Capital Gains With A First And Second-flipper
I bot a house for $200K.
I took out a second mortgage to rehab the property.
At this point I owe $225,000 (first and second).
I then sold it for $260K
My question is what do I get taxed on??
-the 60K difference in selling prices
or
-the $35k (MINUS CLOSING COSTS) that I was issued a check for at closing.
I did own the property for less than 5 months.
Please Advise.
You don't tell us how much you spent for your rehab. Your mortgage balance is irrelevant in calculating your taxable profit.
Take your purchase price and add in the actual cost incurred for your capital improvements (rehab). This total is your cost basis. Subtract your cost basis from your selling price, and then subtract your selling expenses.
Whatever number you have after all these calculations is your taxable profit.
For example, you let's say you bought for $200K and spent another $10K on the rehab. Your cost basis is now $210K. Your contract sale price was $260 but you paid $3000 at settlement for transfer fees and your share of the attorney fee.
Subtract your cost basis and your selling costs from your sale price and you are left with a $47K taxable profit. If you also paid a real estate sales commission, your taxable profit is further reduced by the amount of the sales commission.
Now I have a question to add to this thread. How is the gain reported?
I am getting differing viewpoints on this and would love to hear from someone
who may have actually reported it as capital gain on Schedule D rather than ordinary income on schedule C.
The difference is important since ordinary income requires paying social security tax if you are self employed. Capital Gains on the other hand, can be offset by capital losses you may have from stock market trades. I realize most Rehabs will be short term gains. But if you have short term losses, this would be an equal offset. Has anyone reported it this way? Please enlighten us.
Thanks.
Glenn,
I typed out a long and detailed reply, and then I lost it when Explorer crashed.
The short version is that the area of law concerning whether you will be taxed as a capital asset (investor) or as ordinary income (dealer) is "a quagmire of unworkable, unreliable, and often irrelevant tests". However, two factors considered include the number of sales you have made and whether the property has been improved.
If you have made more than one, or a few sales, and if you have made improvements, this helps tip the balance toward ordinary income.
This is a question for an attorney in your area. Yes, the SE tax is a burden. However, if you intentionally file as capital gain (especially if you have made many sales and a substantial profit), you will be facing a much larger burden if the IRS recharacterizes all of your gain, hits you with the higher ordinary income rate, the SE tax, AND penalties and interest.
Avoidance is not the same as evasion. Seek out an attorney in your area to help you determine where the line is in your individual case.
so if i make NO improvements, does it tip the balance towards holding it for appreciation and hence capital gains?
If you are acting as a dealer to real estate, your sales will be taxed as dealer dispositions. Whether you make any improvements along the way will not change the tax treatment, just your tax liability.