Remember, to do a tax-deferred exchange, both the properties relinquished and those acquired must be for the production of income, held as an investment, or for use in a business. If you buy a property and sell it right away, you risk it being considered dealer property. And dealer property can not be exchanged in a 1031 exchange.
Now, if you have held these properties for rental purposes for a while, then you probably have shown your intent. Probably a couple of years is fine. However, please consult a tax accountant or tax attorney. I am neither.
I was reading a book review and this is what one person said:
May 21, 2000
Reviewer: A reader from NC
“Meyers wrote this book in 1998 but apparently decided to ignore the tax liability of flipping houses. The 1997 Tax Act will have a serious impact on anyone who follows Meyers method of getting in and getting out as quickly as possible. Ignoring the possible 39% taxes a short term flipper has to fork over makes Myers examples too rosey. The book does give great ideas as to where to look for bargins and how to obtain financing. This book is not meant for anyone who buys and holds but only for those who buy and sell. Flippers beware…pay attention to your tax situation. Read Irwin’s guide to the 1997 Tax Act.”
Is this still true or has it changed concerning taxes and flipping?
Hi John, All these answers confused me so much I called a CPA and made an appt. for this Thursday to get some clarification for my own situation. Maybe I don’t understand the terminology “flipping” as used on this board. I lightly rehabbed a house and after a year “flipped” it to another invester. Under Clinton’s 1997 Tax Reform Act I just paid 20% tax on the sale (applicable if you make over 24K annual salary). I am presently selling a rental house and was told I would only have to pay 10% tax as I am not working this year (salary under 24K).
So does flipping mean that the property is resold without ever being rented out?
This is a good reason to flip inside a C-corp. You can deduct all kinds of stuff - health care, retirement contributions, etc. etc. - and not pay the self-employment tax, so it offsets your flipping profits and thereby lowers your taxes.
As far as I understand, the 39.6% is the short term capitol gains tax. You can get around this by selling on a lease option for a year. Then you qualify for long term capitol gains tax of 20%. Check with your accountant to be sure.
Based upon your income. In other words, the income is treated as ordinary income, just as any other “earned income”. Now if you only did one deal, and made only $ 15K net profit, then you will pay taxes based upon that marginal tax rate; probably 15%.
However, if you are doing $ 300K per yr, then uncle sam is rakin in the dough, currently at 39.6%. There has been discussion about lowering this rate, with tax reform, but don’t look for it to fall more than 2 to 3% pts.
The tax rate is worse than that, by the time you factor in the State Income Tax (SIT), and Self Employment Tax, which is 15.3%, up to about $ 77K.
Gotta turn a lot of property to satisfy good ole Uncle Sam. They are your partner, without ever showing up on the job one time, and never taking a bit of risk.
JT - IN
PS. The current top marginal tax rate of 39.6% is a bargain, compared to the 70% top marginal rate, prior to TEFRA in 1984. All things are relative.
The USA federal tax liability for a person who resells a property within one year of buying it would be the same a ordinary income. Thus, the person in the 39% bracket would pay that much. The person in the 15% bracket would pay that much.
Of course, making a big profit in a property is likely to drive a person into a high tax bracket for the year. People who own lots of depreciable rental properties may be in the low bracket or in the zero bracket.
But if you make a profit, isn’t that better than making no profit and thus paying no tax?
If you want to avoid income taxes, buy fixers, rent them out and then refinance them. Borrowed money is not taxable. And the interest is tax-deductable. This reduces your taxable income from the rents. That plus depreciation may put you in the zero tax bracket.
Or buy vacant land, build rental properties on it, and refinance for tax-free income. Hold as long as you like. You are not taxed on the increased value of the property that you have created. Your wealth goes up, your taxes do not. This was advocated by Jack Reed and he says some people read his advice and have actually done it successfully.
Yes, flipping is when you get a house under contract to buy and resell it as fast as possible. In your case of the house that you sold to the investor, that would be “Buying and Holding” property. I don’t know much about how homes are taxed, time limits, loop-holes, ect., (Not yet at least)but I think you made the right move by contacting the CPA.
As far as flipping goes, Lor, it is a very interesting way to buy and sell homes quickly without using money, credit or partners. If you have other questions, post them on this board.
Better check with your tax lawyer on this strategy as well. Profits on dealer realty are taxed as ordinary income, no matter how long the property is held. Before today, 39.6% was the maximum federal tax rate on ordinary income.
If this approach is your business plan, your proposed strategy (though thinly disguised as a sale of investment property) has all the hallmarks of property held for resale at a profit – i.e., dealer realty. If the IRS chooses to audit, there is a good chance that all those lease option deals will be reclassified as dealer realty and taxed at your marginal tax rate.
When this happens, depreciation taken will be disallowed, 1031 exchanges will be recharacterized as taxable sales, tax returns will be recomputed, and penalties and interest will be tacked on. If the IRS really wants to play hardball, and the dollar amount substantial, all your assets could be seized for the payment of the back taxes.
The good news, I am facing some huge capital gains from the sale of three tax foreclosed properties, the bad news, capital gains tax. The 1031 exchange looks to be a way out. Right now I am vacationing in Long Island and keeping an eye out for a summer home.
I may be able to roll over those gains tax-deferred into a beach house which I rent out for a portion of the year and spend a few weeks in myself. Keepin everybody happy, the wife,the tax man and my bank account.Read about this and other strategies in Rich
Dad’s Loopholes for the Rich. Great Book!
Posted by JHyre in Ohio on July 04, 2001 at 11:54:49:
The decision whether to elect S status is highly individualized…Relative to an S-corp, C-corp is advantageous when fringes (e.g.- lots of medical costs anticipated) are significant for individual in question, where indiviual is in a high bracket (e.g.- Sue C.!) and the C-corp produces relatively small after-tax income (
…the net income still is distributed to you individually whether it’s reinvested or not. While that’s a problem for me (I have lots of W-2 income already) it may not be a problem for others - I’m not sayng a c-corp is end all be all but ther are different reasons for using any given vehicle that need to be looked at with yer CPA.
Your absolutley correct. I should have clarified. If I need cash I will sell it immediately in my “dealer” corporation. Other wise, I will hold it or sell on a lease option in my investment LLC. And when I do a lease option, the option cannot be excersied for 1 year. The IRS classifies you as a dealer, when you purchase the property and your intent is to resell for a quick profit. When I put a property in my LLC, the intent is to hold it for long term profit. Most of the people will not excercise their option. But, they take better care of the propery than a renter would. I should have no problems with the IRS on this plan because I end up holding properties for two or three years before they cash out. And I don’t sell everything. I’m trying to hold onto as much as I can. But I still prefer putting lease option tenants in my properties.