Questions About Rehab, Flip And Capital Gains Tax

I am rehabbing a house that I have no intention on using as my primary residence. The rehab will take 12 weeks and then I plan to sell it. I'm trying to find more information on capital gains and my cost basis. I don't know what repair items and upgrades I can count in my cost basis. I'm looking to make sure that I calculate the cost of the home plus other items I can use to make sure my profit that I will pay taxes on is as low as possible. I searched the IRS site, but still need more clarification. Can anyone shed some light on this? Any good books you can recommend? Thanks!

[ Edited by lauralee on Date 05/03/2008 ]

I'm no tax professional, so ask one about what I say. You can write off EVERY expense incurred related to the house you flip. Right down to the pizza you bought for your workers. You must do it right, however. You have to 1099 every subcontractor that you pay over $600. You may also have to pay self employment tax on your profits. It's very complicated and makes me wish for a national sales tax instead of the IRS.

If you are NOT renting it for at least 1 year, you're looking at paying self employment taxes, your profit will be taxed at your ordinary income tax rates, plus state taxes. Add it all up and you could be looking at a combined tax rate just under 50%. This is one of the reasons people rent it for at least a year after completion, when you would only need to pay state, LT capital gains rates (which top out at 15% through 2010) and a little depreciation recapture. You have to weigh the value after a year, dealing with tenants etc. when making this decision.
As to references, you can start with IRS Form 1040 Sch E instructions which would help from a rental standpoint. They refer to IRS publications that would also be helpful. I'm sure others will have additional recommendations for books.
With regards to the 2nd post, you're not "writing off every expense...." - that's really a stretch. You get the same write offs either way, it's a matter of the timing of the deductions or adjustments to sales price. Obviously taxes should not be the main reason you decide when to sell a property.

[ Edited by finniganps on Date 05/03/2008 ]

For a flip there is not much difference between expenses and additions to your basis (improvements). Both are going to be deducted from the sales price before calculating profits, and depreciation does not come into play. But a flip does not qualify as capital gains, and as has been pointed out you could pay nearly half of your profits in taxes if you don't use it as a rental for a year.

Chris

Does the property have to be a 'rental' for a year or do you just have to 'own' the property for a year

Actually it depends on the use of the property. In most cases if you hold a property for 1 year and 1 day you would pay long term capital gains. I haven't seen anything that has proven so far that typical rehab/retail would have you pay no capital gains. Here is an article that will answer the question. I recommend reading IRS Pub 544 (all real estate sales).
http://www.bankrate.com/brm/news/tax/20050922a1.asp

It depends on intent. If you put the property on the market right after the rehab is finished and it takes five years to sell, it is still a flip; you are selling inventory and will pay regular income tax bracket plus SS and Medicare ("self employment") taxes. If you spend a year rehabbing it, then offer it for rent one day and someone happens to come along and buy it, it could be argued that it qualfies as long term capital gains as your intent was to use it as a rental.

The safe thing to do is list it as a rental and take depreciation for at least a year, not selling it until a year and a day after you have "placed it in service". Generally this would be a year after you first tried to rent it.

Chris

You'll definitely want to contact a tax professional on this one. Everyone's situation is different. If this is your first and last flip you may not have to pay self-employment tax. The IRS has no hard and fast rule (as my tax attorney will attest to) and looks at many factors should you get audited. If you can hold it for over a year and rent it out it would probably be worth your while to do so.