So you will be taxed your ordinary income tax bracket + self employment tax 2.

When they raise the rates like this does the tenant actually have to come up with the extra money, or do we, the taxpayers?

Rehab projects are not considered capital assets (investments), so they are taxed as ordinary income, not capital gains.

I represent taxpayers before the IRS.

I am a tax accountant and Enrolled Agent licensed to represent taxpayers before the IRS.

Hi Steve,Thanks for the response, if anything it's good to know that what I'm facing isn't too out of the ordinary.

If so, then I am guessing that the property holding LLCs claim a deduction for management fees, which are in turn reported on Schedule C as self-employment income.If my assumptions are correct, I wonder why you are converting passive rental income that is only taxed as ordinary income, into active self-employment income that is subject to self-employment income taxes in addition to the ordinary income taxes.   

Worth the couple hundred bucks to ensure you're covered.if what you have is a 2nd mortgage, the 'gain' may be considered interest and be akin to ordinary income.

I have done this something like 3 times.While your waiting to sell them back the house, you are holding the house and possible converting a (short term gain, or ordinary income) into a long term gain.AS far as the foundation and inspector goes, most don't have any clue what they are doing. 

The contractor would count his portion as ordinary income...not capital gains.4.