Short Sale Flips And Your Taxes
Different real estate investing strategies have radically different impacts on tax returns.
Those who buy and hold property for over one year benefit from qualifying the income from rentals as passive income. Depreciation and many maintenance expenses qualify as deductions against any rental income. When property held for a year or more is sold, the gains are taxed as long term capital gains at a tax rate of 15% (at least for now). Consult your tax advisor for current law and expected changes.
On the other hand, an Investor who is flipping property must report the sale as income and may also be required to pay FICA as a self-employed tax filer. FICA will be due up to the first $106,800 earned in fiscal year 2009-2010. Above that amount no more FICA is required. Check the recent tax changes to see if that will change for 2010.
The dealer designation comes into play when the intention of a real estate sale is to immediately resell the property and more than one house is sold in a year. You do not want to be designated by the IRS as a dealer. That is a lifelong designation that disallows capital gains treatment of real estate investments and precludes you from doing 1031 like kind exchanges (a tax deferral method used by investors to defer the tax on gains on real estate as long as it is immediately reinvested in a property of greater value). The best way to avoid being personally designated as a dealer is to do all of your transactions through an entity like an LLC or Sub S Corp. Your accountant can help you to choose the right entity. You should have one entity for all of your flips and at least one for your long term hold properties. Check with your accountant or tax attorney to see how to avoid being labeled as a dealer.
It is not uncommon for Short Sale Investors to be required to pay 38% to 55% of their total earnings in taxes because of Alternative Minimum Tax (AMT) add-ons for higher income-earners. Unless you have a sophisticated business entity/entities set up you will find Uncle Sam at the closing table every time.
To avoid any unfortunate surprises either readjust withholdings for FICA with each check you receive, or hold back the amount you or your accountant expect will be required in a special bank account so you will have it in hand come tax day. This play it safe strategy requires some discipline and guidance. Perhaps the best strategy is to hire a book keeper and set up operational procedures to make this an automatic process.
On the good side, your Short Sale career is bound to mean higher income than you had in the past. You will need to keep an eye on your tax planning so that you dont get a surprise at tax time. Always consult your tax advisor for current tax law and the best way to maximize your earnings. Stay in a positive mindset and maybe even consider yourself fortunate that you need to pay more taxes as the years go by. That just means you have made more income.
Parts of this article are attributed to Bob Massey. Visit our website www.RealEstateProsFlorida.com for a link to our blog with current real estate information and resources for Investors & Realtors, Sellers & Buyers. Consult us when you have a property to sell or looking to buy.
by: trafficjsk
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