Posted by JHyre in Ohio on February 20, 2001 at 12:13:37:
Michael,
See my response to Phil Fernandez on this same set of posts, he had asked a nearly identical question (renting instead of flipping in his case)…basically depends on exactly which 2 states we’re talking about. No advantage from a federal standpoint, however.
John Hyre
Capital Gains Tax Dilemma from Flipping? - Posted by Michael Morrongiello
Posted by Michael Morrongiello on February 16, 2001 at 14:19:42:
For those of you that love to pay taxes…
It is my understanding that when you purchase a property, quickly renovate it, and then resell it over a short period of time (always less than a year, most of the time in a few short months) you incurr what is called “a Short term Capital Gain” on any profits or income you may have earned from the sale of that property. If you are in a state that has a State income tax then you are liable to pay State and Federal Income taxes on the profits.
A lot of people advocate using a corporation when doing these property “Flipper” type deals as a way to mitigate the state and federal tax liabilty on any profits, However:
If the quick flip property was purchased in a corporation, let’s say a “C” corporation, again was sold for a profit after only a few months, then it is my understanding that when determining the income for that corporation for the corporations tax year, ALL income from short term capital gains is Taxed FIRST and then any remaining profits are tax at the corporate tax rates.
The Question:
How does one minimize the tremendous tax liability or burden that occurs when you buy low and sell high or “flip” homes over a short period of time? If you are doing business in one state that has state taxation along with your Federal Taxes, Can you use an out of state corporation to acquire title and then sell?
Your thoughts and input is greatly appreciated ?
Michael Morrongiello
Re: Capital Gains Tax Dilemma from Flipping? - Posted by Bud Branstetter
Posted by Bud Branstetter on February 17, 2001 at 24:59:30:
Michael,
Corporations are great or not but let’s minimize the tremendous tax liability by doing it in a Roth IRA. If you want the income now you sold all cash and can have whats left over after taxes.
Here the state boys tax long term gains… - Posted by David Krulac
Posted by David Krulac on February 16, 2001 at 16:02:52:
at the same rate for individuals as short term, or ordinary rates. Therefore the Pa. state tax at least here is a wash.
Out of state corporations here, Pa.are called foreign corporations, and in some cases have additional taxes.
In addition there is this onerous “capital stock tax” which basically taxes your income plus assest as a number derived from a formula. If you sell a property in a Corp. and make $200,000 profit, even long term you would be taxed as having $2million of assets for the next five years. Isn’t that a joy.
Getting back to Federal tax issues, hold the property long term, more than a year, maybe rent it out and stay away from being classified a dealer and exchange (section 1031) out of big gain situations is the best advise.
Dealers can’t depreciate, exchange, or defer installment sales. Who wants to be a dealer?
David Krulac
Some rambling… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on February 16, 2001 at 16:00:58:
Unlike individuals, C-corps are taxed on Cap Gains at the same rate as ordinary income…so from a bracket standpoint, no material diffence between cap gains & ordinary income for a C-corp.
Flips constitute so-called “dealer” transactions and are taxed at ordinary rates. Also, no instalment sales treatment and no 1031s with such property.
One way to defer taxes if the flip involves taking back paper is PROPER use of the cash method of accounting…under said method, what you receive equals cash + FMV of the note (as opposed to FACE value of the note). Given that I deal with mobile homes alot, the FMV of such notes is considerably less than the face, so the initial amount of gain is smaller than if I used face value as the “amount received”. You pay the diffence between face and FMV over time as principal is collected. I’ve yet to meet a CPA who’s come up with this on his own, and several needed to have it explained to them multiple times.
A C-corp may or may not be right for you…depends on your exact circumstances. C-corps do receive a few significant deductions/exclusions that other entities do not, primarily when it comes health care and retirement benies, with some education, shareholder loan & employee perks, to name a few, as well. If these areas are of significance to you, then a C-corp has potential. The VAST majority of deductions out there may be taken by ANY entity, corps, individuals, LLCs, you name it- C-corps are advantaged on relatively few items, which may or may not be of significance to you.
In addition, the corporate bracket can be lower than an indivdual’s bracket IF the individual is a high earner and the corp makes< $50k year after deductions…but the money is still IN the corp. That’s great if you are reivesting the money and lousy if you need to distribute it to live off of.
The name of the game is to generate deductions intelligently. Paying $1 to create a 40 cent tax savings is not smart…getting things tax-free that you would otherwise have bought with taxable dollars IS smart. Unfortunately, it is difficult/expensive to manufacture significant “paper” deductions (like depreciation).
A very good book on the use of C-corps is “Inc. and Grow Rich” by Kiyosaki’s people, i.e. Diane Kennedy et al. It demonstrates the advantages and disadvantages of C-corp’s quite well…though I disagree with them on some of their advice when it comes to multiple entities. Hey, I’m a lawyer- I CAN’T agree with anyone on EVERYTHING!
