Posted by JHyre in TexOhio on June 10, 2001 at 11:34:05:
Ben,
This is VERY similar to what I do with MHs. Sales company does the work with funding from investment LLCs…notes go to LLC’s, with sales corporation retaining a commission. Works for tax and non-tax purposes…the latter being to keep risky assets (mobile homes) in one well-insured entity.
Your plan sounds good to me. If the business purpose documentation is there, the structure should survive audit.
John Hyre
tax liablity of flipping properties - Posted by Clare Z
Posted by Clare Z on June 10, 2001 at 03:10:10:
I have been doing a lot of online reading tonight.
Have flippers found it to be true that fully 39% of your profits go to taxes? If not, how do you get around it? This is from something I read about the 1997 tax law that seems to affect this.
Any comments? Just doin’ my research…
Clare
Steve Cook, Your Take On This Tax Issue Please. - Posted by Mark W.
Posted by Mark W. on June 11, 2001 at 07:39:47:
I would like to here Steve Cooks experience with this issue.
I think he will be able to enlighten us quite a bit.
Thanks All & Thanks Steve
Mark W.
Re: tax liablity of flipping properties - Posted by Bud Branstetter
Posted by Bud Branstetter on June 10, 2001 at 13:11:20:
Continue doing your research and you will find how to eliminate taxes by using IRAs, especially the Roth.
One technique… - Posted by JHyre in TexOhio
Posted by JHyre in TexOhio on June 10, 2001 at 09:20:52:
Careful use of Lease-Options. Make the argument that you are primarily engaged in leasing (i.e.- investing), as opposed to selling via option (i.e.- dealing). The option is meant to attract higher quality tenants, making your leasing business more lucrative and less time-consuming. This works best if few optionees in fact exercise (which generally seems to be the case) and little or no sales-oriented marketing takes place.
John Hyre
and don’t forget… self employment tax, too - Posted by Billm
Posted by Billm on June 10, 2001 at 09:07:51:
IF you are deemed a “dealer”, you must also pay self employment tax at 15%+ of every dollar of profit. Once you become a dealer, you can’t "go back…
Re: tax liablity of flipping properties - Posted by JHyre in TexOhio
Posted by JHyre in TexOhio on June 10, 2001 at 08:45:11:
If you search the archives, you will find a million posts on this topic. If you purchase a home with the intent to resell it (you are a so-called “dealer”), you pay ordinary rates (i.e.- your normal tax bracket…anywhere from 15% to 40%). Properties held for investment (i.e.- for the rental income) AND held for at least one year qualify for capital gains rates, which are generally lower than ordinary rates.
The IRS looks to your actions to discern your intent. If you regularly sell homes, advertise them for sale or otherwise market them, you are probably going to be treated as a dealer. If, on the otherhand, no advertising or marketing occurs, or you regularly rent homes with only ocassional sales, then you may be treated as an investor, eligible for capital gaims rates, installment sale reporting and like-kind exchanges.
This is just a synopsis…lots of factors and case law exist on these points.
John Hyre
Re: NO, it’s not true. - Posted by Ed Copp (OH)
Posted by Ed Copp (OH) on June 10, 2001 at 08:39:37:
The 39% that you refer to presumes that you are in the top income bracket. If you are not there then your taxable will be adjusted accordingly.
It is a simple fact that if you are involved in creative real estate investing, you will sooner or later have a ZERO ($0) income tax year. When this is the case 39% of nothing will still be nothing ($0) taxable.
As you develop more projects that are producing taxable income, it would be only logical to develop more tax shelter, and also; more projects that increase in value but are not taxed right away or perhaps never taxed.
To me it is worth a little extra creative work to place myself in a $0 taxable bracket.
Re: tax liablity of flipping properties - Posted by Ben (NJ)
Posted by Ben (NJ) on June 10, 2001 at 07:09:46:
It’s my understanding if you hold the property for a year and a day, it is subject to long term capital gains tax of 20%. With rigid seasoning requirements which have been discussed recently, one may end up having to hold the property for this long anyway.
Tax tail, business dog… - Posted by JHyre in TexOhio
Posted by JHyre in TexOhio on June 10, 2001 at 09:56:24:
Getting in a zero tax bracket almost invariably involves one of three techniques:
Don’t make any income…this is generally a non-starter for obvious reasons.
Get LOTS of depreciation deductions to shelter income. On RE, such annual deductions are generally @3% of purchase price. So if I buy a rental house, the depreciation deduction shelters a 3% annual return. Most RE investors want well beyond 3% return, so one would need to buy additional properties that produce no net profit so that the depreciation from those properties shelters the first property’s income. The problem with this approach is that tax matters improperly replace total economic analysis…I’d rather buy the additional properties such that produce big profits…I pay taxes, but still end up with more when all is said & done.
