All Forum Posts by: Tom Makinen

@Angelique F.  Per the IRS, it is the intend.  It seems like your accountant already treated it like an investment property as you took depreciation instead of expensing everything.  Since you didn't hear back from the IRS, I am guessing they didn't give you dealer status for this house.  Remember IRS is not 100% cash basis on real estates.  Also less deduction you take now, less you pay when you get the depreciation recapture.  Accounting doesn't lie...

Example 1, dealer status

Year 1 Purchase Price 10K

Year 1 Reno 35K

Year 1 Sold Price 50K

Year 1 Taxable Income 5K as ordinary income (let's call that 25%)

Example 2, investment property

Year 1 Purchase Price 10K

Year 1 Reno 35K

Year 1-5 Rent Income 3K/year

Year 1-5 Depreciation 1636/year

Year 1-5 Taxable Income basis of  1364 as passive income (your tax rate, call it 25%)  (This is for the rental income)

Year 5 Sold Unit 50K

Year 5 Additional tax event for capital gains as you made money on it.  Since your house is only worth (45000-8180=36820).  You would be subject to add back in the $8180 as depreciation recapture to get you back to 45K where your cost basis was.  At the end of the day, you would pay capital gains on $5000 (<20% in tax rate) and $8180 at your tax rate (25%).

Before you complain, look at that math above.  You are essentially paying the same except depreciation allows you to keep more cash up front.  All the taxes you are paying at Year 1-5 is for your rental income, not the actual house.  I know it sucks as you put down 45K up front to do the project, but it makes no difference from an accounting perspective.  

In 5 years, you would pay 25% of the following amount (1364+1364+1364+1364+1364+8180) + capital gains (<20%) of 5K.  

Why is it good to avoid dealer status for flips.  Look at the example above.  If you got labeled a dealer and IRS won't let you depreciate the property.

Y1 - Buy property + reno 10+35 

Y1-Y5 Rental income 3k per year

Y1-Y5 Passive income tax on the 3K @ 25%

Y-5 You sell the property and got a gain of $5K.  Since you got tagged as a dealer, you have to pay ordinary income at 25% for the 5K.  In the 5 years, you would pay 25% of (3+3+3+3+3+5=20K)

Not having the dealer status allows you to pay less taxes on year 1-5 and then less on the 5K in capital gains you received since it is taxed at a smaller percentage than your tax bracket.  

@Angelique F. when you flip you are consider a dealer, that just means you get to expense everything.  The repairs you made offset your sales.  

If you report the property as an investment, you depreciate and get better tax treatment.  

Flip=business

Rental=investment

@Alvin Uy It depends on your situation. Are you doing flips full time, part time? Are you employed, self employed? Is your income high or low? How is your cash flow? It is a loaded question. Someone who is making 10K off each flip in Ohio is different than someone who is doing flips in California at 100K profit. Remember LLC is formed based on state statues, the IRS doesn't care what a LLC is. It only cares if you want to get taxed as a C corp, S corp, partnership or SP.

Reason why I like C corp is that you can shift some of your income to it.  If you make 100K a year, you did a flip and made 50K.  That 50K will likely turn into 30K after taxes as you will be in the 40% bracket after everything.  On the other hand, your C corp can pay you a salary of 30K for the flip role and you can expense out the 20K thru other means such as travel, home office, computers, training (bigger pocket premium membership), 401K.  All of a sudden you will be paying only 40% on the 30K + 10-15% for PR taxes for 30K assuming you didn't cap out.  My math isn't good, but I think it will be less than file as an individual.   

None of these things come cheap, the formation of a company, the accounting, the record keeping will cost you a 2-5k a year, but it might be worth it if your income is high enough.     

I say true C corp over the LLC taxed as c corp because of section 1244 (I think that is the correct number). If I close it down, I can take that losses and deduct it off my AGI.

I don't deal with S corp, so I am not familiar with it.  I think you can take 20% off your 50K as your tax basis, but you don't get to take section 1244 and there are less things that are deductible.  I could be wrong though, but the 20% off the top is the big one.  

Remember some of the commercial deal it is actually a running business, so there could be more upside (and risk).  What's not to say a hotel will suddenly have more occupancy due to some new things going on in town for the next couple of years.  Rent is good, but it is usually stable and don't fluctuate too much.

