), that net amount is just ordinary income and subject to the same taxes as above.

Capital gains tax comes into play when you sell an investment. Rentals are investments. Fix and flips are not - they're inventory. Taxes on sales of rentals are a complex topic, and I don't think it comes into play for James Friedrichsen.

Nope, doesn't matter. Its still inventory. This wouldn't survive an audit.

4Reply
See this reply in the discussion

30 Replies

Jump to latestLatest
  • Eric M.
    Flipper/Rehabber · Louisville, KY · Member since 2008 · 1k+ posts · 1k+ votes
    13y

    I don't really know what you mean. It isn't different from any other business. If you make income, you pay tax on the income. You deduct your expenses and you pay tax on the net.
    Of course, exactly how you pay that tax depends on the business entity you form but again that is no different from any other business.

    As far as specific real estate stuff, you pay property tax when you own property. Same as anyone. In some areas, you pay a transfer tax when you buy and sell a property. Same as anyone.

    I don't think I know of any special taxes that flippers are "Subject to" that any other business is not.

    I guess you have to be more specific with your question.

    In my general business experience, if you spend more time concerned with generating income and less time worried about the tax you'll pay on that income, you end up further ahead.

    0Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    Thanks for your input...im new trying do my research and really unfamiliar with any taxes I also see like a capital gains tax as well and some other jargon...like I said if I could be directed to a place or give insight on business taxes...just trying to learn

    0Reply
  • Scott W.
    Real Estate Investor · chicago, IL · Member since 2012 · 1k+ posts · 231 votes
    13y

    you have short-term & long-term capital gain taxes. if the short-term capital gains tax says you have to wait 12 months before seeling a house, you are taxed 15% (instead of your federal tax bracket of, say 20 something %.

    so if it took you 11 months to rehab, i'd wait 32 days until I'd sell - resulting in more $ in your pocket.

    0Reply
  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    13y

    James Friedrichsen, like Eric said your income from the flipping business will be treated as most other businesses. The income is ordinary income because you are like a retail store pulling property off your store shelf.

    Inventory is not eligible for special capital gains treatment.

    You also will be subject to self employment tax on the net income from the business. SE is essentially social security / medicare.

    A flipping business is treated differently than someone renting out real estate. The rental activity generally is not subject self employment tax. Rental income though is ordinary income. When the real estate is sold it will be eligible to capital gains treatment though subject depreciation recapture rules.

    1Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    ok so you're saying that if im not renting it out it wont be capital gains? it would be like buying from a wholesaler or distributor and resaling as retail(like your example as a retail store). Then in that case all my profits from the sale are just net income?

    0Reply
  • Anthony O
    Chicago, IL · Member since 2012 · 2 posts · 0 votes
    13y

    Im also confused about this topic. Especially the rental part. If you have 1,000 dollars deposited into your back account every month from your rental property.. How is that 1,000 taxed.. just curious

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y

    Fix and flipping (and wholesaling) is exactly like a retail store. Or, more accurately, like a manufacturing business. You buy raw materials (junky houses, building materials), put in labor, and then sell your finished product. The net income (the price you sell it for less all costs) is taxable. Because this is a self employeed business, you're subject to three taxes:
    1) Federal income tax - this is just ordinary income
    2) State income tax, if your state has one - same as for federal. Life gets more complex if you live in one state and rehab in another. You'll pay tax in both.
    3) Self employment tax - this is medicare and social security. From a regular job, you pay half and your employer pays half. Since you're self employed, you pay both halves. There are ways to organize your company than can turn some of the income into dividends and avoid this tax on the dividends. But it assume you're making more than would be a reasonable salary for the job you're doing.

    Rentals are taxes on net rental income. The $1000 from a rental in your example, Anthony O is the revenue. From that you subtract all your expenses, the interest you pay and depreciation. If that's a positive number (it should be, on good rentals), that net amount is just ordinary income and subject to the same taxes as above.

    Capital gains tax comes into play when you sell an investment. Rentals are investments. Fix and flips are not - they're inventory. Taxes on sales of rentals are a complex topic, and I don't think it comes into play for James Friedrichsen.

    Nope, doesn't matter. Its still inventory. This wouldn't survive an audit.

    4Reply
  • Kevin Yeats
    Lender · Fort Pierce, FL · Member since 2009 · 825 posts · 486 votes
    13y

    This question illustrates the reason that accountants stay busy.

    2Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y
    Originally posted by Kevin Yeats:
    This question illustrates the reason that accountants stay busy.

    LOL, let's say it's due to the complexity of the code and changes. What would happen if it really was simplified......heaven forbid, jobs would be lost, markets would fall we'd all be had!

    0Reply
  • Kevin Yeats
    Lender · Fort Pierce, FL · Member since 2009 · 825 posts · 486 votes
    13y

    Bill Gulley that is part of it. The previous responses only touched on the major and most obvious taxes that a real estate investor will pay.

