what are all my options to consider this LLC profit as capital gains?

Question

Here's my situation:2024:- W2 income: ~ $1M (married filing jointly in CA)

LLC profit: $80K (from 2 real estate flips, in NC on spouse's name)

Capital loss carryover: $380K (from stocks in 2023)

In what cases can my LLC profit be treated as capital gains? I had hoped to offset it with my capital loss carryover and haven't planned for any expense documentation etc. can I make the case that I am not a dealer because this is my first time and also have a high w2 income relative to the LLC profit?

I know this question was discussed many times previously, but hoping that high W2 or capital loss carryover bends the case in my favor to claim this as capital gain.

Natalie Kolodij · Answer

There are several things that come into play with determining if a property sale is capital gains or ordinary income.

Intent is one of the biggest ones, frequency is another.

They are known as the Winthrop Factors-

• The purpose for which the property was initially acquired
• The purpose for which the property was subsequently held
• The extent of improvements made to the property
• The number and frequency of sales over time
• The extent to which the property has been disposed of
• The nature of the taxpayer’s business, including other activities and assets
• The amount of advertising/promotion, either directly or through a third party
• The listing of the property for sale through a broker
• The purpose of the held property at time of sale; the classification as an investor or dealer is determined on a property-by-property basis.To me intentionally buying a property to renovate it to resell it for profit, twice in the same year, and opened an entity to do it in ....is going to be ordinary income and not capital gains.

Aaron Zimmerman · Answer

As others have said, there’s minimal chance these get classified as capital gains. Now, you’ll need to maximize deductions. You’ll want to look at expenses that others have mentioned such as pass through entity tax, education, networking, any start up costs, etc.  you’ll also want to make sure to utilize the qualified business income deduction.

Stephen Nelson · Answer

BTW one other idea about treating LLC as partnership: You'd want to see if the pass-through-entity tax helps you out here. That would knock off 4%-ish from the federal ordinary income tax rate...

More info from FTB: Help with pass-through entity (PTE) elective tax (PTE tax) | FTB.ca.gov

Stephen Nelson · Answer

Some comments to add to this discussion (because I agree this sounds like ordinary income and not Section 1221 capital gain):

1. Probably the LLC is irrelevant (a disregarded entity) because it sounds like you've got spouses residing in a community property state? But you might want to treat it as partnership anyway? That would reduce the FICA because you're over the limit.

2. With some upfront planning, you could have used the Section 199A deduction to avoid federal taxes on the last 20% of the gain. That's not as good as paying the 20% capital gains tax and the 3.8% net investment income tax. But it'd have been pretty close. (If this was a 2024 thing, you're too late. You needed W-2 income in the entity because your income is high.)

3. You could probably do a nice pension for your spouse. Something like a solo 401(k) will let you shelter, what, $40K of the $80K? (A chunk for the elective deferral and a chunk for the employer match?)

4. I don't think an S corporation makes sense with $80K of profits but you wouldn't have to make much more than that for an S corporation to make sense?

5. Just in terms of optics, if you rehabbed two properties? Your return will sure look like one of you guys is a real estate professional. (The real property trade or business would be construction or development?)

Ashish Acharya · Answer

@Prav Se Unfortunately, profits from real estate flips are typically taxed as ordinary income, not capital gains, because the IRS classifies flippers as dealers engaged in a business. This means the $80K LLC profit is subject to both ordinary income tax and self-employment tax (15.3%), regardless of your high W-2 income or capital loss carryover. Capital loss carryovers can only offset capital gains, which usually come from assets like stocks, investment property sales, or business asset disposals held for over a year. Since flip properties are treated as inventory rather than investments, they don’t qualify for capital gains treatment. To reduce taxable income, focus on maximizing deductions for expenses like materials, labor, and interest.This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Denver McClure · Answer

Hey @Prav Se, I recommend speaking with @Jeff Nash about this. He's a CPA/CFP and is well versed in this area.

what are all my options to consider this LLC profit as capital gains?

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