Reduce Real Estate Dealer Income Taxes?

Most of the wholesalers I know have the same problem: We are in the 35% plus tax bracket since we earned a lot of money in the first half of this year.

I'm wondering if the following procedure would work and would stand IRS scrutiny. I sell a property to Joe Blow for less than what I paid for it, taking a $50K loss. Joe Bloe sells me one of his dogs, oops, I mean houses, also taking a $50K loss.

We each have a $50K loss to offset income and we have reduced the cost basis of our inventory.

Will this work? Is this legal? [addsig]

The IRS doesn't just look at what you do--they look at what you were thinking while you did it (or what they think you were thinking). Can it work? Yes. Will it work if you get caught? Nope. They won't go after you for fraud (although nothing is guaranteed with the InFernal Revenue Service), but they will definitely disallow the write-offs. They may or may not charge a penalty. To quote a famous tuna, "Sorry, Charlie." [addsig]

On a similar note, two neighbors concocted this ploy: There was a case where an investor sold his house to another investor in the same neighborhood (actually on the same street), and then that Buyer rented it back to him at a low rent. Likewise, the Buyer sold him a house, and he rented it back to the Seller. I'm not sure what they were trying to accomplish, but I think it was for them both to still live in the neighborhood and each get losses and depreciation. A family member ratted them out for an IRS "informant fee," and the deductions were disallowed.

_________________
"A deal is only as good as the quality of your Contracts." --Me

[ Edited by LeaseOptionKing on Date 12/17/2007 ]

Ah, yes, the informant problem...

In general, as a CPA once told me, people who work for the IRS aren't that bright. If they were, they wouldn't be working for the IRS was his logic. So unless someone tells them about a marginal activity, or the computers see something unusual, or you get randomly audited, it is unlikely that anyone will notice.

If it isn't illegal, there is nothing wrong with trying to pay less in taxes. The Supreme Court ruled that every man has the right to try and pay as little as possible as long as no law is broken. So the question is, is it illegal? If not, regardless of what you are thinking (presumably that you want to pay less taxes) it is an acceptable practice according to the Supreme Court. Of course, you may have to go there to defend your action...

Chris

Hi "Bargain King"

This is from Wikipedia: "One of the most famous quotes that Judge Learned Hand is known for is: ""There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible.'

"In another famous quote regarding the U.S. income tax law, Judge Hand wrote:

"'Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes...'"

I've always found it challenging and interesting to - legally, of course - minimize taxes. We try to read up on tax rules (really difficult these days) and brainstorm ideas when confronted with a large potential tax. Of course, we check it out with our CPA before implementing it.

Now, off hand, if you did the proposed sale with a related party (mother, sibling, child, etc.) I would think there might be problems with your proposal. With someone unrelated, it would seem like a different situation. Again, check with your CPA.

Also, with the way house prices have dropped- 50K loss may actually be fair market value (!!!!) - which would make an even stronger case for what you're contemplating. Why not sell at a loss to offset that income?

Good Luck!
ann

Thanks for the replies.

My CPA says he sells depressed stocks at y/e to capture losses. Why not Real Estate?

Anyone else have insight they are willing to share? [addsig]

You can certainly sell your properties for less then you paid, but it must be at arms length (what a 3rd party buyer and seller would agree to). I assume from your post that what you propose wouldn't meet this definition and would therefore fail. If on the other hand you do want to sell your underwater property, by all means, list and sell it and take the loss.

You can sell anything you have for any price you want; however, the arrangement you describe in a scheme with another investor fails the test. Why not sell for as close to FMV as possible and take the money to pay your taxes? Isn't that ultimately fiscally better than a loss? [addsig]