I could write a book on this topic and probably will one day…this post barely even scratches the surface. Also see my post to Phil on out of state corps. If you live in the same state where you are doing business, your ability to “export” earnings to other states is often limited…really depends on EACH state’s specific rules. Beware people from tax haven states selling products (incorporation, etc.)…to a guy with a hammer, everything looks like a nail. Make sure when investigating out-of-state entities that you get competent advice from someone very familiar with the state in which you live, because many states have “anti-Nevada” clawback provisions in their law…one size does NOT fit all!
John Hyre
Re: Capital Gains Tax Dilemma from Flipping? - Posted by phil fernandez
Posted by phil fernandez on February 16, 2001 at 14:42:19:
Hi Mike,
I’m not sure if this will answer your question. Yesterday I talked to my accountant. As you know I live in Vermont where all of my rental properties are located. These rental properties produce the income I live on. I also have a lakefront property over the border in New Hampshire where I intend to make it my personal primary residence.
Vermont has a state income tax, however New Hampshire does not. So the obvious preference would be to claim all of my income as a New Hampshire resident. If I did that I’d save 25% on my taxes.
My accountant says,hold on a minute. It is where you made the money. In my cause the money was made in Vermont. He says even though I would be a New Hampshire resident the income would be taxed in Vermont where I made it.
Now does this apply to an out of state corporation. I don’t know, but there might be the same argument from the state where the money was generated from.
I’d like to here from John Hyre and others on this. I’m not totally in agreement with my accountant and I hope he’s wrong.
Re: Capital Gains Tax Dilemma from Flipping? - Posted by Ed Copp (OH)
Posted by Ed Copp (OH) on February 16, 2001 at 14:34:40:
Michael,
An out of state corp. can do anything that an in state corp can do.
In a C corp. you (the corp. officer or director) would have use of the funds from the time of sale until the time of taxation. You (the corp.) could buy you a few things that may be useful to have, just for you; and purchased with untaxed dollars. Things like: New Car, Gas Oil Maintenence, and Insurance, a Retirement plan, a Medical Plan, Education like seminars, Office stuff like cell phones etc., and a whole bunch of other perks.
Then if there is any money left, you can think about paying taxes on the funds at corp. level. If you can spend (and earn) at a fast enough pace there will be little left for the government.
Re: Here the state boys tax long term gains… - Posted by JPiper
Posted by JPiper on February 16, 2001 at 20:41:35:
I think this is the real point…tax problems occur when you sell…regardless of whether its sold by an individual or corporation. Holding solves the tax problem…but creates a cash problem. Take your pick.
JPiper
Ways to offset the ordinary income? - Posted by Michael Morrongiello
Posted by Michael Morrongiello on February 19, 2001 at 22:43:06:
John:
Your insight is greatly appreciated I’m sure not only by myself but by others.
Maybe I’m missing something here. I want to focus on CASH sales only not selling on terms. Deals that are purchased and sold short term for cash.
I understand that short term gains resulting from the sale of a “quick flip” type deal involving Real property sold for cash within a corporation is taxed as ordinary income to the corporation.
However I was informed that you cannot offset some of this income or profits within the corporaton during the tax year by diverting some of the overall income or profits into a corporate retirement or pension plan, other corporate perks, etc. so that you are then paying tax on the overall minimized profits the CORPORATON earned during its tax year? I was informed that the tax resulting from the sale of the property and short term gain must be figured first BEFORE other expenses within the corporation. I am missing something here in the translation?
Kind Regards,
Michael Morrongiello
Re: Some rambling… - Posted by DavidV
Posted by DavidV on February 18, 2001 at 17:37:08:
How do you determine the FMV of your notes? Do you use a standard guestimate, Say 90%, or do you actually get quotes on the notes for documentation?
Re: Some rambling… - Posted by The Baze
Posted by The Baze on February 16, 2001 at 19:48:47:
John,
I thought I had heard that Rev-Proc 2000-22 had been updated to spell out that the cash method of accounting would only apply to firms that have receivables that were expected to be collected w/in 120 days. Sales on longer term notes would therefore not apply. I haven’t read this myself, but someone mentioned it to me.
You’ve mentioned that using the FMV of the note to report gain in the initial year, then reporting the rest of the gain under OID rules is an aggressive technique, but that adequate case law exists to justify using it. With the woefully inadequate research facilities at the firm where I work, I’ve been unable to locate any cases. And being as I’m trying to woo a mobile home dealer who does Lonnie deals, I’d like to have something to go on before I present him w/ this method. Could you point me in the direction of some documentation? I’d be eternally grateful. At least for a week;) Thanks.
