Self employment or long term investment income

[Robin Evans]

Tax season! We bought a property in 2022, remodeled and sold it in 2023, over a year after the purchase. We did most of the rehab work ourselves. Will the profit be counted as self- employment income or long-term investment income? Thank you for your input!

[Robin Evans]

Quote from @Account Closed:

Hey @Robin Evans, 

To answer your question in a sentence: This will be "long term" income. 

Let's say you finish a house flipping project within a year. In this scenario, you're subject to ordinary income tax. Here's a breakdown:

Project Details:

• Property Cost: $50K
• Renovation Costs: $30K
• Resale Price: $100K
• Profit: $20K ($100K – $50K – $30K)

For instance, if your regular income is $50K, and you add the $20K from the house flipping, your total income becomes $70K. This places you in the third tax bracket, with a 22% rate. Additionally, there's a fixed self-employment tax.

Income Tax: 22% * $70K = $15.4K Self-Employment Tax: 15.3% * $20K = $3.06K Total Tax Due: $18.46K

Remember to account for any state taxes as well.

To defer taxes entirely, you could utilize a 1031 exchange, which allows you to reinvest the proceeds from the sale into a similar investment property, thus deferring the tax payment until a later date.

Example #2: Long-Term Capital Gains

Now, consider a scenario where you hold onto the property for over a year.

Project Details:

• Property Cost: $70K
• Renovation Costs: $50K
• Resale Price: $200K
• Profit: $80K ($200K – $50K – $70K)

Since self-employment tax doesn't apply, you only need to calculate the long-term capital gains tax. Assuming you're in a bracket with a 15% rate:

Long-Term Capital Gains Tax: 15% * $80K = $12K

For tax purposes, we want to either defer it via the 1031 or do the long term capital gains route whenever possible. Best of luck this tax season! 

Thank you for your input! We already sold it so the long term capital gains is what we strive for.