LLC Sells Property -- Business Income or Capital Gains?

Question

I just bought a SFH through my LLC and I'm still not sure if I'm going to flip it or rent it. One thing weighing on my decision are taxes.

If a single-member LLC owns a property, rehabs it, and sells it, are the profits deemed "business income" or "capital gains"? If I owned a home in my name, personally, I would probably rent it out for at least a year before thinking of selling in order to avoid short-term capital gains. Does this work with business owned properties as well?

I also have a self-directed Roth 401k, so I'm wondering how my real estate profits will figure into my contributions.

Joel Block · Answer

These are the kinds of discussions that I find very dangerous on this board. Some of the people contributing know what they are talking about but the issue with professional services is that you need to know all of the facts before an opinion can be provided. Certainly, facts have been omitted - even by accident since a proper interview has not taken place. Be careful if you follow this advice. At a minimum, speak to someone you trust on these topics personally before moving forward.

Account Closed · Answer

How the income is treated has little to do with the entity structure.  At the heart of the issue is are you a dealer or are you an investor purchasing to rent that sells a rental.  There are facts and circumstances that need to be reviewed to make that determination.  Like Joel Block says it can be dangerous to assume that it can be treated one way or another without supporting that approach.  This is a situation I would recommend an investor to seek a experienced tax preparer that is very experienced in real estate transactions.

Holding a property longer than a year is no guarantee that you will qualify for capital gains treatment.  The last thing you want is to report it as a capital gains transaction and have the IRS audit three years from now and reclassify it.  Your penalties and interest would more than double the taxes due.

Account Closed · Answer

Mark you have a number of issues going on here and there are some serious red flags that come to mind.

There is nothing wrong with having a strategy of buying some properties to rent long or short term and to buy some as flippers.  It becomes a tax issue though when you do not separate these activities because they are treated differently regardless of how long you hold a property.  I generally would recommend an LLC for rentals and a corporation for a flipping business.

Buying a single property in an LLC that you sell after rehabbing may or may not be treated as ordinary business income.  Generally though if you are flipping this is business income subject to self employment and it doesn't matter how long you hold it.

The self-directed 401K is another issue all together.  You will want to take care how you fund the 401K, how much is maintained in cash reserves, the type of real estate investing activities and even the use of leverage in a 401K.

I would not say that it is certain that flipping the property will be treated as ordinary income in your case because it sounds like there are some facts and circumstances that I'm not aware of.  I can say though great care needs to be taken when you prepare your return to document these facts and circumstances so that you have answers if you are ever audited.

Bill Walston · Answer

True enough Evan, unless the owner of that single-member LLC elects to have the LLC taxed as a corporation (either C or S).

Evan Huston · Answer

IRS Guidelines for Single Member Limited Liability Companies:
http://www.irs.gov/businesses/small/article/0,,id=158625,00.html

A single-member LLC is a "disregard entity" to the IRS and treated like a sole-proprietorship.

If you hold for more than a year its capital gains.  Some investors that have 2 LLC's.  One for their buy & holds and another for their flips to keep the two separate.

You file Schedule C as if you were a Sole Proprietor. The capital gains and losses go on Schedule D as always.

Steven Hamilton II · Answer

A single member LLC is disregarded. You file your tax return as if it was in your own name. As a Rental it would be on Schedule E rents and royalties.  If you flip, it will be considered business income.

I am a Enrolled Agent licensed by the Department of Treasury in tax. I speak tax. I deal with situations like yours on a daily basis.

Ebere Okoye · Answer

To the first question regarding profits, it is regarded as Business income subject to self employment taxes.
To the second question on short term capital gains - Yes, if the business is a pass through entity, then it follows the same rules as our individual tax return rules.

Mark Beekman · Answer

This is the heart of my original question. I was wondering if my LLC bought a property, rehabbed it, and then sold it over a year later, would those proceeds be treated as business income or would they be considered long term capital gains, as they would be if it were a person owning the property. I'm also now wondering if it would help/hurt to have the property in question be the actual legal place of business for the LLC, which it is currently not. My LLC is taxed as a pass-through.

I don't invest in real estate with my 401k (yet). I just figured that if there were no way around paying tax on business income, regardless of how long I hold the proerty, I want to contribute to my Roth for other unrelated investments that I have planned.

Thanks to everyone for their replies!

Steven Hamilton II · Answer

provided it is an S-corp the business does not have to have income to pay its shareholders benefits or wages.

Carl Randal · Answer

@Steven's remarks....Steven, what is the tax implication to the LLC if Mark chose his entity classification election (via 8823) as an S-Corp?

LLC Sells Property -- Business Income or Capital Gains?

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