Tom Bazley
Re: Capital Gains Tax Dilemma from Flipping? - Posted by les gee
Posted by les gee on February 16, 2001 at 20:29:25:
John writes:…
I’m not sure if this will answer your question. Yesterday I talked to my accountant. As you know I live in Vermont where all of my rental properties are located. These rental properties produce the income I live on. I also have a lakefront property over the border in New Hampshire where I intend to make it my personal primary residence.
Vermont has a state income tax, however New Hampshire does not. So the obvious preference would be to claim all of my income as a New Hampshire resident. If I did that I’d save 25% on my taxes.
My accountant says,hold on a minute. It is where you made the money. In my cause the money was made in Vermont. He says even though I would be a New Hampshire resident the income would be taxed in Vermont where I made it.
Now does this apply to an out of state corporation. I don’t know, but there might be the same argument from the state where the money was generated from.
Les writes… okay now set up a corp or dba in the zero state income tax. It’s business is lending hard money loans easy qualifying but lousy rates. Loan it to the property. Result is… siphon income to the zero state income tax. You can even issue 1098-int forms.
Your CPA is correct, but… - Posted by JHyre in Ohio
Posted by JHyre in Ohio on February 16, 2001 at 15:22:14:
may be missing an opportunity to get around the rules. Typically, when a taxpayer resides in a 0 income tax state but has income being produced in another state, opportunities to “export” income exist. The classic scenario…business in state A is taxed on its income, while state B has no income tax. Owner of the business lives in state B. Owner licenses a process, provides consulting advice or charges interest from state B to the company in state A. Such transactions typically reduce the income of the business in State A and results in income in state B. Whether or not this works depends on the EXACT law in EACH of the states in question. For example, my home state essentially disallows an interest deduction for state income taxes…so using an out of state entity to siphon income out of Ohio is difficult. As I’m not familiar with NH & VT tax laws, I cannot opine as to the specifics. But the general principles should apply…maybe consulting or management fees or creation of some notes in relation to the property could work to export earnings from VT to NH.
John Hyre
Re: Capital Gains Tax Dilemma from Flipping? - Posted by Michael Morrongiello
Posted by Michael Morrongiello on February 19, 2001 at 22:52:02:
Ed:
I thought as you do that you can offset some of the profits earned within a corporation by diverting some of this income into “perks” or a retirment program, etc. However See my post to John above at:
http://www.creonline.com/wwwboard/messages/12384.html
Your thoughts are appreciated?
Kind Regards,
Michael Morrongiello
You’re right … - Posted by David Krulac
Posted by David Krulac on February 17, 2001 at 10:06:52:
Mr. Piper,
and a couple of key points are that you must know the law in your state to maximize your return. Often times we discover a tax problem after it occurs.
Secondly to balance cash flow and taxes, I think that you need to balance your portfolio by having some rentals, some keepers, AND some flippers. By using the tax benefits of 1031 exchange, tax free refinancing, reduced long term gains, and avoiding dealer classification to retain rights of depreciation and installment sales, you can offset and balance the
possible 39.6% tax on flipping.
David Krulac
Re: Ways to offset the ordinary income? - Posted by JHyre in Ohio
Posted by JHyre in Ohio on February 20, 2001 at 07:08:05:
The information described in the last paragraph of your post is flat out wrong- you’ve been seriously mislead. Any income from flipping, or other activites, to the corporation may be offset against legitimate expenses, pension plans included. The expenses must of course be timed to occur during the same tax year as the income…generally, this means paying for and receiving the benefit of said expenditure.
John Hyre
Re: Capital Gains Tax Dilemma from Flipping? - Posted by JPiper
Posted by JPiper on February 16, 2001 at 20:46:32:
Uh…isn’t that what John said?
JPiper
Next level…(perhaps advanced) - Posted by Michael Morrongiello
Posted by Michael Morrongiello on February 20, 2001 at 10:42:02:
John:
I had thought that I might have been mis-informed over this issue. Clearly this is one of the reasons WHY doing the “Flipping” business within a corporate entity makes some sense, so that you can offset some of the income earned.
This subject has also been touched on here by myself and others. Now let me ask you for feedback on (2) two scenarios:
Are there any advantages to operating this way to minimize STATE corporate income taxes due in the state where you reside and corporate FEDERAL income taxes due at the more favorable corporate income tax rates based upon the state where the corporation is domiciled?
#2- Can one have one corporation set up to do the “flipping” business in their primary state where they reside (the corporation has now earned income in that state where they live) and then have that corporation heavily indebted to ANOTHER out of state corporation that is incorporated in a different state where corporate income tax rates are more favorable.
The corporation actually doing the “business” shows a loss or a minimal profit because as one of its corporate expenses it is paying on an “indebteness” to the out of state corporate entity.
In essence one is attempting to shift corporate income from one state where taxes are prohibitive to another state where they are more favorable.
Your thoughts?
Warmest Regards,
Michael Morrongiello