Taxes and flipping properties

[Spenser Murphy]

Are there any tax advantages to house flipping like depreciation? Are the profits tax free? I want to get into multifamily rentals. Someone recommended flipping houses to raise capital to purchase the rental properties. Thanks

[Caleb Rigby]

I'm very new to investing but I don't believe the profits are tax free. To be tax free, you would have to live in the house for at least 2 years (or 2 out of the last 5 that it was owned), and I don't think that is common practice for flips since you're trying to turn them around quickly and reduce your holding costs. It's only tax free if your profit is $250k or less (single) or $500k (married filing jointly). This is my understanding at least.

[J Scott]

There are essentially no tax benefits to flipping houses.  You'll pay ordinary taxes at your marginal rate, and you'll likely be on the hook for self-employment taxes as well.

If you're looking to reduce your tax burden, you won't want to flip houses to do it.

[Ben Wendt]

Different question, but I don't really see a forum for this kind of question, is the following: currently, I can't afford to go full-time into REI. This necessitates that I keep my 8-5 job for a little while longer until my wife feels comfortable with a successful flip. I understand that I will have more protection by having an LLC to conduct my flips in. If I am employed full time yet have a business on the side, am I still subject to a self-employment tax for that business? I imagine yes, but I'd like to be sure so that I can set aside the correct monies from flip profits for tax time.

By the way J, great book. I'll be following it closely as I set up a new future for my family and newborn son. 

[Curt Riffel]

You would be paying capital gains tax on any property where you do not live there for 2 out of the last 5 years. Hence for a flip, you would be responsible for paying the tax on the gains.

[Ben Headrick]

@Ben Wendt I am in no way an accountant, but the way I understand it is that you and your employer pretty much split Social Security and Medicare taxes. When you have no employer, you have to pay both halves in the form of self employment tax.

Someone please correct me if I'm wrong.

[Spenser Murphy]

That's my understanding as well.

[Ben Wendt]

Thanks for your replies. I'll have to research capital gains taxes in DE and the brackets for that for the near-term future until I can commit full-time to REI. Thanks @Ben Headrick @Curt Riffel @Spenser Murphy

[Matt Turbitt]

With flips you would be on the hook for the 15% in self employment tax and the income taxes on the profits. Once your flipping multiples you'd want to set up an s Corp for flips and llc's for rental. Listen to the podcasts with the bigger pockets cpa, it's like 11,43ish and 155ish she covers this area and why you'd go one way vs another.

[J Scott]

Originally posted by @Curt Riffel:

You would be paying capital gains tax on any property where you do not live there for 2 out of the last 5 years. Hence for a flip, you would be responsible for paying the tax on the gains.

 Incorrect.  Flips are not taxed as capital gains.

[Linda Weygant]

This can be a complex scenario.

As a W-2 employee, your employer withholds 6.2% of your income as social security tax and 1.45% of your income as medicare tax.  Your employer matches this amount, so the total amount paid in for you is 12.4% social security and 2.9% medicare.

When you are self employed, you are both the employer and the employee, so you have to pay both parts of this for a total self employment tax of 15.3%.

There is also a maximum earned income amount subject to social security tax ($118,500 for 2016).

So let's say you earn $90,000 per year at your W-2 job and $50,000 as a flipper.

Your employer has covered the social security and medicare taxes on the first $90,000, so even though you made $50,000 as a flipper, you've only got to cover another $28,500 in social security taxes.

Medicare has no maximum.  So in this example, you'll pay:

$28,500 x 12.4% = $3534 Social Security Tax

$50,000 x 2.9% = $1450 Medicare Tax

Depreciation is not a consideration when flipping and the profits are most certainly taxable.

The IRS sees no distinction between buying a house, fixing it up and selling it as compared to buying a bunch of widgets, assembling them into a final product and selling it.  It's all ordinary income to them.

[Manolo D.]

I also understand that on LLC or Corp, you need that subchapter S before you'll get the 15.3, I do not think it is worth forming an entity on your first few, unless you have at least 100k equity to protect, especially on flips where exposure is not that big. But if it is cheap like Delaware, it might just be worth it. I'm in CA so we have a minimum 800/yr fee regardless if you income or not so it's not worth forming in my opinion.