House flip tax question

[Joel Miller]

Hey everybody,

I’m working on my first deal with is a house flip and I’m wondering if I’d be better off keeping it a year due to tax implications. To the people that have done flips out there...don’t I have to pay self-employment, state, and my regular tax rate (22%)? It adds up to like 43%! Federal tax of 22% + Self-employment of 15% + Idaho state tax of 6.9%. I may just be adding this up wrong. I appreciate any feedback!

Joel

[Michael Plaks]

@Joel Miller

Your math is fine, but your overall perspective is not.

1. I assume you realize that taxes are figured on your profit and not on the selling price.

          Deal Profit = Sale Price - Purchase price - Closing costs - Rehab costs - Holding costs - Financing costs
         Business Profit = Deal profit - Marketing - Driving - All other business expenses

As a result, 95% of first-time flippers lose money in their first year. You may not even have much if any tax to worry about, although I certainly wish otherwise.

2. If you do have taxes, then yes, you will always have your regular income tax and your state tax. The self-employment tax is not automatic. It depends on your overall income (you may be maxed out on your Social Security tax thru your W2 job if you have one) and it primarily depends on your real estate business. In other words, it is case by case. Yes, it is possible to face close to 50% in combined taxes in the worst case.

3. Waiting a year does not automatically lessen your tax burden. It might, but only IF your deal will qualify for capital gains treatment. This is also case by case and needs professional input.

4. Holding on to your flip for longer than necessary can be very expensive. First, you incur monthly holding costs (taxes, insurance, utilities) and interest on your loans, and that last one can be crippling. Second, you run the risk of losing your potential buyer who can lose his job, die, get divorced or simply change his mind. Third, you run the risk of the unexpected changes in the environment - from accidents to natural disasters to riots and Covid. I know several very unhappy investors who could close in February of this crazy year but thought it would be OK to wait another month. In 2020.

5. @Don Spafford mentioned the opportunity cost. You could pull the cash and reinvest it into the next great deal. Chasing tax savings at the cost of missing a business opportunity could be foolish.

My general rule-of-thumb advice is to never let the tax tail wag the business dog.

Best luck.