lets talk taxes
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
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.
Joel Owens
1) Not sure how his plan might impact us. It sounds like he wants to eliminate a lot of the current deductions. If that is the case it will have varying impacts on taxpayers in the first year. Quite likely afterward you will see business owners changing how they do business to tax advantage of the new tax situation.
2) Retirement contributions can be a great way to reduce current taxes. There are a number of options to consider not just the defined benefit plans like IRAs and 401Ks. Business owners can also consider defined benefit plans that can allow a significantly large amount of money to be deferred.
There are limits to how much can be deducted as a charitable deduction in one year. If you exceed the limit you don't lose the deduction it is carried forward to future years. I had a good friend whose husband needed some expensive medical equipment while he was alive. When he passed away she donated these items and had a sizable charitable deduction that she has been using for several years now because it exceeded her charitable deduction limit.
One great piece of advice i was given was to just read the tax code. It may be boring and not apply to many things but as you go into business you will recall some of the things you read and didnt understand at the time.
Dont be lazy and just tell yourself your accountant will take care of everything. just as a realtor, a wholeseler, contractor will lie, let you down or give you incorrect advice so will an accountant. Ultimately you are responsible no matter if your accountant makes a mistake.
Knowledge is power and just as you will invest time in other areas of real estate this is a worthwhile investment of your time.
Another tip is that succesful business people do their taxes at the begining of the year not after the year is over.
projecting and forecasting your taxes for 2013 should start at the end of 2012. this wil help you understand where your tax liablitly is and you and your acountant can stratigize in the front end of the year to minimize your taxes based on some realistic yearly goals.
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.
Kevin Yeats you make a very valid point. The tax code can be very complex.
Code sections 1.103-8(b)(4) and 1.103-8(b)(5) bring up some interesting exceptions that real estate investors might not consider.
See the following light reading in well versed IRS speak:
http://www.irs.gov/pub/irs-wd/0345022.pdf
Code section 1.103-8(b)(5) in summary says that a residential rental project must be open to the public to be considered residential rental property.
Code section 1.103-8(b)(4) states that a residential rental property can not be transient in nature and must meet open to the general public.
I won't bore you with all the details.
Some interesting situations that come up due to the code.
A manufacturing plant purchases an apartment complex to house it's employees. The employee's pay rent to stay in the apartment. Because it is not open to the general public this would not be residential rental property and would not have the benefits of that tax treatment.
An adult care facility, retirement home, low income housing and other similar types of housing might be residential rental property. One has consider the code here carefully.
In similar vein. Someone renting rooms to others in there own home or boarding house may or may not have residential rental property.
Needless to say if the property wasn't properly classified from the beginning assets were probably misclassed and depreciated over inappropriate life times. Self employment tax may have been applicable. The entire nature of the income could be different than assumed.
IMHO - Honestly, find yourself a good CPA to prepare your return. It will cost you a couple hundred dollars but WELL worth it. You have to take depreciation, if you hold a rehab over into the next year you need to inventory it, and then you have the short / long term capital gains. If you make an improvement you have to write that off over time also. Your CPA can also work with you on the best structure - C corp or a sub S or an LLC depending on what you want to do. There are filing nuances within those categories also. You'll drive yourself nutz trying to figure all of this out.
Save all of your HUDS, take all of your expenses and drop them onto an Excel spreadsheet - one for each property - and send it to your CPA at the end of the year. They also know where to put things and what schedules to use to make an audit less likely.
Thanks Ann Will do that definately, my head hurts just thinking of all the possibilities out there.