Tax Considerations for Flipping

[Anas B.]

Hello all, What are the best tax preparation practices for house flipping? I utilize two methods of home repairs: rehab then rent; or rehab then sell (the typical flip). Would my tax planning differ in each of the two cases? My thinking was to have the contractor separate repairs from improvements in his invoice, that way I could easily determine and claim repair costs. What are your ways of tax planning and preparation? Thanks

[Brandon Hall]

@Anas B. your tax planning will be very different as one activity is considered passive and the other active.

Buying, rehabbing, and renting a home is considered a passive activity subject to the passive activity loss limitations. You generally capitalize and depreciate your rehab expenditures over a 27.5 year period. 

Buying, rehabbing, and selling is considered a flipping activity where the home is treated as inventory. You may only deduct the directly allocable costs upon the sale of the property which may not be in the year you perform the rehab (i.e. Rehab in 2015 and sell in 2016 - cannot deduct on your 2015 returns).

Flipping is an active business and subject to SE taxes, both the employer and employee halves. Generally speaking, if you expect to profit at least $40k, you should be flipping in an S-Corporation as you will be able to pay yourself a salary less than your total profits (i.e. a salary of $20k on a $40k profit). Only the salary portion will be subject to SE taxes, the remainder of the profit which avoids SE tax is still taxable but can either stay in the company or be taken as a distribution.

Rentals should generally not be held in an S-Corp which means you need separate entities for your businesses. Holding rentals in any corp can lead to serious tax headaches.

You absolutely should hire a CPA and engage in tax planning. The engagement should cover various strategies you can implement to reduce your tax liability. The engagement should also cost less than the NPV tax savings allowing you to benefit from the service.

Do not try to set these entities up or undertake tax strategies without first consulting a CPA. While what I've outlined above is a general scenario, variables such as your total earnings can greatly affect the tax plan's results. Additionally, if set up incorrectly, you won't stand a chance during an audit.

Hope this helps!