Finding the right tax loopholes to lower taxes can be very beneficial to you as a fix and flip investor. The associated specific tax structures are among the key profit-reducing agents in the real estate trade. There are various strategies you can employ for reducing taxes or avoiding taxation altogether. Some available options for fix and flip investing include: tax deductions, 1031 exchange exemption, holding the property longer, and offsetting losses with profits. With these options, you maximize your tax benefits and minimize tax liability.
Below are five tips that can assist you in minimizing the tax bill on your property to manageable levels.
Maximizing Tax Deductions
Always include all your soft costs, labor, material, and renovation expenses as tax-deductible. Since Uncle Sam views home flippers as dealers, your mortgage and part of the rent for your home office should be deductibles. You can also include utility bills and gas mileage as well as office supplies and equipment. Finally, the deductible includes your mortgage interest from the loan you acquired for the property.
You need to have perfect record keeping. For this reason, we recommend you open a business bank account. That way, you can deduct all expenses from that account.
Holding the Property for Over a Year
Quick turnaround in a fix and flip earns huge capital gains taxes. If you own the property for less than a year, the profit is taxed at the ordinary income tax rate (10%–37%), classified as a short-term capital gain. Under short-term capital gains, you pay double Federal Insurance Contributions Act (FICA) taxes between 25.3% and 52.3%.
Over thirteen months, owning the same property earns lower tax rates and is viewed as a long-term capital gain. FICA taxes after owning the property for a year is 0 to 20%. The caveat is you’ll need to have a longer financing program than one year, or refinance the property. You may also rent out the unit during the first year of ownership and enjoy the monthly cash flow.
Live in the Property
There are many advantages of living in your fix and flip unit. You can fund the project through a cheaper homeowner mortgage. Living in the property for more than two years will earn zero capital gain tax for profits over $250k and $500k, depending on marital status.
1031 Exchange Exemptions
To defer paying taxes, Internal Revenue Service (IRS) section 1031 permits taxpayers to engage in "like-mind exchange." In the fix and flip business, you realize this exemption by using the profit from one project to fund another. You can use your profit to pay for a down payment on another property.
You will file this move as a 1031 exchange allowing you to pay no taxes on the profits. After growing your investment with larger properties from deal after deal, you may exit by making no profit or a loss on the last sale.
Offset Losses with Profits
As an informed fix and flip investor, you should minimize the risk of losses. You should know which improvements will add value to the property and the pricing of your unit after renovation.
For tax purposes, a loss may offset your other properties' profits. If you have suffered losses that offset gains, you don't have to go through the various hoops mentioned above to avoid paying taxes.
Knowledge Is Key
Having a wealth of knowledge on fix and flip taxes lets you know which tax loopholes to employ to minimize taxation. A savvy fix and flip investor will capitalize on reducing the tax burden using the five tips above.
You may include the five tips in your business portfolio as fewer taxes mean higher returns on investments. Reinvesting your profit in the business warrants wealth creation. Use our tips to make your fix and flip investment a success story.
Looking for Funding for Your Next Fix and Flip Project?
RCN Capital offers short-term and long-term financing options for real estate investors, commercial contractors, developers & small business owners across the nation. Whether you are looking to fix & flip properties or hold properties for rental income, RCN has flexible options that are suited to your needs. Connect with us today to discuss your next fix & flip investment.
