Tax strategy advice for flipping/wholesaling

[Jessica Parker]

Hi fellow BP'ers! So My husband and I are at the very beginning stages of getting our investing career going! We just created an LLC to flip and wholesale out of. We don't need any of the money we will be making from wholesaling or flipping as our current business provides more than enough income to live off of. So we plan on reinvesting everything!

If we re-invest all profits that we make from flipping and wholesaling, will we have zero tax liability for that portion of income at the end of the year? 

We have a plan on moving to the South here in the next couple years...so would we then be able to take whatever our capital is up to at that point and put it all into buying properties in cash or use the money as down-payments on multiple properties and completely avoid any tax?    We would then plan on Refinancing properties to pull our money back out after we rehab them.  I'm just wondering, is this a good tax strategy?  Will we in essence be able to avoid all taxes on that income doing this? 

[David M.]

@Jessica Parker

Hmm..  In think you need to get a hold of the basics.  The "reinvesting" thing is more of a 'business strategy' than a 'tax thing.'  Think of it this way:  assuming you've invested stocks before, if you purchase then sell some stock for a profit, you have a profit.  If you take that profit and buy some more stock, you still have a profit to report to the irs.  The fact that you purchased more stock doesn't change that for tax purposes.  It just means you don't have any cash because you "reinvested" it.

The concept of "taking money/profits out of the business" only really makes any sense if you have a C Corp.  Most people don't use C Corps because of the double taxation.  All the other legal entities / tax status' are pass through entities.  In this manner, the profits/losses are passed directly to the owners who then have to report those profits/losses on their personal tax returns.

S Corps can be useful to save on the self-employment tax.  However, you really need to making a good deal of income since you have to pay yourself a "reasonable salary" first, then take the rest as dividend/distribution.  Meanwhile, you have more reporting/filing (i.e. more accountant fees) when you have a S Corp.

You mentioned "inventory."  When you are flipping or wholesaling, the IRS considers you to be in the business or trade selling inventory. That is why all the income is active, earned income subject to self employment tax.  If you are investing, e.g. buy and hold rentals, then by definition you have a passive investment which is passive profits/losses and capitals gains/losses when you sell.

1031 like-kind exchanges are only valid for passive investments.

There is a whole bunch here.  I'd be happy to chat with you about all this and any other ideas you have so you are better educated before spending time and money with an accountant.  Just send me a direct message.

Take care, and good luck.