Capital Gains + State & Federal???

Question

I'm a 25 year old Journeyman Carpenter and my wife is a Realtor.  We have successfully "flipped" two homes on the side now.  We lived in each house two years to avoid capital gains. I did 100% of the work myself, made $40,000 on the first home and $30,000 on the latest. 
Each of these homes produced a profit as large as my yearly salary and required MUCH less labor then a standard 2000 hour work year.  Due to this I've decided to work 3 more years, build up a sufficient bank roll then quit my job as a Carpenter & become a full-time Flipper.

Of coarse I have tons to learn before embarking on this but I have all the enthusiasm and motivation in the world!

My Question:
Say I flip 3 houses in a year and earn $90,000 in total profits. I realize uncle same is taking 25 ish% for capital gains since I'm not holding them over a year but will I also have to pay  federal and state income tax and if so what's the total % taken out of my "flipping profits" for taxes?

* I will be contacting an accountant... right now I'm just trying to soak up all the knowledge I can

J Scott · Answer

Welcome to BP, Brady...and congrats on the first two successful flips!

First, the income from flipping houses is not considered capital gains, it's considered ordinary business income.  The IRS looks at buying and selling houses just like buying and selling any other commodity -- you could be buying and selling shoes, buying and selling clothes, buying and selling jewelry, etc.

So, the income is taxed at whatever your marginal income tax rate is, not a fixed rate like capital gains.  You'll also pay self-employment taxes (though you may be able to avoid them for part of your income) and you'll pay state income taxes if you live in a state that has them.

This should give you an idea of what you'll pay for Federal taxes:

http://www.taxbrackets2013.com/2012_tax_brackets.html

Remember, these are progressive taxes, so if you make $90K, you're not going to pay 28% tax on all $90K.  You'll pay 10% on your first $17,400 (if you're married and filing jointly), 15% on your next $53,300 and 25% on your next $19,300.

As for state income taxes, do some research on your particular state.  And for self-employment taxes, worst case you'll pay 13.3%.

Steven Hamilton II · Answer

Brady,

J Scott has it right except SE tax is 15.3%. I'll try to elaborate on everything tomorrow.

Steven Hamilton II · Answer

Craig Kucera,

It doesn't matter if he holds it for over a year unless he was originally keeping it as a rental.  Intent is to flip, that means NO capital gain rates.

Toying around with turbotax won't do anything to educate him.  He needs to learn what can and can't be done.

Yes, a home office deduction could be considered if it is used: Regularly and exclusively for business.

Depending upon your current rate you would be looking at adding that income to your current income and paying over the course of the progressive rates.  THEN you will be subject to SE tax of 15.3% in addition to that.  This is one of the reasons many choose to utilize corporations.

David Robertson,

I'm assuming even if you have a full-time job, you still have to pay the SE tax on your earnings from flipping?

Yes, you will be subject to SS up to the limit on earnings of (113,700) Cumulative.  That means if you earned that much from your employer you will only be subject to Medicare on earnings greater than that.

Is income tax based upon the state the house was located or the state you live in?

You will pay taxes based upon the state in which you earned the income.  SO if you live in CA and the house you flipped was in IL, you will be subject to IL taxes on the flipped home; however, you will get a deduction on your CA return for taxes paid to IL.

Also, if I have a full-time job will I still be able to have deductions such as a home-office?

It is possible as long as it is used regularly and exclusively for business.

-Steven

Steven Hamilton II · Answer

Craig Kucera,

Yes, you are misreading it.   Intent is very much a factor.  Even consider that if you are trying to flip a property and can't sell it so yuou decide to lease it out.  You cannot take depreciation AND, you are subject to SE tax on the income.

-Steven

Craig Kucera · Answer

Steven Hamilton II

I think if he holds it for more than a year than it is classified as a long-term capital gain regardless of "intent"?  Or am I misreading #5 in the following link?

http://www.irs.gov/uac/Ten-Important-Facts-About-Capital-Gains-and-Losses

David Robertson · Answer

I also have a few questions of my own:

I'm assuming even if you have a full-time job, you still have to pay the SE tax on your earnings from flipping?

Is income tax based upon the state the house was located or the state you live in?

Also, if I have a full-time job will I still be able to have deductions such as a home-office?

Thanks for your help.

Craig Kucera · Answer

Keep in mind that if (presumably) you are working from your home, you can take a number of deductions against your net income from the above to reduce your tax rate (i.e. home office expense, health insurance, mileage/auto depreciation, your own mortgage interest, etc).  So I would think that your actual adjusted taxes would be at a substantially lower rate than 36% (32150/90000).  
You may want to try and hold each home for just over a year to see if you can get better tax treatment.  Definitely seek the advice of an accountant or toy around with a more advanced version of turbotax to get better numbers.

J Scott · Answer

Whoops!  Thanks Steven...

Brady Lucero · Answer

So including a progressive federal tax, a fixed state and a fixed self employment on $90,000 I come up with $32,150 in taxes.  Would still pull in $57,850....

Now...

When you include wright offs for all the things self employed house flippers can wright off can I figure on getting some of that $32,150 in taxes back?

Brady Lucero · Answer

Can't edit my post but I wanted to be a little more specific:
I've been worried I'd be paying 28% capital gains  + federal + state + self employment all on total profit which would be like 70%ish  
Good to know that's not the case!

I had no clue that these taxes are progressive.  This is excellent news... 
Being anything over $16,000 in my state is taxed the max 6.9%, progressive rates won't help much there.

One more question:
Are self employment taxes progressive or fixed?

Capital Gains + State & Federal???

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