Flip Income Tax help needed (and appreciated!)

[John M.]

Oh man how I hate doing taxes! Although I must admit that as I learn more and more, it does get a bit less intimidating. I've got pretty slim chances of getting an audience with a CPA this week so I hope one of you guys can advise me (Joe??).

Background: I've got several single family rental houses and I've done a few fix-and-flips as kind of a side job. But now my RE activities are taking the forefront and I've all but quit accepting environmental consulting jobs (former day job). In the past I have (incorrectly, I now realize) treated fix-and-flip income as short-term capital gains. Hopefully I won't be too bad off if the IRS checks me out since I believe the short-term capital gains rate is the same as my ordinary tax rate, but I'm starting to think that maybe I should have paid self-employment tax even though I only did a couple.

In any case, now that I am going to focus more on REI, I will set up a S-corp to do the fix-and-flips and a llc for the rentals. But I'm having trouble figuring out how to report the last two flips that I did in my name. Basically, my question is how do I report business income/loss on my personal return when there isn't an actual business entity? Do I use Schedule C even though is says it's not for "a sporatic activity or a hobby"? I'm not really sure that my flip activity could be called continuous and regular. I spend a large portion of my time personally rehabbing properties to rent out (not the most effective use of my time, probably, but I enjoy it), but I think that should be considered a separate activity. Schedule C doesn't really look set up well to deal with flips and it appears that I still can't get any credit for my own labor.

Perhaps I should report my flip income on Line 21 - Other Income?? If so, I'm unsure of how to tackle the accounting: just add everything up that I put into the property and subtract it from the sales proceeds? What can I include? Personal labor, mortgage interest, insurance, etc. or just purchase cost + hard rehab costs?

And I guess I need to download and study Schedule SE for the Self-employment tax? Oh goodness, the IRS is taking all the enjoyment out of real estate investing and not even giving me a credit for it! :beer:

Any guidence appreciated!

JMac

[Richard Warren]

If you aren’t prepared, your best bet may be to file for an extension. You have to send in what you think you owe with the extension form. If you miss the deadline you will have to pay a penalty for not filing and also for not paying if you owe money. The extension will eliminate the penalty for not filing and the penalty for not paying can be avoided by sending in at least the amount that is owed. The penalty for not filing is much worse than the penalty for not paying. The extension form will give you another four months to get your return done.

8)

[Joe Wilson]

Actually the extension will give you the full 6 months. You do not have to double extend anymore. That is much better, glad they finally changed that.

Well, you should report it on your Sched. C. Your selling price of the homes is your Gross Receipts. The cost of the home (originally), fixup costs, closing costs are all costs of goods sold. You can't take any deduction for your work unless you paid yourself a salary. Chances are you didn't. Other expenses can be booked there to offset the income which would be better to reduce your SE income tax effect. You can deduct the costs you incurred while looking for property. If you use the internet to find properties, deduct the internet costs for the year. If you have a cell phone and use it regularly during your businees, deduct the cell phone bill for the year. If you travel to many different properties to check them out, then track your mileage to deduct those expenses. If you have costs that can be spread between the rental business and rehab business, then you would want to split the expenses up in a reasonable manner. I would put of the expenses on the rehab side so it lowers some of that SE tax liability. Your rental income will probably be a tax loss anyway.

Hope this helps.

Where in SC are you, on the coast? I moved from Greenville to Charlottesville, VA 2 1/2 years ago.

Joe

[Eric Fellows]

Sounds like you have a pretty good idea as to what you may be facing. A little more information is included below for your reference.

IRS Eyes Flippers
If you complete multiple transactions in a short period of time, the IRS may consider your property transactions to be a business or trade rather than an investment strategy. Whoops, it now qualifies as earned income, rather than as capital gain income. Income that is deemed earned, is taxed at a higher rate than that of a so called long-term capital asset (held for more than 12 months). Additionally, 2008 to 2010 marks a great time to sell capital assets that have been held for at least a year or more, as the capital gains tax rate has been dropped to 0% for certain tax brackets. There is no hard and fast rule to determine whether you are a dealer or whether you are just an investor, however, if your primary source of income is from flipping a bunch of houses every year, you will probably get called a dealer. This is a major hit, because not only is your income subject to being taxed as normal income, but you may also be subject to an additional 15.3% self-employment tax. Ouch!

[Eric Fellows]

If you want, the rest of this article can be found at:

http://www.homefundingpros.net/MyBlog

[John M.]

I'm keeping the extension option in my pocket, but if I can determine how to deal with this flip I should still be able to file on time. Upon further research, it looks like I could safely treat this flip as short term capital gains on Sched. D. Most things I read seem to indicate that I would probably not be considered a dealer by the IRS if I only flip one or two a year. This is the only one that I sold in 2007 so wouldn't you agree that I can consider it an investment rather than a business?

Thanks for the link Eric. That article seems to support the idea that I would not likely be considered a dealer with just one flip on my '07 return.

Joe, I live in Aiken but I do spend a good bit of time in Charleston, which is where my avatar photo was taken (Chas harbor to be exact). Since you have experience in SC, do you think I'm on the right track with setting up a llc for the rentals and a S corp for the flips? If so, should they be in SC or another state? Can I flip and hold properties in other states with these entities or should I set up additional ones for each state I do business in? Can you suggest any good books/sites/resources on how to set them up to best advantage and how to run them and do the accounting and fulfill the other requirements?

Much thanks,
JMac