Contract Assignments: Ordinary Income Or ST Capitol Gains?

So, I put a property under contract (held by an LLC) and assign my interests to a Buyer/Investor for a Fee, who closes on property in less than 30 days and I collect fee at closing.

Question: is that income taxed as ordinary income, even though it was earned from the sale of property?

And if so, is that because I never took title to property and closed escow in my name?

And if I do this 20 times in a year, is my income still merely taxed as ordinary or do I need to consider there will be self-employment tax? My husband and I file jointly, he is a consultant but gets W-2'd (over $100K). I do not have other income.

Thank-you for your wise comments.
Teresa

Well with just about anything you always would pay SE Tax, regardless of the entity. The only difference is that you can defer SE Tax depending if you are an LLC or Corp. Many people do assignments thru corporations as well, but since you are not doing a lot of assignments you can pretty stay as an LLC. When you do an assignment it generally does not matter what you are holding the contract under, but some places like banks and very savyy home sellers sometimes will not allow you to sign under an LLC or Corporation, and generally there is little legal recourse for them to sue if you have the right clauses. Remember you are doing an assignment, not a simultaneous close or double escrow. As long as the contract is held by an escrow/title company (legal way of doing an assignment), and you can assign the contract before closing there should not be too much of a problem. Do you have a buyer's list of people ready to buy?

Sounds like you'd report everything on a Sch C. You'd pay ordinary income taxes on the income as well as SE taxes. To minimize your tax hit in the future, you can keep the properties for 366 days as a rental then sell them to get long term capital gains tax rates (max 15%) and NO self employment taxes. The way you are doing it you could pay almost 1/2 your income to the tax man.

"you can keep the properties for 366 days as a rental then sell them to get long term capital gains tax rates (max 15%) and NO self employment taxes"

Problem is, I'm not sure the capital gains rate will still be at 15% in 366 days- we have this little 3 trillion dollar war to pay for, so the government needs to figure out how to extract an additional $40,000 from the average family.

The advice is basically sound, however. But given the choice between holding one or two properties for a year to avoid about 30% in taxes, or flipping 20 and just paying the taxes, the chances are you will wind up with more money in your pocket after the 20 flips. Better to make twenty dollars and pay almost half of it in taxes than to only make a dollar or two and pay 15% in taxes.

Chris

There's also the issue of being classified as a Dealer (if you make frequent transactions). Then, whether you hold for 36 days or 366 days would be inconsequential. You'd pay ordinary income tax rather than capital gains tax.

Finniganps Posted: 23:49 on 04-09-2008
To minimize your tax hit in the future, you can keep the properties for 366 days as a RENTAL then sell them to get long term capital gains tax rates (max 15%) and NO self employment taxes
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My question Do you have to RENT the property or just have (OWN) it in your name. I see different ideas from different post in different forums
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FROM ANOTHER FORUM. “the long term capital gains apply to property HELD for more than one year....he has not held it (Owned it) if he sells it in less than one year
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My question to that other forum post
I purchased the property in Jan of 07, sold it in March of 08. (14 months). So I have held the property for the one year and one day time requirement. Sounds good so far but I have also heard that you must have been RENTING , leasing etc. the property, not just OWNING it in your name and it just be sitting there . Any guidance on this.
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OK TCI members what is it. Do I have to RENT the property or just OWN it in my name and possession?????? Thanks

Great news I was just on the phone with the IRS. You can call an 800 directory, and ask for the IRS. When you contact them ask them for there business department. Basically when you sell a contract you would pay under ordinary income. I found this out when I was transferred to there COMPLEX ISSUES Dept. By the way they do not have an ordinary number for this dept, you can only be transferred there.
Business IRS number 1-800-829-4943
Also the primary info concerning this and profits and losses in real estate are Publication 544. Chapter 1 goes in great detail, for current 2007 returns.

You will pay SE tax, but the reasons for an entity like an LLC, S-Corp, or Corp are the following:
-Veil of protection
-Deferring SE Tax

Since you do not own the property, and only assigning you interest in the property you do not pay capital gains. You would have to either had owned the property in your name.

On the bottom of Pub 544 there is a list of Tax Publications for Tax Payers, this includes info on Trusts as well.

Well thank-you all so much for your responses to this.

Omicron: Really appreciate your input. I, too, was thinking that if i only assign my interests, and never close on the properties, Capitol gains should not be a consideration.

I will of course, confirm all this with my accountant, but generally speaking:
If I collect a $20K assign fee, I should put aside $9400. of it for taxes. THat's 47%. Yuck. But if my gross income is between 180K and 230K, that's a realistic buffer. SE tax is 14% and income at 33%.

Finni: I don't intend to hold any of these houses, already have 6 of those, and that's enough of a pain. But I haven't done full time contract assignments before, and want to be sure I'm aware of the tax implications.

Chris: you agree that SE tax in this scenario is inevitable, yes? Still, I agree that quick turning, esp. with the market the way it is, proves a more reliable method.

My accountant specializes in REI and he's very good with deductions.

Thank-you all!

THS44- yes, I agree that you will have to pay SE tax.

Haynesm, it is all about intent. If your intent is to flip the property, even if it takes you two years to sell it it is still a flip. If your intent is to hold it for investment, even if you are unable to rent it out and so choose to sell it your intent was to hold it, and so LTCG rates apply.

Advertising it for sale during your first year of ownership shows intent to flip. Advertising the property for rent/lease shows intent to hold, as does taking the depreciation deduction on your first tax return after the purchase. The key is to prove intent.

Chris