short term vs long term capital gains?

Question

i invest in sub 50k homes.

i bough a house for 25k in December of 2016.  i have an offer for 59k.

what should i expect to pay in capital gains if i sell for a 34k profit within one year (short term)?

what should i expect to pay in capital gains if i sell for a 34k profit after one year (long term)?

my wife and myself are in a high tax bracket.  last year we grossed 150k combined.  this year (2017) we will probably gross over 250k combined income.

thank you

Michael Plaks · Answer

@Tim Ivory

These are good questions eventually, but it's the wrong focus for now.

1. To your specific question: flips are taxed as business income, same as contract jobs or commissions. This is the most brutal taxation: ordinary rate plus SocSecurity/Medicare tax, also known as self-employment tax. Together, they can be as high as 40%. A good rule of thumb is plan to pay 1/3 of the net profit.

2. The net profit concept is critical. It's whatever money is left from the flip itself after everybody (except you) got paid MINUS all business operational expenses: driving, marketing, technology, supplies and whatnot.

Example: you bought it for $90k, put in $20k in repairs, $15k in interest and taxes and sold for $150k with $10k closing costs. Your profit from the flip itself is $15k.

If you spent another $10k on driving and marketing - your net profit is only $5k. Your taxes are calculated on $5k.

3. Why I said wrong focus? Because making this $5k from my example is much tougher than it looks on TV and seminars. Approximately 95% of first-time flippers lose money, not make money. Their taxes are zero, but so are their bank accounts. How do I know? I prepare their taxes.

The initial focus should be on how to make money. Taxes are something way down the road. Don't worry how you are going to pay for college for your future kids when you're on your first date. ;)

4. That said - capital gains, long or short, and 1031 exchanges do not apply to flips, period. They are for rental properties. What @Dave Foster alluded to is that you could change your business model and hold to these properties longer and possibly rent them before 1031. Yes, it can work, but it's a fundamentally flawed approach to build your business model based on taxes, particularly early on. Later on - maybe.

Dave Toelkes · Answer

@Robert Hastings

From your comments, I get the impression that you purchased this property with the intent to flip for profit.  In this case, just holding for a year does not change the character of your income.  Flip profit is always taxed as ordinary income regardless of the holding period.

Tim Ivory · Answer

Thanks guys. My business model is to start wholesaling to build up money for fix and flips, leading to BRRRR buy and hold long time strategies. However, my plan is to close on every property I have under contract. If I can't wholesale. I will buy it with HML to fix and flip. I  cannot BRRRR for now. I need to build up more income and file taxes for atleast 1 year to conform to their guidelines which allow them to sell to secondary market. Unless of course I can find other sources of private money which do not require proof of income or otherwise accept a different proof of self employment income - like a monthly paypal income and expenses worksheet.

*  I did not pay taxes because I was not legally obligated to do so. This year I will cross the self employment income threshold for my online business (most definitely if I get a few flips done). I suppose a better question to ask is how is wholesale money taxed.

Does it look like this on 100k income?

Federal Tax (~15%) + State Tax (TN 6.5%) + Self Employment Tax (14.4%) - So around 41% for either Fix and Flips and/or wholesales!?

The federal is the averaged progressive tax percentage.

Dave Foster · Answer

@Tim Ivory, Slow down your flip model and the 1031 could work with it.  Purchase reno hold (refi if you want and use the refi for new purchases) then after a year or so sell and 1031 into two more using the proceeds as down payments.

Your intent must be to hold.  But there's a way to do that and still get your adrenal rush flipping also.

Tim Ivory · Answer

@Natalie Kolodij Is there a chart I can look up to get an idea how much tax I will be paying on flips? If I'm in the 25% bracket, that doesn't mean I will be hit with a 25% sales tax on the profit, or will it? I assume not since the long term capital gains could be 15% on someone within the bracket of 33%. Is this only because it is classified as a long term capital gain, therefore, if it were held less than a year, then, indeed, they would then be taxed 33% on their profit?

Edit* One more question, if I may, couldn't I instead do a 1031 exchange on the flip and defer the taxes? How would that work, is it possible to use the profit 'housed' in a 1031 as a down payment for another fix and flip?

Natalie Kolodij · Answer

Yes sir- If Trumps plan goes into effect he's cutting the brackets way down.

Not terrible for those who flip as normal income rates drop down but those with stock sales and such may get hit quite a bit harder depending on where they fall

Dave Toelkes · Answer

@Natalie Kolodij

You are correct, I was getting ahead of Congress.

If President Trump manages to push through his tax plan that consolidates a few tax brackets, there will only be three brackets (12%, 25%, and 33%) for 2017.  The highest bracket (33%), with taxable income above $225K MFJ will have a 20% capital gains tax rate.

Natalie Kolodij · Answer

If his AGI is more than 250k he may end up with the additional 3.8% medicare on capital gains too...

But given the info here I think it's just going to be regular income for him at 28%

Natalie Kolodij · Answer

@Dave Toelkes

Tax bracket for $225k for MFJ is 28%

28% Tax bracket falls into 15% capital gains bracket. It only hits 20% for those in the 39% bracket

short term vs long term capital gains?

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