    Others: Property taxes, employment taxes, local income taxes, personal property taxes, business property taxes, healthcare taxes (don't get me started). I certainly feel that license fees and restrictions amount to a "tax" as well.

    1Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
    13y
    Originally posted by Scott W.:

    so if it took you 11 months to rehab, i'd wait 32 days until I'd sell - resulting in more $ in your pocket.

    this isn't true. See Jon's response above -- flipping is a business, not an investment, and it's taxed as income, not a capital game. You would pay the same before or after 12 months.

    Podcast Guest on Show The Truth About Real Estate Investing in 2024 (What Investors NEED to Know)
    2Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    Jon- thank you so much you clarified alot in that response...I was looking at irs.gov. and got side tracked on a few different things...it makes sense...are these difficult to do yourself or would it be easier to hire an accountant? And as far going about paying these taxes is it something done annually?

    0Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    J scott- this could be a good topic to kinda touch on for people wanting to start a business

    0Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    13y
    Originally posted by Kevin Yeats:
    Bill Gulley that is part of it. The previous responses only touched on the major and most obvious taxes that a real estate investor will pay.

    Others: Property taxes, employment taxes, local income taxes, personal property taxes, business property taxes, healthcare taxes (don't get me started). I certainly feel that license fees and restrictions amount to a "tax" as well.

    Not sure how "healthcare taxes" are impacted by assets or earnings, but yes, in a way, but if we are going to count all taxes, fees, charges, compliance expenses required by government.....how about,

    Occupany certificates, sales taxes on materials for improvements which fall again under any gains, sewer assessments, utility deposits and inspection fees, engineering approval fees to building regs for improvements, all hidden taxes and fees hitting a property owner. Then wait til the health department or fire department makes new requirements, building a fence around your trash container, putting up fire exit light and exterior (in the open stairwell) fire extinguishers, and don't forget the replacement of the extinguishers after kids steal them as the must be accessable! All kinds of expenses induced by loacl government.

    And then, there are the expenses incurred in reducing your tax liability like getting appraisals to reduce personal property assessments, paying Charles (lol) to take all the possible deductions (which is deductable).

    Wait till you get an SBA loan and they want you to buy life insurance to cover the balance owing, guess we could throw in mortgage insurance premiums on government loans, filing fees for public notices and

    we forgot transfer taxes!

    Why the heck are people investing in RE, LOL!

    It's pretty much why I view government as our largest organized criminal activity. :)

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y
    Originally posted by James Friedrichsen:
    Jon- thank you so much you clarified alot in that response...I was looking at irs.gov. and got side tracked on a few different things...it makes sense...are these difficult to do yourself or would it be easier to hire an accountant? And as far going about paying these taxes is it something done annually?

    Whether you're doing rentals or fix and flips, you need a knowledgable CPA. I think doing your own taxes is penny wise and pound foolish. Even if you can figure out the forms or have TurboTax to help you, you don't know enough to know what goes where. Or even what you may be able to deduct. A good CPA will save you more than you pay.

    If you run any sort of self employed business, you need to pay taxes quarterly. You still do an annual filing, just like always, in addition to the quarterly filings. But if you're underpaid your taxes on a quarterly basis, you'll have penalties.

    0Reply
  • Kevin Yeats
    Lender · Fort Pierce, FL · Member since 2009 · 825 posts · 486 votes
    13y
    Originally posted by Jon Holdman:

    Whether you're doing rentals or fix and flips, you need a knowledgable CPA. I think doing your own taxes is penny wise and pound foolish. Even if you can figure out the forms or have TurboTax to help you, you don't know enough to know what goes where. Or even what you may be able to deduct. A good CPA will save you more than you pay.

    If you run any sort of self employed business, you need to pay taxes quarterly. You still do an annual filing, just like always, in addition to the quarterly filings. But if you're underpaid your taxes on a quarterly basis, you'll have penalties.

    This confirms my original response in this thread.

    0Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    thanks all for the inputs, i think i will look into hiring a CPA for all that financial stuff, i just wanted to gain an understanding of what to expect. i am in a business management program for my BS Degree but havent been in any financial courses yet. It is alot of information but this forum clarified alot of questions i did have. Thanks again!

    0Reply
  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    13y
    Originally posted by Kevin Yeats:
    Originally posted by Jon Holdman:

    Whether you're doing rentals or fix and flips, you need a knowledgable CPA. I think doing your own taxes is penny wise and pound foolish. Even if you can figure out the forms or have TurboTax to help you, you don't know enough to know what goes where. Or even what you may be able to deduct. A good CPA will save you more than you pay.

    If you run any sort of self employed business, you need to pay taxes quarterly. You still do an annual filing, just like always, in addition to the quarterly filings. But if you're underpaid your taxes on a quarterly basis, you'll have penalties.

    This confirms my original response in this thread.

