| Understand the tax consequences of flipping houses, | | | | just a few more weeks. |
| rehabbing houses, and how to defer taxes with the | | | | 1031 Exchange |
| 1031 Exchange before you get into real estate | | | | However, the Internal Revenue Code provides real |
| investing. Problems arise when real estate investors | | | | estate investors away to defer capital gains taxes |
| don't follow federal and state tax laws. This is why | | | | indefinitely. Section 1031 of the Internal Revenue |
| you need professional advice. Although I am not a | | | | Code provides a tax-free exchange. Also known as a |
| tax advisor, here are some common mistakes | | | | "like-kind" exchange, this code allows you to sell a |
| beginning real estate investors make by not | | | | business or investment property and defer |
| understanding tax liabilities: | | | | capital-gains taxes by immediately reinvesting the |
| Flipping Houses | | | | gains into a similar piece of property. The key, |
| The reason flipping houses is a mistake for some | | | | replacing a business or investment with similar |
| beginners is that they don't know the income tax | | | | property, means that no gain gets paid to the |
| consequences. One problem with flipping houses, or | | | | investor. Any profit taken out of escrow gets taxed. |
| selling too many properties too quickly, the IRS could | | | | This means that beginning investors might take out a |
| say that your real estate business is your trade, | | | | portion of the profit after they carefully explore their |
| subject to ordinary income and self-employment | | | | tax liabilities. In other words, talk to an accountant |
| taxes. | | | | and find out what your tax would be according to |
| Self-employment tax, a social security and Medicare | | | | your current usual income. Many business owners |
| tax primarily for individuals who work for themselves, | | | | take advantage of this because they have many |
| is similar to the social security and Medicare taxes | | | | business deductions. |
| withheld from the paycheck of most employees. The | | | | The big mistake beginning real estate investors make |
| self-employment tax rate costs you 15.3% of your | | | | doing a 1031 tax-free exchange, taking possession of |
| profits. (However, this may provide retirement | | | | the profits, voids the tax deferment. You must |
| benefits.) | | | | declare the sale of your property to be a part of a |
| Rehabbing Houses | | | | 1031 exchange before you sell the property. Then |
| Another common mistake that beginning investors | | | | you have the money placed in a trust account held |
| make is selling a property after holding it for almost a | | | | by an intermediary until you purchase the new |
| year. Some rehabbers work part time on a fixer and | | | | investment property. You have 45 days to identify a |
| take six months to get the house ready. Add on two | | | | replacement property and 180 days to close on the |
| months to sell with a 60 day closing, and they're up | | | | new investment. You can't purchase a primary |
| to ten months. To take advantage of the low 15% | | | | residence or a vacation home with funds from an |
| capital-gains tax rate, you must keep the investment | | | | investment property and defer taxes in a 1031 |
| property for at least a year before selling. If you sell | | | | exchange. |
| before a year, your tax rate, the usual capital gains | | | | The best advice for beginning real estate investors: |
| rate of 35%, could eat up a significant amount of | | | | Talk to an accountant. |
| your profits. | | | | Would you be better off making extra money, even |
| If you're rehabbing houses, be patient. You could | | | | if you must pay taxes? |
| save thousands in taxes by holding your property | | | | © 2005 Jeanette J. Fisher. |