Leverage- this has promise. Buy properties, rent them out and refi for cash. One gets the cash and avoids large amounts of income tax because no sale has occurred and some or all of the income is sheltered by the interest deductions. Just remember- interest deductions represent REAL money (unlike depreciation deductions) flowing out of your pocket. Also, high leverage carries serious risks of its own…risks that may or may not be justified in light of the related tax savings.
In general, deductions cost REAL money…paying $1 for 40 cents in saved taxes does not make sense. Legally converting personal items into tax deductions (e.g.- seminar “vacations”) saves taxes while leaving you in the same position you would have enjoyed…in other words, you’d have spent the vaction money anyway, but making it deductible saves taxes/lowers your bracket. The tax code greatly limits such conversion of personal items into business deductions…this angle can be worked, but only to a point. Once truly necessary business deductions or opportunities to convert personal expenses run out, all additional deductions make no economic sense. Taking inferior economic returns to get into a zero tax bracket (e.g.- buying municipal bonds) makes no sense from an economic standpoint.
Now, Ed is a seasoned investor. He knows things that I do not. But, as an experienced tax attorney, I can tell you that getting to a zero tax bracket rarely makes sense…it ususally involves foregoing opportunities for profit, directly or indirectly. By all means, use planning to reduce your taxes. Be aggressive. But don’t let the tax tail wag the business dog. In the majority of business types described on this site, getting into a zero tax bracket involves unacceptable opportunity costs. I challenge anyone out there to prove me wrong!
John Hyre
The year requiremehnt does NOT apply… - Posted by David Krulac
Posted by David Krulac on June 10, 2001 at 10:20:15:
to dealers.
Dealers property is subject to ordinary rates up to 39.6% even if held longer than 1 year and 1 day!
Dealers can not use installment sales deferments.
Dealers can not depreciate property.
Dealers can not do Section 1031 tax free exchanges.
Oh the life of a dealers, so carefree and easy!
Re: Tax tail, business dog… - Posted by Dave T
Posted by Dave T on June 11, 2001 at 16:43:56:
John,
Don’t forget that low income property tax credits may make it possible to reduce the actual taxes due to $0 for the year.
Re: We do not disagree - Posted by Ed Copp (OH)
Posted by Ed Copp (OH) on June 10, 2001 at 12:27:10:
My point was that while one is accumulating knowledge, and doing business agressivly, it is possible to have a year where one could show a loss on paper. Hopefully this will be in exchange for some future profits.
Getting into the zero bracket is not desirable, but it can sneak up on us (me). It is not the end of the world, and certainly is not a reason to pay taxes that could have been avoided.
John, as you know depreciation is limited… - Posted by David Krulac
Posted by David Krulac on June 10, 2001 at 10:17:03:
effectively by the $25,000 limit on losses over gains, and that limit goes to zero after $150,000 income. Oh how sweet it was pre-1987 when depreciation schedules for rentals could be as low as 15 years and there was no limit on losses over gains. There were many people, some whom we know, who didn’t pay any taxes due to excess depreciation. If you had $100,000 income and $100,000 depreciation over gain you had no income and paid no taxes. The 1987 changes and the AMT pretty much put an end to that gravy train!
David Krulac
Let me clarify… - Posted by Ben (NJ)
Posted by Ben (NJ) on June 10, 2001 at 11:01:06:
Dave, you are right, I should have been more clear.
The plan I have developed with my accountants goes like this, I have a lien owned by one entity (the dealer), when that lien ripens into foreclosure and
we are about to take title to the property, at the last minute the lien is assigned to a holding company. (This is done for a variety of reasons, not JUST tax purposes, also liability, lender’s protocol,etc.) Final judgment (i.e.,title) is taken in the name of the holding company (the legitimate purpose of this holding company is to INVEST in real estate, as well as other things, mortgage notes, stocks etc.). The property is held for a year then sold, thereby incurring long term capital gains. Like I said this is the plan, it has not been challenged so who knows how it will stand up but my accountants are pretty confident it will. As a real world investor (unlike my accountants ! LOL) what do you think? Do you see any flaws?
Re: We do not disagree - Posted by JHyre in TexOhio
Posted by JHyre in TexOhio on June 10, 2001 at 16:28:15:
Ed,
Thanks for the post, I obviously misunderstood the first one…I am QUITE sensitive to zero bracket issue. You wouldn’t believe the number of people who expect me to get them paying zero taxes. I generally react quickly to squelch such expectations, particularly from credible sources like yourself.
Hope all is well & thanks for the post,
John Hyre