Can I report zero gain if I build a house, sell it and buy 2 lots

Question

Hi all, I am buying a lot and building a house under an LLC. Let’s assume that the lot costs 50K, I spend 50K to build the house, and that I sell the house for 150K. Within the same year, let’s say I buy 2 more lots for 50K each. So then my 123 LLC has technically zero gains. In such scenario, can I report zero gains for 123 LLC to avoid paying taxes on the

Bill Exeter · Answer

Hi @Hector Test,

@Bob Norton is a licensed CPA and can certainly help you.

Christopher Smith · Answer

Of course your costs will reduce your gain on sale.

What was your intent in building the property? A one time build would not necessarily make it inventory. Is it your intent to go into business as a builder/contractor or is there the possibility of build and hold? Being able to articulate well your intended business plan will ultimately determine treatment and ultimate eligibility for 1031.

So is it your long term intent to be a builder or an investor?

Bill Exeter · Answer

Hi @Hector Test,

Your costs would be $100,000 and your profit would be $50,000.  This would be taxed as ordinary income since it sounds like you are a builder/developer.

You might be able to qualify for long-term capital gain taxes if you are not really intending to be a builder/developer and you hold the property for more than one year.  However, it sounds like you intend to repeat the process so you would be a builder/developer/dealer.

The same applies for 1031 Exchange treatment.  You must have the intent to buy and hold both your relinquished property and your replacement property for rental, investment or business use.  Developer, builders, dealers, etc., hold property for sale in their real estate business and do not qualify for 1031 Exchange treatment.  You could qualify if you build and hold for rental vs. hold for sale.

Bob Norton · Answer

@Hector Test The tax law doesn't work that way.  In your example, you will have a $100k profit on the construction of the house (taxed as regular income, not capital gains, because you are a builder/developer).  You do not get to deduct purchases of property against your income until you sell the property.

You could defer the tax using a 1031 exchange.  However, you would have to be an investor and not a builder/developer to do this.  Property for builders is considered inventory, which does not qualify for a 1031 exchange.  So, you would have to convert your property to a rental in order for it to qualify for a 1031 exchange.

Bob Norton · Answer

@Hector Test There are quite a few good CPAs on BP that can help you structure your business to be tax efficient.  I recommend that you contact several to see which ones will be a good fit for you.

Hector Test · Answer

Thanks @Bill Exeter but as I mentioned above, my intend is to be an builder/developer so it seems like strategies such as 1031 will not work for me.

@Bob Norton, in the prove scenario, as a builder, how can I structure the deals so that they are set up as investments? I don’t know a CPA who is familiar with this. Can you recommend one?

Bob Norton · Answer

@Hector Test Yes, your cost of materials and services are expenses that you get to deduct when you sell the property.  Any costs spent to build the house is capitalized and then expensed when you sell the house.  So, if you purchase the property and build the house in 2020 and then sell the house in 2021, then you do not get to deduct the costs of purchase and construction in 2020 and will get to deduct those costs in 2021 when you sell.

As @Christopher Smith mentions, intent is important when you purchase a property.  That can determine if you pay additional self-employment taxes on your income, or the low capital gains tax rates.

It sounds like your intent is to be a builder/developer, so you will be paying the highest tax rates possible.

Since you are operating as a business, you will get to deduct any related business expenses as well.  However, the only way to defer taxes as a builder is to wait to sell your properties.  Because as soon as you sell them, you have a taxable event.

The beauty of real estate is that you can structure your deals so that they are set up as investments, which are treated favorably under tax law.

I recommend that you discuss your business plans with a CPA who is familiar with real estate investing and who then can advise you on how to structure your ventures to lower your taxes.

Hector Test · Answer

@Christopher Smith, thank your reply. Yes, the intend is to sell the property as soon as it is built, then build more properties with the proceeds.

I noticed I posted the fist draft not the final draft of my question. Please see below the intended final question.

“Hi all, I am thinking to start a property development company. I want to start by buying a lot and building a house under an LLC. Let's assume that the lot costs 50K, I spend 50K to build the house, and that I sell the house for 150K. Within the same year, with the 150K let's say I buy 2 more lots for 50K each, and spend 50K building another house in one of the lots. So then my 123 LLC has technically zero gains in the first year.

In such scenario, what strategies can I use to legally avoid/reduce taxes on the 50K profit/income (150K sale - 50K lot - 50K material/contractors)

Also, is the 50K I spent to build the house considered expenses?”

Christopher Smith · Answer

Spend a little time understanding the basics of 1031 exchanges.

Hector Test · Answer

@Bob Norton, thank you for the quick response. On the first point as a builder, is the money I spend on materials and services to build the house not considered as expenses in my construction business? Hence the 50K income in my example rather than the 100K.

Since 1031 does not work for inventory, are there any other strategies I could use to reduce tax in the above scenario?

Can I report zero gain if I build a house, sell it and buy 2 lots

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