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