Help Avoid "dealer" Status
My accountant says that we will be hit a 15.3% tax for owner financing "Dealer" tax. If we are taking houses "subject to" and selling them owner finace is there and how can we not dealer tax?
Info we are doing this in an LLC.
Thanks
Sire[ Edited by sire on Date 01/24/2004 ]
There is no such thing as a "dealer tax". In your case, when you are buying (Subject To) and selling (on Contract for Deed) property for profit, you are engaged in an active business. Your business is a "dealer" to real estate.
As such, your net income is subject to "self-employment" tax and this is the 15.3% tax your accountant is referring to.
By the way, did your accountant also tell you that the net profit on all of your sales is fully taxable in the year of the sale, even though you will receive most of it in future installments?
As for the self employment tax will we be taxed on net profit after all business expense (classes, new computer,etc.) So selling on installment sales there is no way around self employment tax, but you are only taxed on net profits.
If you use a S or C corp can you get around the "self employment " tax. Do you get taxed like this if you have a partner in the business? Help tell me what to do here?
It sounds as though it is not worth selling on an installment sale do to the tax issues. If I sale on a 2 year ballon I get taxed the total profit the day we get the people in the house. Then we pay self employment tax on that. There has got to be a better way.
Sire
You need to talk to an attorney along with your accountant on which type of entity to www.use.No matter which entity you use be it an llc or a corporation (s or c),they can help decide the best route for you to take.
sire,
First, you need to get rid of the notion that it is bad news to be a dealer. There is no stigma attached to dealer status. There are some tax treatments denied you, such as installment sale tax treatment and 1031 participation, but you can structure your deals to adequately address your tax liabilities.
Secondly, if you are afraid of making money because you will pay taxes on your profits, then you do not have the right frame of mind for this business. Your attitude should be "I can't wait for the day when my income tax bill is ONE MILLION dollars". Why...because if your tax bill is one million dollars, you probably made at least five million dollars during the year.
Which entity to use is better left to your attorney, CPA and tax advisor. You might avoid payroll taxes if you conduct your business in a C-Corp and never take a salary, though if you take money out of the Corp as a dividend it will be taxed twice. You can minimize your self-employment taxes by conducting your business in a S-Corp and taking a reasonable salary with the balance of your net income taken as a dividend.
It seems to me that the federal tax effect of either corporate entity will be almost the same, so the decision on which is better for you should probably depend upon other factors such as asset protection and which entity provides the best opportunity to expense corporate perks.
Now, let's address your fear of having to pay the tax on all your profit up front when you sell your Subject To property on a CFD. Let's say that your total profit on the deal will be $15K. If you are in the 15% tax bracket and conducting your business in an S-Corp, you will want to take a reasonable salary, say $3K. Your ordinary income tax on your salary amounts to $450, and your share of the payroll taxes reduce your salary draw by $229.50. After the income tax and payroll tax are applied to your salary, you net $2320.50. Now you have $12K still left to deal with. Your company share of the payroll taxes on your salary is a business expense so let's deduct $229.50, and let's assume there are no other business expenses to deduct (like advertising, office supplies, office rent, auto lease, legal fees, etc.) leaving a net income of $11,770.50 which you take as a dividend. This dividend is reported on your Schedule B and adds $1766 to your tax liability.
Add up all the taxes you will pay because of this deal and you get $2675. Your $3K salary seems to be sufficient to cover this tax bill. With business expenses, your tax liability should be a lot lower. By the way, you did collect an up-front down payment between $3K and $5K didn't you, so you have the money to pay your salary and your taxes?[ Edited by DaveT on Date 01/26/2004 ]
Thank you. My accountant talks in accounting terms.
Thanks
Brian
DaveT,
Excellent...
John $Cash$ Locke
well done DaveT !!!!
DaveT,
Thank you for your very clear explanation, I am sure we all appreciate it.
One more question, I am not much of a tax wizz and leave that to my CPA, however, since you are so well versed, I'd like to get a "preview" answer:
Since we will be taxed over the total profit upfront, even if we haven't received it, will we be taxed again when we actually receive the "back-end" profit? or does the IRS know that we already payed for it?
Ladybug
Ladybug,
Once you pay your income tax upfront on your profit, then installment payments against the principal balance are tax free, even the balloon payment at the end of the contract is tax free.
The interest your buyer pays on your note is taxable income in the year in which it is received.[ Edited by DaveT on Date 01/26/2004 ]
There are some tax treatments denied you, such as installment sale tax treatment and 1031 participation, but you can structure your deals to adequately address your tax liabilities.
DaveT -- Very useful information, I have one question re: your statement above. Say I sold investment property on a deferred exchange last July, which I held in my own name. I bought replacement property within the 6 month deadline, closed escrow in January. Can I transfer title for the new property to my C Corp. and still do a 1031 Exchange when I decide to sell or am I considered a dealer? Can't a corp. do exchanges?
I know this is an old thread but maybe Dave T can just clarify something for me. When you are flipping with Dealer status, you don't pay capitol gains tax yes? and if you aren't a dealer you do pay it along with the 15.3% self employment tax yes? If this is the case then isn't it better to be classified as a dealer than not for tax purposes?
Thanks
Joe
[addsig]
oi vey, it's better to understand the concepts prior to quantifying the tax bill.
-Investors make their ordinary income and invest in property they hope will appreciate. They will pay at the reduced capital gains rate on the profit from the investment.
-A Dealer makes their ordinary income by selling real estate to customers in the ordinary course of business. Therefore, any gain or loss realized on its disposition is ordinary gain or loss. In addition, if self-employed and owned directly, they are subject to the the 15.3% self-employment tax.
Investor = cap gain rate
Dealer = ord income rate PLUS S/E tax
It's not usually that simple, but that's a possible scenario.