First Flip Listed! Any strategies to avoid CAPITAL GAIN$?

Question

Dave Foster · Answer

@Doug Watts, I like the "silent partner" analogy.  There is no specific holding period for a 1031 exchange in Texas or anywhere.  It is a federal statute.  But it must have been your intent to hold that property for productive use.  Purchasing as a "flip" indicates that your intent was primarily to resell and you cannot 1031 that.  It also means that you are stuck with ordinary income on the sale of that property theoretically as long as you own it.  Once that property is tagged as "inventory" rather than investment because of your intent to resell rather than hold it will be ordinary income until it sells --or you change your intent.  And this is gonna run you 30 - 40%.

Demonstrating intent is doing the things that you would do with a property you are going to keep.

The best way to get rid of the silent partner and maximize your return is to put a rentor in that property and as soon as you can refi it.  That will do two things.  First the refi gives you the cash to go ahead and buy your next property.  Secondly when ever it is time to sell after a year or so  you can do a 1031 exchange and use the silent partner's money to buy more real estate for yourself.

Jake Thomas · Answer

@Steve Vaughan most expensive and useless silent partner you will ever have right? haha

Steve Vaughan · Answer

Until day 366, you are an operator in an ordinary (highest marginal rate) income tax world.  Always factor in your 40% silent partner who did none of the work or took none of the risk showing up at your closing table.  The realtors will earn another large chunk. Some states have high excise taxes as well as income tax to boot. Then you get to start all over again with the next deal.

The good news is the tax rate isn't 100% (yet) and it's hard to obtain a better learning experience than flipping. Some of us learned it's difficult and net expensive lol.  From sourcing to analyzing, updating, to selling - it's the whole package.  Good luck with your sale @Doug Watts!

Chris Soignier · Answer

1031 rules aren't state-specific, the IRS governs those.   Basically, flips are one of the least favorable REI strategies from a tax perspective.     My CPA is great, and based in the Austin area if you want a referral.    Please don't ask him (or any other CPA) for free advice, though, as that's disrespectful of his time especially during the height of tax season.

Robert Herrera · Answer

@Dave Toelkes S-CORP INFO:

I AM NOT A CPA-or Tax Professional. Check with your Advisors in your area.

Let's say you start an S-Corp and put all your money into an account Owned by the S-Corp. This is an Owner Contribution and is non-Taxed as it was already taxed when you got it. Buy things you need with this account. Use a card or checks attached to this account to make it easy to identify what you spend. All of your expenses, are tax deductions, from your "eventual profits" . If you make $50 in profits, and spend that money on lets say a permit, gas, insurance, credit card payment, internet/WiFi, Fees, Loan Payments, paper, WHATEVER it may be... you can write off the expense, and not have to pay taxes on the $50 profit. Example: We sold something and made $50. We used that money to pay for GAS to get around to look for more deals.  -$50 for gas. You made nothing, and so are not taxed.

As an Individual worker, you are TAXED first, then you get PAID your pay Check, and you SPEND what's Left OVER.

In a business, you are PAID from a sale or service performed, you SPEND what you made, you're TAXED on what's Left Over. Use Your Business to pay everything and take the profits. You will take what's left over, as a Wage and/or Business Draw (taxed at a lower rate).

Some things get write offs at different rates, like Business Lunch/Entertainment is only 50% Write-off.

There are a lot of write offs for everything from wood, nails, glass, equipment, to legal fees, wages, contractors used, etc.

Robert Herrera · Answer

I am NOT a legal Professional Or CPA. Check with yours to confirm this Information.

You will always have a high tax in FIX and FLIPS. Your Hold time will always be too short no matter how you try and structure it if you want the profits.

1031 exchanges only allow for like kind exchanges Rental/For A Rental-etc. Also you cannot "sell the property" it must go through a trade with someone else looking for a 1031 of mutual benifit. The money can never touch your account if cash is involved, it must be traded with a mediator who handles all money and properties. You will only have 90 days to complete the exchange or it's void. You will be paying fees, mortgage, etc, during this time as well. Also if it doesn't get traded, you have that issue.

Try Lease To Purchase. It's easier and you can differ tax easier. It's a buy and hold strategy with big returns. Large amounts Down from the Tenant/Buyer ($3k-$15K) Tenant pays maintenance, repairs, and all utilities. Read Kris Krohn: Straight Path TO Real Estate. This book will give you the understanding of the different types of Real Estate Investing, Pros/Cons. This includes Fix n Flips, Wholesaling, Traditional Rentals, Lease To Purchase... Etc

Cameron Skinner · Answer

@Doug Watts In a former life I was licensed to practice tax before the IRS, private message me if you want to try and connect, we can talk about your tax options, because I'm free, and I was where you are a decade and a half ago.

Bill Exeter · Answer

Hi Robert,

I wanted to jump in here and clarify your post.  You are right on the money regarding the requirement to exchange rental/investment property for other rental/investment property, that it must go through a mediator (Qualified Intermediary), and that the taxpayer/investor can not touch or have access to the net proceeds from the sale of the rental property.

The one clarification is that the investor has 45 calendar days to identify potential replacement properties - not 90 days.  The 45 day period goes by very quickly, so it is important to start doing your planning early on.

Bill Exeter · Answer

Hi Doug,

Property acquired with the intent to rehab and sell (or flip) does not qualify for 1031 Exchange treatment.  Those properties are bought and held as inventory in your real estate business and not held for rental, investment or business use as required for 1031 Exchange treatment.

It is your intent that is the critical issue.  There is no required holding period.  There is only the requirement that you buy with the intent to hold for rental or investment purposes.  The length of time that you hold the property can go a long way in helping to prove your intent to hold for rental or investment purposes, but it is not the only criteria.  The key is your ability to demonstrate that you did in fact have the intent to buy and hold for rental or investment purposes should you get audited.

You could always buy with the intent to rehab and HOLD for rental investment purposes (as opposed to flip) and then you would qualify for 1031 Exchange treatment.

Dave Toelkes · Answer

@Doug Watts

A lot of misinformation in these posts.  Flip profits are always taxed as ordinary, self-employment income regardless of your holding period.  Even if you employ a lease/option strategy to lengthen your holding period beyond one year, profit on the sale is still flip profit subject to ordinary, self-employment income taxes.

As @Dave Foster said, flips are not eligible for 1031 tax treatment.  I want to expand on what @Chris Soignier said about 1031 exchanges and state specific rules.  The 1031 exchange tax-deferral strategy is part of the federal tax code.  Whether you can defer the gain on a state income tax return varies by state (for those states that have a state income tax).

Many states follow the federal tax code so you can defer the state gain through your 1031 exchange.  A few require that you must buy a replacement property in the same state the relinquished property was located.  Pennsylvania does not recognize 1031 exchanges which means that Pennsylvania will tax the 1031-exchange gain that you deferred on your federal income tax return.

First Flip Listed! Any strategies to avoid CAPITAL GAIN$?

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