Basis for Taxable Income

[Gary Michalske]

Hey there BP Tax experts,

I have a question regarding taxable income from property sales. I have a CPA that does my taxes but I’m not convinced he’s an expert on the real estate side of things. And furthermore, if I call him to discuss options or just to explain things he charges me $75 and that kind of bothers me. Hint...hint....

Here’s my current transaction scenario. I’m kind of doing a favor for my real estate agent’s mother. She is going to purchase a house from me after I purchase it from the seller. I’m only looking to make $2,000 for my efforts.

Purchase price: $130,500

Repairs: $7,400 (I pay for the repairs)

Selling Price: $139,900

My Profit: $2,000

The purchase closes on 7/28 and the sale will close on 8/17.

My question is what will be the basis of my taxable income on this? I work a full-time W2 job and have a LLC on the side with which I use for business transactions as described here. My thinking is the $2K will be considered regular income taxed at the tax bracket rate defined by my W2 job. I don't think I will be charged capital gain tax or self-employment tax.

I know the profit is a very small amount but the example would apply to larger transactions too. Will someone let me know if my assumptions are correct please?

[Ben Raygor]

The IRS is going to look at what your intent is. Your intent is to purchase a property and sell it quick with $2,000 as compensation for your efforts.  It looks like you are acting as a dealer in this case.  You had no intent to hold onto the property as an investment, so reporting as a short-term capital gain is less likely.

You should be receiving a 1099-S for the property sale, so the IRS would be expecting to see gross proceeds somewhere on the return.  The usual spot for that would be either on Sch D as a capital gain transaction or on Sch C as a house flip.  Your efforts appear to be active income to me, not investor type income. 

I don't think your assumptions are correct, because it seems like you are hoping to report your net income for $2,000 as Other Income on your 1040.  That's not the right way to report a sale of property.  Schedule C seems like a pain, but it will be your safest reporting option.  If you are bothered by paying 15.3% on that $2,000 net income, I would just raise your selling price to account for your SE taxes if you want to pocket $2,000.  Plus, you'll be able to deduct mileage expenses on Sch C.  

Your $2,000 is compensation for your time.  Taxes are generally setup so that 15.3% of compensation "for time/efforts" gets paid in.  This would apply to larger transactions as well.  It is hard to argue that you are not flipping the property.  You appear to be actively involved in rehabbing the property, even if it's just calling in contractors to do work and purchasing new appliances for example.  Filing Schedule C and paying SE taxes should be the assumption anytime you flip properties unless you know of some tax rule, or have a purchase intent, that allows you to avoid it.