Accounting method, implications for rehabbers?

Question

Hi All,

We just started a c-corp to take advantage of ROBS capability, and I'm doing some basic research on cash vs. accrual method for accounting.  For a rehabbing business it may not make much difference due to relatively quick turnover, but I am curious as to what other business owners/investors are doing.

I am also wondering about the tax implications of rehabs in terms of "repairs" vs "improvements", or if it even matters.  Do you have to capitalize all construction (labor and material) expenses associated with a rehab until it is sold or can you deduct them right away as they are paid? Maybe this question only applies to your principal place of business and not homes that you buy and sell?  Thanks for any advice!

Bill Gulley · Answer

My question would be why would you do fix and flips in a C-Corp to be taxed twice? LLCs are usually the best way to go, unless you are going with retained earnings, increasing stock prices, but a closely held Corp stock isn't that  marketable to sell.

Anyway, use the cash basis running inventory as your COGS as J. Scott mentioned.

Accrual, running inventory under LIFO or FIFO only has advantages in taxation when costs of inventory adjust to raising or falling prices of parts or unfinished goods that are held over your accounting period, as in inflationary periods or long holding periods. Such may be applicable if you were buying truck loads of sheetrock and plywood storing it in a warehouse for future use. If you're buying materials for each job, you need to assign the actual cost to that job under a cash basis.

Your accountant may love for running inventory through on short periods for the time in making adjustments as they may make about 50% more putting you on an accrual system.

You should be in and out of any flip in 3-4 months holding it for sale, that's not enough time for accrual to effect costs unless you're in the millions of dollars, in which case, your accounting department and CFO should be addressing the matter...LOL  :)

J Scott · Answer

Sounds like he is doing a ROBS, which is a way to direct your retirement funds to fund a business and generate taxable income outside of your retirement.  ROBS are required to be organized as C-Corps, for some reason that is outside my scope of knowledge (in other words, I've seen ROBS products from several companies, and they all seem to use C-Corps, which leads me to believe that it has to be done this way).

John Hixon · Answer

Bill Gulley  a lawyer I once talked to said it is good to do flips in a C-Corp because you avoide something called "trader or dealer" status.  Not sure how true that is, but he was pretty adamant that it was important to avoid being labled by the IRS as a trader or dealer.  And, having your business set up as a C-Corp helped with that.

On a side note.  I always appreciate your posts. You are one of the few that provide great info.

J Scott · Answer

Cash basis for me.  It's much simpler (in my opinion), and much easier to justify accounting decisions if you ever get audited (accounting matches up with bank/credit deposits, withdraws and charges).

As for how to handle deductions, with flips, the houses are considered inventory and all costs (purchase, rehab and sale) are considered cost of goods sold (COGS).  This means that all costs are added to the basis and are deducted in the year that the inventory (the house) is sold.

Now, that said, I believe there are a few things (like taxes) that can be expensed (deducted in the year the costs were incurred), but for simplicity, I track everything as COGS -- my accountant says the IRS doesn't have an issue with this, as they get to hold my money longer...  :)

Michael O'Byrne · Answer

@J  Scott , Bill Gulley , thanks much for your responses.  A c-corp setup is necessary for a robs transaction to avoid 401K distribution taxes and the early withdrawal penalty.  This is a big deal as it provides me significantly greater financial leverage to do some deals and get our business off the ground.

Originally posted by @Steven Hamilton II :

No it is not the end of the world. A "dealer" depends upon the transaction. If you purchase a rental, and keep it for years as a rental it is not inventory. If you try to flip a property and end up holding it, it is still inventory. It strongly depends upon your approach.

We will be primarily flipping houses, and don't plan to invest in buy and hold until we at least double our current cash on hand.  That said, it sounds like cash method is simplest and better suited in our case, except for inventory accrual - is this considered a hybrid accounting method, and will it likely survive an audit?

I also need to do some research on the c-corp double taxation referred to by Bill Gulley .  I was told the corp will need to match the FICA tax paid by employees (my wife and I), but clueless beyond that.  As you can tell, I haven't hired or consulted with a CPA yet, definitely need to do that very soon. We just formed this business 10 days ago, we haven't bought our first property yet, but expect to in June.

Thanks again, I highly appreciate the feedback from everyone - what a great resource!

Steven Hamilton II · Answer

No it is not the end of the world.  A "dealer" depends upon the transaction. If you purchase a rental, and keep it for years as a rental it is not inventory.  If you try to flip a property and end up holding it, it is still inventory.  It strongly depends upon your approach.

Steven Hamilton II · Answer

Inventory is always accrual; however, you can use cash basis for everything else.

All purchases, holding costs and rehab costs are held in inventory until the property is sold.

It strongly depends upon your business. With a C-corp use accrual.

Bill Gulley · Answer

@Steven Hamilton II is one of our tax guys on BP. I'm not a tax type nor have I done any tax/retirement planning for awhile so I don't know ROBS either. I jumped in from my accounting background.

I'd think, from a tax perspective that being considered a dealer would be less painful than the double taxation, but if you're doing other things to avoid that, you may be on to something. I know that a C-Corp can be an advantage above the smaller dealer especially if holding the property under different alternatives in estate planning.

Attorneys usually have other concerns in entity structures besides the initial tax or accounting considerations, but I suggest speaking to both your accountant and attorney or have them hash it out between them, an attorney isn't an accountant and an accountant isn't a lawyer. I have no idea of your situation so I can't suggest more than I have, just to say go with the cash basis unless there are related business operations involved where an accrual system would be more appropriate. :)

Accounting method, implications for rehabbers?

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