|LM says: John, that is a very good question and a very important concern for anyone that is rehabbing and reselling houses. There are several reasons why I cannot go into details on the tax implications of my deals. Before I go any further I need to clarify that I am not a Tax or Accounting professional so any information I give you here is merely my opinion. The best tip I can give you is to consult with a tax professional if you are engaging in any kind of real estate investing activity. |
Now that I am done with the disclaimer…the reasons I don’t write much about taxes…
First, when you see the final analysis of my deals in this site, you are looking at the results just a short time after the sale is done. Therefore I have not had to deal with taxes yet. That won’t happen until early next year…
Second and most important my tax implications for my deals could be completely different from yours. For example, I can tell you that for last year I was able to offset a big part of the capital gains on my house flips with all the deductions I am entitled to. From deducting the thousands of miles I drive in a year for business purpose, business meals, office equipment, rent and utilities for my home based office, even a car we bought for business use.
Also when calculating profits for tax purposes you first deduct all the rehab expenses, utilities, loan interest payments, commissions, and lots more. So the profit that gets taxed is as small as possible.
There are dozens of deductions that you can take due to both being a real estate investor and small business owner. This is one of the benefits of using a tax professional to handle your taxes.
The general answer to tax implications of house flipping is that for properties that you buy and hold for less than a year and then sell are subject to short term capital gains which can be as high 35% vs. the 15% you would pay if you keep that property for more than a year and it’s considered long term
However it’s not that straightforward (when is anything simple with the IRS?). It will also depend on whether you do several deals in a year or just one or two, whether you have another income, such as a full time job, if you hold the property and do all the transactions under your own name, etc.
One of the moves I have made in order to minimize my tax impact is create two Limited Liability Corporations (LLC) and have one of them be taxed as an S corporation by the IRS. The S Corp is the one I use to do all the house flipping activity and the other LLC I use for my rental properties.
This move also has the advantage of shielding my income on the rental properties from the tax implications of the house flipping business.
Another thing I do is whenever I sell a house and the final accounting is done I immediately put away at least 20% of that profit in a separate account to pay the taxes come April 15. Fortunately this past April due to all the deductions I mentioned above I did not have to use all the money in that account. We’ll see what next April brings…
One more thing that will greatly simplify your filing and let you sleep better at night is to keep good records and paperwork. EVERY SINGLE EXPENSE gets recorded in my ledger. I keep a separate spreadsheet for each house and a paper receipt for every expense.
Not a single contractor gets a check from me without giving me an invoice or receipt. My accountant has thanked me profusely for this and in turn he is able to find more deductions and significantly reduce my tax foot print.
I highly recommend that for any serious real estate activity you consult with a tax professional that is experienced with real estate. Yes, they will not be cheap, but in my mind if they keep me away from the IRS and find me more money they are absolutely worth it.
Finally, remember one thing…if you are paying taxes it probably means you are making money! Sure we would all like to pay as few taxes as possible but in my mind if I make $35,000 on a deal and have to pay $7,000+ to the tax man I still walk away with $28,000…