    Kevin Yeats I'm not sure I get your meaning. Am I giving some mis-information here?

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    James Friedrichsen,

    For not being tax guys Bill Gulley and Jon Holdman definitely know their share. Charles Perkins is a fellow accountant and you can trust what he says.

    You need to sit down or have a good conversation with an accountant. Start with small questions and work your way up or you will overwhelm yourself.

    -Steven the Tax Guy

    [email protected]224-381-2660
    0Reply
  • James Friedrichsen
    OP
    Dover, DE · Member since 2012 · 26 posts · 0 votes
    13y

    Thanks steven, do you have any good advice to someone that is starting out? like lets pretend i go in and dont really know anything, what should i start out asking and where do i build from there? this of course all just on the financial side of things.

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    James Friedrichsen,

    Here is a list from another thread that I posted 9 months ago. I also have a link to the thread:
    I have compiled a list of questions that you can select which are most pertinent to your situation:

    What was the most recent CE course you took and when?
    What subject is/are your academic degree(s) in?
    What is your specialty (tax accounting, tax representation, etc.)
    How long have you been practicing?
    How many clients do you have?
    What percentage of your practice today is in real estate?
    Have you represented clients in front of the IRA, and what is your success rate?
    Will you share a reference(s) from your current client who runs a business similar to mine?
    Will you share a reference who can speak to your representation before the IRA?
    How can you or your professional network help me with entity structuring, retirement/estate planning, business analysis, etc.?
    Help you define the appropriate business structures, both from a legal protection and from a financial/tax perspective
    Help you create a tax strategy for your business that will allow you to legally keep as much money as you possibly can
    Help you make smart decisions with respect to your individual real estate investments
    Prepare your annual tax returns
    Recommend other team members (attorney, insurance agent, real estate agent, etc) who can help make your business a success
    What are your credentials?
    What services do you offer?
    What areas of tax and accounting do you specialize in?
    What is your background and do you personally own real estate?
    How would I be able to communicate with you? Can I get questions answered by email?
    Given my circumstances, what business structure(s) do you recommend? Why?
    Can you register the business structures for us?
    How can you help in the various phases of real estate investing (acquisition through sale)?
    Do you specialize in tax strategy? Specifically geared towards real estate?
    How aggressive will you be in helping us keep as much money as possible?
    What tax strategies/issues should I be aware of upfront?
    How often would you suggest we meet to review our progress/plan?
    Do you do tax preparation?
    What software do you use (and expect me to use) to do our accounting?
    Can you help me find other team members (attorney, insurance agents, real estate agents, etc)?
    What is your schedule of fees?
    Do you have references?

    Some of the questions are duplicated in here for the reason of asking them a different way for a different response.

    Also here is a link to another similar discussion we had on this topic (it is some very good reading): http://www.biggerpockets.com/forums/51/topics/63679

    And the link to the topic: http://www.biggerpockets.com/forums/51/topics/70447-questions-to-ask-a-cpa

    -Steven the Tax Guy

    [email protected]224-381-2660
    0Reply
  • Dylan Long
    Real Estate Investor · Forest Grove, OR · Member since 2012 · 105 posts · 37 votes
    13y

    What about in situations where you're the sole owner of the LLC. Aren't you then a disregarded entity, and don't file taxes for the LLC itself, but just as part of your personal tax return?

    0Reply
  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    13y

    Dylan Long,

    You will need to pay any required estimated tax payments. This is true for an individual whether or not they have a disregarded entity or not. They will be filed under your personal SSN and not the entity's EIN.

    -Steven the Tax Guy

    [email protected]224-381-2660
    0Reply
  • Kevin Yeats
    Lender · Fort Pierce, FL · Member since 2009 · 825 posts · 486 votes
    13y

    Jon Holdman

    No Jon you have it exactly correct and I agree with you 100%. Running any business more complicated than a kid's lemonade stand requires keeping keen records especially if the business how outside investors or hires employees. All this record keeping become triply complex when the business owner seeks to comply with various tax laws and has to prove certain facts.

    All of these multiple layers of complications makes lots of work for accountants and bookkeepers ... a Full Employment Act?

    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    13y

    Okay so a few questions.

    1.If Romney gets in and we have the 20% tax change he wants to do how would that impact things??

    2.If you were looking at a huge tax bill would it make sense to contribute max to your IRA,buy more properties with excess funds,and then instead of cutting a huge check to Uncle Sam give a good amount to charity??

    I know Rich Weese has supposedly figured out a way to pay almost no taxes yearly no matter what he does.

    Is there a limit on what you can give to charity annually as a business??

    If you give to charity you know where the money is going instead of a blank check to the government plus it's good will for your business.

    As you can tell I am not a tax expert in the slightest so I was just curious.

    Podcast Guest on Show #47
    NNN Invest53 Reviews
    WebsiteView Page
    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free