Developers And Taxes
I'm working on building a new warehouse building, to be sold as condos. The dreaded IRS "dealer" classification has reared its ugly head. I've done a bunch of research, but have not found a way to get around it, for my set of circumstances. (Buying the land, putting up the building, and selling it as condos)
That means that I'll be paying ordinary income tax rates (40%+) to Uncle Sam, instead of capital gains. Does anyone out there have any good ideas for avoiding this situation? I'm not sure there IS a way around it, but thought I'd ask.
Thanks,
CT
Doggone, those two ideas are excellent!
I ran them by my real estate attorney, and my accountant, and they like the ideas as well.
Now, another two weapons in my personal arsenal.
I love this place!
CK,
Thanks for the suggestions. On your first suggestion, it just so happens I had thought of that myself, and this morning ran it by a tax lawyer I know. He told me that he thought the IRS would have trouble with this idea if there was common ownership between Company A and Company B. However, I am not giving up on the concept, and will investigate it further.
On your second suggestion, I had thought of using an SDIRA, but was put off by the fact that it's apparently difficult for these entities to borrow funds. It's not that they are forbidden to do it, but the loans have to be non-recourse, which is a tall order. On top of that, in most cases the trustees for SDIRA's won't let you borrow over 50% LTC, so that kind of kills the economics of the deal.
But I sure like the way you think.... got any more ideas??
CT
We have used the first suggestion before in order to complete a 1031 exchange transaction. However, in that particular transaction Corp A already owned the property and the building. However, we created Corp B and sold stock such that NEW investors owned 92% of Corp B and our client only owned 8%. This way we were able to preserve our client's 1031 exchange transaction and virtually guarantee the new investors an acceptable rate of return.
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We have used the first suggestion before in order to complete a 1031 exchange transaction. However, in that particular transaction Corp A already owned the property and the building. However, we created Corp B and sold stock such that NEW investors owned 92% of Corp B and our client only owned 8%. This way we were able to preserve our client's 1031 exchange transaction and virtually guarantee the new investors an acceptable rate of return.
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I always take the philosophy that no one ever went broke paying taxes. That said it is certainly not illegal or unethical to try to reduce your tax liability. I actually highly recomend it.
I am not an accountant nor attorney so my thoughts are as a layman only.
The senario with two corporations would not work in this senario for the reason that if corp A sells to corp B after building that is certainly development activity that is subject to ordinary income rates reguardless.
If you were use the building as a passive investment, thats where capital gain rates kick in. You could do the condo conversions and rent them out with an option to buy any time after 1 year.
The 1 year thing is important because you must keep them rented for over a year before capital gain rates kick in. The building would be subject to deprecation and the recapture tax but you'll still make out better than ordinary income rates.
I'm not sure what type of financing you have on the property but that long of holding time may create the need for some permanent type financing. The good thing is that you could go with a 3 or 5 year adjustable mortgage for about 1% over prime.
Just some thoughts...
GOOD LUCK