@Angelique F.  Unfortunately great tax planners are expensive, so you have to make sure it is truly worth it before you go down that rabbit hole.  If your entire profit is 8K, there is no reason to spend 5K on tax advisors when you can just pay $3K in taxes and move on.  

If you are tagged as a dealer on this house, the 10K would be treated like inventory and anything you do to it should be tax deductible.  For example if you pay 10K for the house, spend 40K to fix it up and got 60K in a sale after all fees.  Your ordinary income (taxed at whatever bracket you are at) is 10K.  There is no capital gain.  Flippers don't qualify for capital gains.  If you get lucky and don't get tagged as dealer, yes you would have to go through and depreciate a lot of the expenses.  Every year you will only be able to get a small portion of it to offset your rent income.  When you sell it, you pay the gain on the house subject to recapture, not on the sales amount.  For simplicity sake, let's say you paid 10K, did 40K of capital improvement, took 5K in depreciation every year.  When you sell it for 60K in year 2, you would actually pay capital gains on 10K (should be lower than your current tax rate, it is below 20%) because your house is worth roughly 40K, but you add the depreciation back in to get back to 50K as your basis.

Remember GAAP, tax and cash accounting are all different.  Sorry...

@Jing Chai  How about adding your spouse's income, maybe that will get over the cliff?  I say this because EM has an apartment now with a 5 year min hold., much higher numbers than what you are looking at.  You can start with $10K instead of $50K.  Heck, they even have a 2-4 year building lease that is expected to carry nearly 12% in return, but no equity though.

@Andre Williams  BTW if you need a referral, PM me your email.  I think you get better returns

EquityMultiple today just listed a rehab center lease. It is a NNN list so it is basically guarantee income unless the tenant files for bankruptcy. They target to keep that for 2-4 years. The return is 12%. You are not finding that in any sub 100K condo right off the bat with no work. I can literally put in $10K tomorrow. It will start paying me $100 per month once they start. If they sell it in 3 years, I can take the 10K back and see what house I can buy, perhaps it will be cheaper.

This duplex I am looking at.  It is $500K with $50K in renovation.  Even if everything is rented at top of market, I am barely going to make $300 a month.  This is after I put down $100K to secure it.  

@John Corey  Agree.  I have made some decent money in the stock market the past couple of years.  While I still believe the stock market should be a big part of anyone's portfolio, I do know I have to diversify to spread the risk.  I can't take the up and down of the stock market due to the self inflicted wounds by our politicians.  I am definitely proceeding into the real estate with a lot of caution.  I have done the math in many cities around the country and I came close in pursuing a few small deals.  Yet after calculating the numbers, I think the best deal for me are either going to be flips or play in some of the strong appreciation markets.  At this point, strong appreciation is too expensive and no jumps are going to happen for a while unless I bail a homeowner out of a situation if I get lucky.  That's why I am not really hopeful in finding a good turnkey property, I am likely going to have to get homes that I can do flips on.

@Andre Williams  You should qualify as an accredited investor.  You can go to crowdstreet.com equitymultiple.com for some crowdfunding COMMERCIAL deals.  You might not be able to leverage your 25K like you can with your own place with mortgage, but the returns on them are much much greater than anything you have going on if you buy the place yourself.  You can invest 25K, get nearly 10% back in return for 5 years plus 1.8x equity back on some of these deals.  Best yet since they are running business, there is a good chance some will be recession proof.  I want to get in on more, but I am still trying to buy my own properties first just for the sake of the challenge and even more diversification.

You are not going to make any substantial income on a little SFH or condo at this point. Do it because you want it, crowdfunding is likely where you can make more short term.

As I said before, you should think about tax consequences.  If you play for cash flow, you will likely lose half of what you earned after factoring in taxes since they are taxed at your income.  If you hold the property, you can turn the gain into a capital gain and result in 20% tax instead of 30%+.  Flips will be taxed at your bracket, but you can do some workarounds to trim some of that number.  That's why I said the flips better be worth it.  Is it worth it for you to spend 4 months on a flip and make $20K.  After taxes it would be like $12K.  

@Account Closed  You can always be a corporation and pay after expenses and on your profit only at 21% flat.

The accounting and tax reporting is easy if you know basic accounting, the tough part is finding all the loop holes you can explore (it's legal).  This is especially easy for people who are self employed or don't get paid by W2.  For people with enough money, there are plenty of loop holes they can use to take advantage. 

if you bought the flip under a c Corp, you can do a few things to minimize the impact of the gain.