Tax treatment - Lending for a fix and flip

[Kurt Pourbaix]

We partner with a guy who does fix and flips.  He buys the house and does the rehab.  We loan him the money both to buy the house and do the rehab and we share in the profits when it sells.  We don't charge interest per se.  It is not a capital gain because we never own the property.  It doesn't seem like it would be a business activity (subject to SE) because all we do is lend the money.  Would that mean that is it an investing activity (and classified as Investment income)?  And if so, would expenses of running our business be considered investing expenses and subject to the 2% rule?   Thanks for your help.    

[Brandon Hall]

@Jonathan Godes the advice you provided is incorrect, however no fault to you as the code surrounding a situation like this is extremely complex :)

@Kurt Pourbaix To answer your question, if all you are doing is lending then this will be considered a passive activity for you so your profits will completely avoid the SE tax aspect. Instead, you will report some amount of interest earned on your loan. Even though you are only involved in profit sharing, the IRS will impute an interest rate on the lended funds, of which you will need to report as interest income.

The other part of the equation depends on how you are doing business with this person. Since you are splitting profits, it sounds like you will need to file a partnership return and be issued a K1 with your share of the profits - however these profits will not be subject to SE tax for you personally.

Additionally, any business expense you incur should be deducted as "UPE" or unreimbursed partnership expenses on Schedule E - that is only if you are filing a partnership return.

One final note. For flips, there is no short-term capital gain. Rather, profits are reported as an ordinary gain as the property that was flipped is considered inventory.