Taxes Weigh Out The Profits
My dad and I will be looking to invest in Sub 2 transactions come January. We will be selling on a wrap or L/O. Since we live in Texas a Contract for Deed is not recommended.
I understand that once we sell a property we are taxed on all of the profit in the same year even though we receive the money over the next couple of years.
Example:
I take over a house by sub 2 for $100K and sell with owner financing for $125K. I get a down payment of $6K with a ballon payment due in 2 years for the rest of the balance.
From my understanding I am taxed for the 25K profit right away, which could cost me around $7.5K (30% X 25K) or more. Since I only collected a 6K down payment. I'm loosing 1.5K this year.
It seems that if I am having to pay 1.5K on every transaction I will not be in business that long. Is there any way to offset these taxes even though I am considered a dealer. If not, I don't understand how I can get started in this business by having to pay so much money the first couple of years.
Any thoughts would be greatly appreciated!
Aron
After further reading I understand that if I sold the property using a wrap I will only be taxed on the market value of the note plus the cash down payment, instead of being taxed on the entire $25k profit.
In this case I would find out the market value of a 125K note secured by a $115K house (supposing the FMV of the house is $115K). If the market value of the note was $107K I would take the difference of 107K (market value) - 100K (original mortgage). This $7k plus the down payment of 6K is what I would be taxed on. So I would be taxed on $13K instead of $25K.
Do any experienced investors have any thoughts on this? Please let me know if I am missing anything.[ Edited by apa3705 on Date 11/29/2004 ]
In the first post, you estimate a $7.5K tax bill but only have $6K in hand from the downpayment. You only have this situation when you sell in late November or December. You are overlooking the monthly payments made by the buyer throughout the year. True you are receiving taxable interest income, but the total monthly payment after only two months should give you the $1500 you are looking for.
In the second post, you outline an approach to arriving at your taxable profit by doing a market analysis of the note you are taking back. My question, if you don't have to actually sell the note to claim the discounted value, what happens to the difference when your note is paid off? Seems like you will get the income and, therefore, will be (should be?) taxed on the income anyway.
Let's illustrate. You take a property Subject To a $100K mortgage. You sell for $125K on a wrap with a $6K downpayment. You "value" your $119K note at only $107K for a $12K discount. Since your purchase price is $100K, you claim only $13K profit and compute your taxes accordingly. Now, let's say that the buyer refinances one year later and pays off the full balance due on your $119K note. Isn't the extra $12K in unreported gain now taxable?
Thanks for the reply.
IN REGARDS TO POST 1
Quote:
You are overlooking the monthly payments made by the buyer throughout the year. True you are receiving taxable interest income, but the total monthly payment after only two months should give you the $1500 you are looking for.
I'm a little confused about the above statement. It seems like I might make an extra $300 (estimate) a month (new owner finance - original mortgage = $300). For example, If I bought the property half way through the year (June) I would gain an extra 6 X $300 = $1800. Which would also be taxable. This might allow me to come out even for the year (assuming all the tax is due).
IN REGARDS TO POST 2
Quote:
On 2004-11-29 19:10, NewKidinTown2 wrote:
In the second post, you outline an approach to arriving at your taxable profit by doing a market analysis of the note you are taking back. My question, if you don't have to actually sell the note to claim the discounted value, what happens to the difference when your note is paid off? Seems like you will get the income and, therefore, will be (should be?) taxed on the income anyway.
Let's illustrate. You take a property Subject To a $100K mortgage. You sell for $125K on a wrap with a $6K downpayment. You "value" your $119K note at only $107K for a $12K discount. Since your purchase price is $100K, you claim only $13K profit and compute your taxes accordingly. Now, let's say that the buyer refinances one year later and pays off the full balance due on your $119K note. Isn't the extra $12K in unreported gain now taxable?
This is a good question. In this scenario is it right to assume that I will be paying taxes on $13K the first year and then $12K the second year (not including any monthly cash flow)? Does anyone have any insight? Does anyone here buy sub 2 and sell by owner financing, and if so how are you taxed (assuming that the transaction has a dealer status and is not an installment sale)?