Minimizing Capitol Gains Question!

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Hello, first post on this informative website. I am just about done my first rehabb project. I bought the single family house for 25,000. I put 6,000 into rehabbing it. The comps in the area are around 65,000. My question is this: If i sold the house for 65,000 outright I would be looking at capital gains tax of about 34,000. But if I refinanced the note with a cash out option of 26,000, my understanding is that I dont have to pay capitol gains on cash out from a refinance. Is that correct? If so, The difference now between what I owe on the loan 57,000 and what I could sell for 65,000 would leave a capital gains profit of 8,000. So it would seem that I could only be taxed on 8,000 which would be better then 34,000. I hope I explained this clearly.Any response would be appreciated. Thanks in advance.

Comments(5)

  • myfrogger29th September, 2004

    You are taxed on the difference of what you bought the property for and what you sold the property for, minus expenses.

    It doesn't matter your loan balance.

    So if you bought the house for $25k, put $6k into it, and sold it for $65k, you are correct in that you have $34k taxable income.

    A few notes:
    1. Rehabing a home is considered an active trade or business and is not subject to capital gains but rather oridionary income rates. You can save yourself a signficant amount of an additional "self employment tax" of 15.3% by placing the property in an s-corp when purchasing.
    2. You are allowed to decut every reaonable and normal expense related to your rehab. This includes mortgage interest, utility bills, gas for your truck, insurance, etc. My guess is that you have more into it than $6k.

    GOOD LUCK

  • treymanda29th September, 2004

    There is also a matter of depreciation that must be added back into the basis of the property (whether you deducted it or not).

    I'd like to add that I would use a Limited Liability Company (LLC) to hold properties rather than the SubS corp. SubS status must be granted by the IRS (usually no problem).
    Can also make for an easir transfer of property. You can simply sell your share of the company rather than having a formal closing on a property. The new owner will own the company that owns the property.
    **Please See My Profile**
    grin

  • NewKidinTown229th September, 2004

    treymanda

    Quote:There is also a matter of depreciation that must be added back into the basis of the property (whether you deducted it or not).In an active income business, the flip property is non-depreciable merchandise to the business. No depreciation expense is allowed.

    I don't know of any instance where depreciation is added to the basis. Perhaps you could outline a scenario.

    Quote:I'd like to add that I would use a Limited Liability Company (LLC) to hold properties rather than the SubS corp. SubS status must be granted by the IRS (usually no problem).Again, because property flipping is the business activity, an LLC treated as either a sole proprietor or as a disregarded entity does not provide the opportunity to declare a dividend. The S-Corp can pay a reasonable salary then declare the net corporate income as a dividend. Even though subject to ordinary income tax along with his salary, the taxpayer has no self-employment income tax liability on the S-Corp dividend.

  • Erick2nd October, 2004

    I don't think the OP said anything about flipping the property. He said that he's taking a loan out on it and I would suspect that means he's going to hold it long term and renting it out and keeping it long term means that it is an investment property and therefore he can depreciate it.

    I think the other poster just mis-spoke when he said that depreciation is added to the basis. It is subtracted from the cost basis (which includes the rehab) to arrive at the adjusted basis. This adjusted basis is what is then used to calculate the gain on the property when it's sold.

    Don't get confused about putting financing on a property. Any money you contribute to a company to buy a property or you borrow from someone to buy a property has no bearing on your taxable income and neither does the principal payoff. The way it affects your income is via the interest expense it generates which is an expense as noted earlier.

  • dupont6th October, 2004

    New kid in town,
    You hit my intentions percisely. I do want to flip the property, while at the same time reduce my capital gains liability.

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