Flipping Tax Question, Is this Legal?

Question

I was talking to a friend of mine and he mentioned that he is refinancing his deals just before he sells them to elevate his cost basis. For example

actual money spent/cost basis                     $100,000

appraised Value                                              $200,000

Refi                                                                    $170,000

Sale price                                                         $200,000

the sale shows a taxable profit of               $30,000

actual money spent taxable profit is         $100,000

so by elevating the cost basis through the refi they have dropped their taxable income by $70,000 and put $70,000 in non taxable income in their pocket (non taxable since it is borrowed in the refi). still made the same amount of money but got to keep more buy showing a lower taxable income.

I can see how the refi with cash out is legal and I see how at closing the loan gets paid and it shows a smaller taxable profit. My question is that if used in combination with each other is this legal? It appears that its just a way to artificially inflate the cost basis to lower the tax burden. They swear that the CPA they use supports this as legal and that they have been doing it for years. If this is legal it's a really great strategy.

Any tax people in here that can weigh in?

Ned Carey · Answer

@Shelton Eubanks nobody that can pass the CPA test would say that. The sale does not show a profit of $30K. The profit is 100k. The tax and the amount you should report has nothing to do with loans.

You are not taxed on the amount you receive when yo sell a property. The profit is the sale price minus the basis of the property. The basis of the property does not show up on any re-sale documents.

You can get a big check when reselling and still claim a loss of the property. You could receive no check at settlement or even have to bring some money to settlement to sell a property and still have a large profit that you have to pay tax on.

I will try putting it a different way. Your friend did make a $100K profit when he sold. He used $70k of the profit to repay part of his loan.

Kyle J. · Answer

What I think you're saying is, your friend spends $100k, gets the home appraised for $200k, and then does a cash-out refi for $170k just before selling the home for $200k?  If so, this scenario doesn't make sense to me for several reasons.

1)  Not sure if you're using actual numbers or just hypotheticals, but doing a $170k cash-out refi in this scenario ($200k appraisal = 85% LTV right after finishing the rehab) doesn't seem likely.

2)  A refi doesn't change or "inflate" the cost basis to whatever amount the bank valued the house at (in this case $170k).

3)  Why would anyone incur the cost of doing a cash-out refi right before selling the home?

4)  If you did do a cash-out refi right before selling the home for some reason, that loan would immediately have to be paid back in full once you sold the home.

I could see why he'd do a cash-out refi if he was going to hold onto the house (that's basically the BRRRR strategy), but not if he's going to immediately sell it.

Basit Siddiqi · Answer

@Shelton EubanksAs others have pointed out. That is not the correct way taxes work.Flips income is reported as selling price less costs of real estate less all the general/admin costs.Refinancing has little impact on the cost basis of the real estate.Refinancing is just exchanging cash for a larger liability.

Bob B. · Answer

You doesn't matter what number your put on your tax return. it's when you get caught in an audit that counts.

Flipping Tax Question, Is this Legal?

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